|63, 3-ft
S. HRG. 110–1017
ALTERNATIVES TO THE CURRENT
FEDERAL ESTATE TAX SYSTEM
HEARING
BEFORE THE
OOMMITTEE ON FINANCE
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
MARCH 12, 2008
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COMMITTEE ON FINANCE
MAX BAUCUS, Montana, Chairman
JOHN D. ROCKEFELLER IV, West Virginia CHUCK GRASSLEY, Iowa
KENT CONRAD, North Dakota ORRIN G. HATCH, Utah
JEFF BINGAMAN, New Mexico OLYMPIA J. SNOWE, Maine
JOHN F. KERRY, Massachusetts JON KYL, Arizona
BLANCHE. L. LINCOLN, Arkansas GORDON SMITH, Oregon
RON WYDEN, Oregon r JIM BUNNING, Kentucky
CHARLES E. SCHUMER, New York - MIKE CRAPO, Idaho
DEBBIE STABENOW, Michigan PAT ROBERTS, Kansas
MARLA CANTWELL, Washington JOHN ENSIGN, Nevada
KEN SALAZAR, Colorado JOHN E. SUNUNU, New Hampshire
RUSSELL SULLIVAN, Staff Director
KOLAN DAVIS, Republican Staff Director and Chief Counsel
(II)
C O N T E N T S
OPENING STATEMENTS
Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee
on Finance ............................ • * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * - - - - - - - - - - - - - - - - - - - - - - - -
Grassley, Hon. Chuck, a U.S. Senator from Iowa .................................................
WITNESSES
Batchelder, Lily, professor, New York University, School of Law, New York,
NY
Dodge, joseph, professor, Florida State tiniversity, Čoliege of faw, failahas.
see, FL ..….
Duff, David, professor, University of Toronto, Faculty of Law, Toronto, On-
tario, Canada …
ALPHABETICAL LISTING AND APPENDIX MATERIAL
Batchelder, Lily:
Testimony .....................................................................…...... .......................
Prepared statement ..........................................................................................
Responses to questions from committee members ........................... • e º e º e º g º gº e e s e e
Baucus, Hon. Max:
Opening statement ...........................................................................................
Bunning, Hon. Jim:
Prepared statement ............................................................ , t e º e º e º $ tº e º e º & © tº e & g g tº e e º 'º $ 3 e º 'º
Cantwell, Hon. Maria:
Prepared statement ..........................................................................................
Dodge, Joseph:
Testimony ...........................................…...........…...…................
Prepared statement ................................................................…..................
Responses to questions from committee members .........................................
Duff, David:
Testimony .......................... * * * * g º e g º g g º g g g : º g º a g º g g g g g tº º ºs e º ºs º 'º º sº º º ºs º gº & # tº 8 e º ºs e º & tº $ tº $ tº gº & © tº e º & e º 'º gº tº e º 'º gº tº º º e º 'º º ve
Prepared statement with attachment .............................................................
Grassley, Hon. Chuck:
Opening statement ...........................................................................................
Mahoney, Hon. Tim: .
Prepared statement ..........................................................................................
Roberts, Hon. Pat:
Prepared statement ..........................................................................................
COMMUNICATIONS
American Family Business Institute .....................................................................
American Farm Bureau Federation .................... e º e s tº e º e º ºs e < e < e e it e º is e º e < * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *
Anthony Timberlands ..............................................................................................
Blum, Warren I. ........…....…....…...........
National Cattlemen's Beef Association ..................................................................
RATA Associates, LLC ............................................................................................
Schumaker Trucking and Excavating ....................................................................
Simkins-Hallin …..…...…..........................
(III)
Page
ALTERNATIVES TO THE CURRENT
FEDERAL ESTATE TAX SYSTEM
Wednesday, MARCH 12, 2008
U.S. SENATE,
COMMITTEE ON FINANCE,
Washington, DC.
The hearing was convened, pursuant to notice, at 10:06 a.m., in
room SD—215, Dirksen Senate Office Building, Hon. Max Baucus
(chairman of the committee) presiding. -
Present: Senators Lincoln, Salazar, Grassley, Kyl, and Bunning.
OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR
FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE
The CHAIRMAN. The hearing will come to order.
Edmund Burke once criticized his opponents by saying, “They de-
fend their errors as if they were defending their inheritance.” We
are here today to examine the estate tax. We are here today to con-
sider whether taxing estates is an error, and we are here today to
examine whether there are other ways to address inheritance.
This is a second hearing in a series of hearings focusing on estate
tax reform. We hold a third when we return in April. Now usually,
when people talk about estate tax, they focus on the current sys-
tem. They talk about a little change here, a little change there.
They talk about turning one dial a quarter to the left, turning an-
other dial a quarter to the right. They work on the issue as though
they were tuning a radio. -
In this hearing, we put the old radio aside. Today we are going
to take a look at other concepts, other ways to deal with inherit-
ance outside of the box. Under current law, the estate tax changes
every year through 2011. Every year, the law changes. The law
phases out completely and then it springs back to its original high
rate and low exemption level. -
Our estate tax law is complicated. It is intimidating to small
businesses, ranchers, and farmers. The law lacks certainty for the
American people. We seriously need estate tax reform.
I know that accomplishing an estate tax mark-up this year will
not be easy, but let us work toward that goal. I am committed to
getting estate tax reform done, and I am ready to roll up my
sleeves and work with Senators to get a reform proposal that will
benefit Montana, and the rest of the country.
These Finance Committee hearings will give us a review of some
reform possibilities. These Finance Committee hearings will begin
a good policy debate, and I hope that the debate will lead to a bi-
partisan estate tax compromise.
(1)
2
Today we will hear about taxing the beneficiary rather than the
estate. We will hear about an income exclusion system, and we will
hear about how other countries deal with this issue and the re-
sults. Now, I do not endorse any of these proposals, certainly not
at this time. They are very interesting, but they are not ones that
I yet endorse.
What I do want is the committee to have thought widely about
the possibilities for replacing the estate tax, so today we are not
going to defend the tax law's errors. Today we are going to talk
about fundamental change to the estate tax, and in so doing see
if we can leave a better inheritance for everyone.”
The first witness is Professor Lily Batchelder, professor at New
York University Law School. I am very proud to note that in her
earlier career Professor Batchelder served as a law clerk for the Fi-
nance Committee. In fact, I was just talking with Jon Selib in my
office, and how he and Lily were here at the same time as interns,
and he has a very high regard for you, Professor. I know you have
been talking with him since you have come back, but again, he has
very high regard for you.
The second witness is Professor Joseph Dodge, professor at Flor-
ida State University College of Law. Also, we have with us Pro-
fessor David Duff, who is professor from the University of Toronto
in Canada. Thank you all for coming.
It is our practice here that every witness speaks 5 minutes, and
your statements will automatically be included in the record.
Why don’t you go ahead, Professor Batchelder?
STATEMENT OF LILY BATCHELDER, PROFESSOR, NEW YORK
UNIVERSITY, SCHOOL OF LAW, NEW YORK, NY
Prof. BATCHELDER. Thank you. Mr. Chairman, members of the
committee, my name is Lily Batchelder. I am an associate professor
of law and public policy at NYU’s School of Law. Thank you for the
opportunity to testify before you today.
I would like to briefly discuss the distribution of inherited income
and estate tax burdens under current law, and then discuss two re-
form options. Both of these could be implemented on a revenue-
neutral basis and I think would make the estate tax system better
targeted on the unearned income that extraordinary inheritances
represent.
As I have outlined in my written testimony, wealth transfers
tend to significantly exacerbate existing economic disparities.
Surachai Khitatrakun and I have estimated that, in 2009, heirs
will inherit about $400 billion. While people of all income levels
often receive relatively small inheritances associated with the fam-
ily bonds that I think we do, and should, value, a very small num-
ber of people at the top receive extraordinarily large inheritances.
For example, Figure 2 in my written testimony shows that, on
average, inherited income of those in the top 1 percent of the inher-
itance distribution is about 34 times larger than the average inher-
itance of all others receiving a bequest in a given year.
* For more information, see also, “Description and Analysis of Alternative Wealth Transfer
Tax Systems,” Joint Committee on Taxation staff report, March 10, 2008 (JCX-22–08), http:/
/www.jct.gov/publications.html?func=startdown&id=1318.
3
And I think this concentration of inheritances is important be-
cause it means that they are exacerbating existing economic dis-
parities. About 40 percent of all household wealth is inherited. I
think it is also important because disparities in inherited income
appear to be the single largest barrier to intergenerational eco-
nomic mobility. -
The current estate tax system is the most important mechanism
by which the fiscal system mitigates the effects of inheritances on
economic mobility. This is the case because, under the estate tax
system, the burden actually generally falls on heirs and not donors.
As Figure 4 in my written testimony shows, on average, the estate
tax only burdens heirs who receive really extraordinarily large in-
heritances. -
To me, this means that it is not really a double tax on the dece-
dent, who may have worked very hard to accumulate this wealth,
but instead it is a tax on a major source of unearned income of
those who are fortunate enough to be born into a family that leaves
them a really extraordinarily large inheritance.
The estate tax system is a blunt instrument, though. In my view,
its biggest weakness is that this relationship between, on one hand,
the heir's financial circumstances, and on the other hand, the es-
tate tax burden, is relatively imprecise. Some people receiving rel-
atively modest bequests may bear a substantial tax burden if they
are inheriting from an extremely large estate, and some people re-
ceiving really extraordinarily large inheritances may bear no estate
tax burden if they are receiving from one or more estates that are
just below the lifetime exemption. This basically happens because,
under the current system, the tax rate depends on the amount
transferred and not the amount inherited.
There is an opportunity for reform in 2009 because of the un-
thinkable, in my view, incentives created by a 1-year repeal of the
estate tax. I think we should use this opportunity not to repeal the
estate tax, but to reform it so that it is really better targeted on
extraordinary amounts of inherited income.
The option I would like to discuss first, which in my view is the
best alternative, would be to replace the current system with a
comprehensive inheritance tax. Under this alternative, an indi-
vidual inheriting an extraordinary amount over their lifetime
would pay income tax and a flat 15-percent tax on a portion, and
only a portion, of that inheritance. So in effect, extraordinary in-
heritances would then be taxed at the same rate that earned in-
come is now taxed under the income and payroll tax.
We have estimated that this reform could be implemented on a
revenue-neutral basis relative to 2009 law if about the first $2 mil-
lion in inheritances were tax-exempt. To state the obvious, $2 mil-
lion is a big inheritance. If an heir inherits this amount at age 18,
he and his spouse can live off the inheritance for the rest of their
lives without ever working and their annual household income will
be higher than that of 9 out of 10 American families.
If this proposal were adopted, it would have important effects.
The distribution of burdens among heirs under the estate tax
would stay relatively similar on average, but Figure 8 of my writ-
ten testimony shows that the burdens would be allocated very dif-
ferently at an individual level. It shows that about 60 percent of
4
heirs burdened by the estate tax would bear no tax burden under
this inheritance tax, and, among those who are burdened by both
taxes, their rate would often be very different.
I think these differences illustrate how this reform would im-
prove the equity of the wealth transfer tax system because it would
base the tax rate on the person that actually bears the burden of
the tax, the heir, and it would make it better targeted on the un-
fair advantages that exceptionally large inheritances create. It
would also have some other advantages. It could simplify current
law. It would only burden about 3 heirs in 1,000.
But I do want to mention a second alternative because this is
very ambitious, which would be to simplify current law.
The CHAIRMAN. If you could, very briefly.
Prof. BATCHELDER. Sure. There are a bunch of simplification op-
tions that one could apply to current law. For example, allowing
carry-overs of the lifetime exemption for spouses, narrowing the
differences between the tax rates on gifts and bequests, reforming
the treatment of illiquid assets, including family businesses. I
think all of these options are worth considering as well and could
; implemented on a revenue-neutral and distributionally neutral
aSIS.
Thank you.
The CHAIRMAN. Thank you, Professor, very much. That is very
interesting.
[The prepared statement of Professor Batchelder appears in the
appendix.]
The CHAIRMAN. Professor Dodge?
STATEMENT OF JOSEPH DODGE, PROFESSOR, FLORIDA STATE
UNIVERSITY, COLLEGE OF LAW, TALLAHASSEE, FL
Prof. DODGE. Thank you, Chairman Baucus, Senator Grassley,
committee members.
Well, I think the existing system is seriously flawed. It is quite
easy to plan around. It does not really serve directly a purpose, as
Professor Batchelder explained. It sort of creates incentives for
wealth to either be destroyed or to be hidden. So now you have a
great opportunity, since the estate tax is scheduled to expire soon,
to in a sense start over again and come up with a better system.
But there are basically two different tracks that can be followed
here, as I see it. One is reforming the income tax system, which
sort of has a gap with respect to gifts and bequests. The other has
to do with a better wealth transfer tax system which serves a dif-
ferent purpose. I would say the purpose is to mitigate undue dis-
parities of unearned wealth, to further the dispersal of wealth. As
a general matter, I do not think the income tax and the transfer
taxes should be blended. I do not think features of a transfer tax
should be imported into the income tax.
So in general, I do favor transferee-oriented taxes. I really do not
have anything significant to add to that, except taxes on transferee
directly tie in to goals of preventing undue accumulation of un-
earned wealth, furthering equality of opportunity, and encouraging
the dispersion of wealth.
So apart from the accessions tax, the other transferee-oriented
system that I want to talk about is what I call the income inclusion
5
approach, which involves treating gifts and bequests as income to
the transferee without a deduction to the transferor. If this system
were adopted, then another income tax alternative, which would be
to tax gains and losses at death or gift, would not be necessary.
Of course, that system of taxing gains and losses at transfer is
a system that Canada now has. That is fine standing alone, but it
should not be combined with including gifts and bequests as in-
come. Basically, receipts of gratuitous transfers are income. If the
statutory exclusions were repealed, they would be included as in-
COIſle. ... -
Well, I see time is flying. So I want to mention, briefly, some of
the features of the income inclusion proposal as I see it. There
would be no lifetime exemption, as such. However, support received
would be excluded, as under present law. Third party payment of
bills would be excluded. That is like tuition and health care. Gifts
of consumable items should be excluded, the general idea being
that things that look like support would be excluded from the tax
base. Even bequests could be excluded under certain circum-
stances, like bequests received by persons under 25. They could be
annuitized and treated as support. There could also be an exclu-
sion, within reason, for tangible personal property because that ba-
sically represents a consumption decision by somebody else.
Next, the income tax has a realization principle so that gifts and
bequests received in kind would not necessarily have to be taxed
upon receipt, but instead they could be taxed later on. Now, prob-
ably marketable, publicly traded, highly liquid assets should be in-
cluded, but hard-to-value assets, which would include, of course,
closely held business interests and some real estate, would not be
income upon receipt, but instead the income would be deferred
through a zero-basis mechanism. So either you would have a
stepped-up basis if an item were included, or you would have zero
basis, but historical basis would be erased.
Well, there are other features. I see my time is up. But basically
the system would be integrated with the existing income tax sys-
tem, including subchapter J dealing with the taxation of trusts and
beneficiaries.
Thank you.
The CHAIRMAN. Thank you, Professor, very much.
[The prepared statement of Professor Dodge appears in the ap-
pendix.] -
The CHAIRMAN. Professor Duff?
STATEMENT OF DAVID DUFF, PROFESSOR, UNIVERSITY OF
TORONTO, FACULTY OF LAW, TORONTO, ONTARIO, CANADA
Prof. DUFF. Thank you, Mr. Chairman. And thanks to the com-
mittee for giving me the opportunity to speak with you today.
My name is David Duff, and I am a professor of tax law and pol-
icy at the University of Toronto, Faculty of Law, where I have
taught since 1996. -
My testimony today is based on two articles that I have written
on wealth transfer taxation, and they are appended to my written
testimony. .
The first argues for a wealth transfer tax in the form of an acces-
sions tax, which would apply to the cumulative amount of gifts and
6
inheritances that are received by individuals over the course of
their lifetimes rather than aggregate amounts given by donors over
the course of their lifetimes, as is the case with the current Federal
wealth transfer tax system in the U.S.
The second article attempts to explain the apparent political
unpopularity of wealth transfer taxes and the abolition of these
taxes in Canada, Australia, and New Zealand, which repealed their
estate and gift taxes in the 1970s, 1980s, and 1990s. -
Beginning with the first article, let me briefly explain why I
think that a society should tax transfers of wealth and why an ac-
cessions tax is a better tax for this purpose than the current Fed-
eral wealth transfer tax system in the United States.
As a philosophical matter, I believe that it is both legitimate and
desirable for a society to moderate extreme inequalities in the dis-
tribution of wealth and in the opportunities that wealth provides
by taxing substantial gifts and inheritances above a generous ex-
emption.
While I believe that a society should value and encourage the
family bonds that are associated with the transfer of assets from
one generation to another—and I think that is particularly the case
with family heirlooms, family enterprises, family farms—I believe
that this value needs to be balanced against the negative social and
political consequences for a democratic society that can result from
the transfer of large dynastic fortunes from one generation to the
next.
In addition, to the extent that recipients have not earned the
gifts and inheritances that they receive largely because of the luck
of their birth, I do not believe that they can legitimately complain
about a tax that requires them to share some of their good fortune
with others who have not been so lucky. From this perspective, it
is clear why an accessions tax would be a better tax than the cur-
rent Federal wealth transfer tax system in the United States.
While the current gift and estate tax applies to aggregate
amounts transferred by donors over the course of their lifetimes
and at death—regardless of how this wealth is distributed among
recipients—an accessions tax would apply to the cumulative value
of gifts and inheritances that are received by beneficiaries over the
course of their lifetimes, which are, after all, the amounts that ac-
tually contribute toward inequalities in wealth and opportunities.
As well, the current gift and estate tax sends exactly the wrong
message about a wealth transfer tax by taxing successful, hard-
working and generous donors who have accumulated wealth out of
income on which they have often already paid tax.
In contrast, an accessions tax sends a very different—and I be-
lieve justifiable—message, by taxing the beneficiaries of substantial
gifts and inheritances on amounts that they themselves have not
earned and on which they themselves have not paid any tax. Why
then do wealth transfer taxes seem to be so politically unpopular,
and why were they abolished in Canada, Australia, and New Zea-
land? -
Although I do not have time to go into all the details here, it is
important to note that the wealth transfer taxes in each of these
countries were estate and gift taxes, much like the current wealth
transfer taxes in the United States. For this reason they were vul-
7
nerable to the same kinds of criticisms that have been rightly di-
rected at the Federal estate and gift taxes in the United States:
that they impose a second tax on donors who have accumulated
wealth out of income on which they have already paid tax, and that
they punish their success, hard work, and generosity.
As well, since affluent retirees can avoid donor-based wealth
transfer taxes by moving to jurisdictions without these taxes, es-
tate and gift taxes like those that existed in Canada, Australia, and
New Zealand are also vulnerable to competition from jurisdictions
that do not collect these taxes. This is probably not as big a con-
cern in a large country like the United States, but was a significant
concern in Australia, New Zealand, and Canada. -
In contrast, since recipient-based wealth transfer taxes, like an
accessions tax, apply to gifts and inheritances that are received by
younger and less geographically mobile recipients, they are much,
much less vulnerable to this kind of tax competition. As a result,
when one surveys wealth transfer taxes around the world, it is not
surprising that it is recipient-based taxes that have been far more
resilient than donor-based taxes, and in fact in several countries
account for a larger share of total tax revenue and Gross Domestic
Product today than they did 30 years ago.
In conclusion, therefore, I believe that questions of principle, as
well as practical politics, support replacing the current Federal
wealth transfer tax system in the United States with an accessions
tax that would apply to the amount of gifts and inheritances re-
ceived by individuals over the course of their lifetimes.
The CHAIRMAN. Thank you, Professor. That was very interesting.
d [The prepared statement of Professor Duff appears in the appen-
ix.] -
The CHAIRMAN. Senator Grassley, do you have a statement?
Senator GRASSLEY. Yes, if I could, please.
The CHAIRMAN. Sure.
Senator GRASSLEY. Just a short one.
OPENING STATEMENT OF HON. CHUCK GRASSLEY,
- A U.S. SENATOR FROM IOWA
Senator GRASSLEY. I apologize for being a little bit late. First of
all, it is very important that we deal with this issue, because 2010
and 2011 are just around the corner and it is something we should
have dealt with if we wanted to make estate planning easier for
everybody. I bear some responsibility for that because I was chair-
man of this committee for a while as well. Because of these dates,
it has become imminently necessary to discuss, and hopefully to de-
termine, the fate of the estate tax.
As I have stated before, I believe that the death tax is fundamen-
tally unfair from both a philosophical and technical perspective. I
do not believe that it is appropriate for government to come in fol-
lowing the death of an individual and tax the money that a person
has legally earned and saved during his lifetime.
Additionally, since the estate tax has to be paid 9 months after
the death of an individual, many small business people and farm-
ers have had to sell off their business assets simply to pay the
death tax arising solely because of the death of a prior owner. To
me, this situation is fundamentally wrong because death should
8
not be a taxable event and government should not be profiting from
death. -
While my personal view of repeal is firm, I understand that other
alternatives need to be explored in order to come to a fiscally ap-
propriate compromise prior to the sunset of the 2001 reforms and
the return of exorbitant rate schedules for 2011, with a 1-year re-
peal in 2010. I am going to be working towards that compromise.
Many of my colleagues have discussed changes to the current
rate and exemption schedules, and their suggestions are well re-
ceived. However, beyond these suggestions, both the chairman and
I believe that it would be helpful and informative, as we are hear-
ing today from academics and experts who have written extensively
in this area, for the committee to have another hearing to address
other issues in the current estate tax system if it remains un-
changed following the expiration of the 2001 reforms.
Finally, the chairman and I believe that it is important to draw
on the experiences of other countries, and we have heard about
that.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Senator. .
A question comes to my mind. These are all very interesting
ideas. That is, transition rules. Say we were to move toward an ac-
cession type of system, inheritance rather than tax to the trans-
feror. What kind of transition rules do you contemplate? Professor
Batchelder?
Prof. BATCHELDER. Yes. I think there are a couple of alternatives.
I would actually suggest—
The CHAIRMAN. And I would say, because people plan. They plan
their estates.
Prof. BATCHELDER. Yes.
The CHAIRMAN. A lot goes into planning by a lot of people, and
then, lo and behold, it becomes a totally different system. Just your
thoughts on transition.
Prof. BATCHELDER. Yes. Yes. Well, there is one country that, to
my knowledge, has transferred from an estate tax to an inheritance
tax, which was Ireland. What they did was have the transition
occur prior to enactment. One of the issues is, if you enact an in-
heritance tax and have it go into effect right after the bill passes,
many people, knowing that the bill will pass, will max out their
lifetime gift tax exemption.
So in order to prevent that kind of gaming, I would recommend
having the transition occur maybe back to the date of introduction
or some prior date. -
You could give credit for prior taxes paid, but I actually think
that would give relatively small benefits, because most people who
receive a substantial inheritance just receive one. In some of the
data that I have looked at with my co-author, we find that, of peo-
ple who inherit $1.7 million or more, that tends to represent, if
they inherit that in 1 year, 94 percent of their lifetime inherit-
ances. So giving them credit for prior taxes paid may not be nec-
essary, but it certainly is an option.
The CHAIRMAN. Again, in Ireland, why the change? Do you know
much about what happened in Ireland?
9
Prof. BATCHELDER. As far as I know, it has been very successful.
It has been in place for about 30 years, and it is sort of similar to
the accessions tax that Professor Duff was describing in terms of
aggregating your inheritances over time and applying a tax rate to
the amount received.
The CHAIRMAN. But is the amount of income taxes or the revenue
gain saved by the government about the same, or not? .
Prof. BATCHELDER. Yes. I do not have this in my written testi-
mony, but the percentage of tax revenues raised from most transfer
taxes cross-nationally is generally around 1 or 2 percent, and actu-
ally, inheritance taxes are much, much more common than estate
taxes. --- .
The CHAIRMAN. But even those countries that have inheritance
tax, it is about 1 percent?
Prof. BATCHELDER. One to 2 percent. Some go up to 6 percent.
It varies to some degree. - .
The CHAIRMAN. All right.
Mr. Duff, transition?
Prof. DUFF. Well, it is not an area I have actually done work in
because, of course, in my context we abolished these things, so the
transition would be starting from scratch.
The CHAIRMAN. Right. Right.
Prof. DUFF. And that poses much more significant issues than in
the U.S., where the incentives obviously would not be as significant
to game the system as if you are starting from scratch. I think, ac-
tually, Professor Batchelder has written about some of this. I think
the transition issues where you already have an estate tax are not
so serious because you already have something in place. -
I think one thing that could be considered is a credit for prior
estate taxes paid, but I think, as Professor Batchelder points out,
it is not a huge issue because, for the most part, you get an inherit-
. once and you do not receive these small amounts over a period
of time.
The CHAIRMAN. So what is wrong with this idea? I mean, there
is always the other side of the coin. What are the down sides of
an inheritance as opposed to estate tax?
Prof. DUFF. I actually find it difficult to see what the down side
is. I am surprised that the world has not moved in this direction.
I think if the U.S. were to do this, it would be a leader in this and
a lot of other countries would follow.
º: CHAIRMAN. If you had to think of a down side, what would
it be? -
Prof. BATCHELDER. I can offer a down side. -
The CHAIRMAN. All right. .
Prof. BATCHELDER. It sort of depends on your perspective. It does
change incentives for giving. I tend to see this as a bit of an up
side, that it creates an incentive for very wealthy households to dis-
tribute their wealth more broadly. But people may not like that.
It also would shift, to some degree, the incentives regarding char-
itable contributions, so in general, because charities are tax-
exempt, they would not be subject to an inheritance tax, because
when they receive inherited income that is not income. It might
change the charities eligible for that exemption. Right now, my un-
derstanding is that certain charities, including 501(c)(4)s, are not
10
eligible for the estate and gift tax exemption. They presumably
would be for an inheritance tax exemption.
The CHAIRMAN. Professor Dodge?
Prof. DODGE. Well, the charitable community might not like it
because they might actually prefer that wealth be highly con-
centrated so that the tax incentives for giving to charity would be
maximized.
The CHAIRMAN. What about the countries you mentioned, Pro-
fessor Duff? I am now addressing charitable giving. Is there as
much, less, say in those countries compared with the U.S., and
does it have any effect? Does the form of wealth transfer in those
countries have an effect?
Prof. DUFF. I think there have been studies that suggest there
is less charitable giving in Canada than in the U.S., but of course
we do not have any kind of wealth transfer tax system that creates
those incentive at all. So, if you get rid of the taxes altogether, I
think the evidence is that there is actually less of an incentive for
charitable giving. But that is an argument for some kind of wealth
transfer tax system, not an argument for a particular kind, nec-
essarily.
The CHAIRMAN. Senator Grassley? Thank you very much. Very
interesting.
Senator GRASSLEY. Yes. I am going to start with Ms. Batchelder.
One of our concerns with your program is the potential that a fam-
ily farm or small business, whose assets by their nature are il-
liquid, will have to sell the assets of their business in order to pay
off the inheritance tax. I know you address this issue in your paper
by suggesting that an heir can defer payment of the inheritance tax
based on illiquidity, while requiring the heir to pay a market rate
of interest on the amount that was deferred.
What argument could you make that this market rate of interest
requirement would not ultimately be more punitive in nature to
the small business owner/farmer who may not even have the cash
on hand to pay this amount of interest on the business or farm that
they have inherited?
Prof. BATCHELDER. Thank you. Well, I guess one response I
would have is, I think you could defer the interest as well. So the
general idea was that, if you inherit a business and you do not in-
herit liquid assets sufficient to pay the associated tax liability, that
you would be able to defer those taxes due with interest. I would
be fine with deferring the interest payments until you actually sell
that business. Frequently, with family businesses, heirs do choose
§ sell them just because they do not wish to continue operating
them.
There are a number of provisions within current law to address
family businesses. To my knowledge—but you may very well know
of people who have been forced to sell their business—there has not
been a family farm that has been forced to be sold under the cur-
rent provisions, but I do think it is worth trying to establish the
rules that make that not even a theoretical possibility, which is, I
think, what this proposal could do. -
Senator GRASSLEY. Mr. Duff, was it the experience of Canada,
New Zealand, and Australia that the estate tax was replaced by a
less divisive tax, like sales tax or value added tax, to replace the
11
revenue which was lost based on the estate tax repeal, or was the
revenue simply lost? The reason I ask this is because it would be
instructional to know what tax had to ultimately rise in order to
replace the revenue lost from the repeal of the estate tax or wheth-
er it simply went away with nothing to take its place.
Prof. DUFF. Right. Well, to answer that, one has to understand
the nature of taxes that are based on the English model. Histori-
cally, neither Canada, nor Australia, nor New Zealand taxed cap-
ital gains at all, so capital gains in Canada were not taxable until
1972, in Australia, not until sometime in the 1980s, and New Zea-
land, not until the 1990s. So, in fact, what ended up happening in
all of these countries is the wealth transfer taxes were repealed
and capital gains taxes were introduced.
In Canada, actually the way it fell out politically is, it happened
at the very same time in 1972, and partly it was because, in Can-
ada, a decision was made to tax capital gains at death and there
was a sense that the Federal Government had that, well, they
should reduce the level of combined taxes on death from a deemed
realization at death and the wealth transfer taxes. Their policy was
not to eliminate wealth transfer taxes completely because provinces
had collected wealth transfer taxes. -
The Federal Government in Canada said, we will get out of the
area and leave it to provinces to collect their share, but, of course,
then what ended up happening is inter-jurisdictional tax competi-
tion took over. Once one province was out of the game, others also
got out of the game and it all unraveled.
A similar phenomenon happened in Australia. In Australia and
New Zealand, the wealth transfer taxes were repealed before cap-
ital gains tax was introduced, but once the transfer taxes were re-
pealed it became a stronger argument for having capital gains tax.
In Australia, there is a carry-over basis at death, not a deemed
realization at death. So, if one were to say what replaced them, it
certainly was not value added tax. In Canada, that did not come
until much, much later. It would be capital gains tax, which of
course the U.S. has had right from the outset of its income tax.
Senator GRASSLEY. Do you want to comment, Mr. Dodge?
Prof. DODGE. I wanted to comment on Professor Batchelder's
comment. I actually disagree with her on this point. I do not think
an interest charge would need to be imposed on deferral because
the tax base would grow, because the future tax base would include
income and appreciation; therefore, there is no real revenue loss
from deferral. In fact, there would be possibly a revenue gain if the
greater amount were taxed in higher brackets. So, therefore, I do
not think you need an interest charge on deferral.
Senator GRASSLEY. All right.
Do you want to react to that?
Prof. BATCHELDER. Yes. I actually do think it would be impor-
tant. I think the general philosophy should be to try to not create
incentives or disincentives to hold illiquid assets, so not to penalize
ºwned businesses, also not to make them especially pre-
€I’I'êOl. *
In that case, it would be important to have the tax liability be
assessed at the time of the transfer with interest, because other-
wise you could have people withdraw a lot of the cash from the
12
family business, sort of depreciate the value, and then when they
ultimately pay tax, pay a much smaller tax burden, but they effec-
tively would have received a huge amount of inheritance just by
spending the cash of the business.
Senator GRASSLEY. All right.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Senator.
Senator Salazar? -
Senator SALAZAR. Thank you very much, Chairman Baucus and
Ranking Member Grassley, for holding this hearing on this impor-
tant issue.
I think, at least for me as I approach this issue, one of the big
concerns we have had as we look at reform is, how do we deal with
the reality of paying the bills of the government? The pay-go rules
that we have adopted in this Congress are very important to me,
and at least to some members of this committee.
So to you, Ms. Batchelder, I would ask this question. On your re-
form option one, you say you would impose a 15-percent tax on ex-
traordinary bequests that would be beyond the inheritance and you
would create some kind of a $2-million exemption. Can you elabo-
rate on your proposal and what the consequence of that would be
in terms of the fiscal consequence sent to the government?
Prof. BATCHELDER. Sure. So the roughly $2-million exemption
would be revenue-neutral relative to 2009 estate tax law, which is
a $7-million per-couple exemption, $3.5 million per donor. The idea
would be that you would include amounts above that $2 million in
income and there would be a 15-percent flat tax, so that means
that I could inherit $2 million tax-free. If I inherit $3 million, I
would include $1 million in income, so it would be subject to the
income tax and it would be subject to a 15-percent flat tax, so the
marginal tax rate would start off at 15 percent.
Senator SALAZAR. So the $2 million, we are taxing the heir. We
are taxing the inheritance, we are not taxing the estate, under your
concept. That $2-million exemption is a lifetime exemption. It
would be similar to, say, a household’s primary residence, the life-
time exemption that we have under tax law. Is that the kind of
concept that you would be pushing here under that proposal?
Prof. BATCHELDER. It would be lifetime inheritances received.
And one thing I should note is, the $2-million revenue-neutral
threshold is sort of arbitrary relative to 2009 law. In my written
testimony I did include our estimates of what the revenue-neutral
threshold would be relative to 2008 law, to 2011 law, a few dif-
ferent permutations. So it would depend on what revenue baseline
Congress would like to set in order to achieve the targeted level of
deficit reduction.
Senator SALAZAR. Mr. Duff, I will ask you as well. You talk about
the importance of I think you said, if we do the accessions tax,
philosophically where you approach this issue from, I think your
words were that it is all right, a good thing for society to moderate
extreme inequalities in wealth. Then you continued on and you
said that it is also important to protect certain heirlooms, family
farms, family businesses, and the like.
How, under your concept of the accessions tax or your reform
package number one, would you deal with that issue of those spe-
13
cial properties? I think Senator Baucus, myself, and others on this
committee are very concerned about ranchers and farmers, and the
fact that we have many estates out there that have a high value
but very low cash. One of the things we want to make sure we do
is to prevent having farmers and ranchers from having basically to
give up the family farm or ranch to pay some kind of an estate tax.
That is one of my key interests in dealing with this issue. So how
would you deal with that issue under your concepts?
Prof. DUFF. Well, I think there are two responses. One, with a
significant-enough exemption, it is generally not a problem. The
statistics I have seen in the U.S. suggest that, as the exemption in
the U.S., the estate tax has gotten high enough. Most of the estates
that have these illiquid assets generally have very liquid assets as
well. I think the evidence is pretty clear on that.
But I agree with Professor Batchelder that, even if in theory
there is a problem with illiquid assets, then it should be addressed.
As I said, my arguments suggest that there should be a balance be-
5. the values of transferring these kinds of family assets and
the tax.
Senator SALAZAR. So would you create an exemption then for
those illiquid assets under your proposal?
Prof. DUFF. I think my preference would be not an exemption,
because of course that creates strong incentives for people to trans-
fer assets like that and then, of course, liquidate them. So I think
a deferral approach, as Professor Batchelder suggests, is probably
the best kind of approach to deal with those concerns.
Senator SALAZAR. All right.
Yes, go ahead.
Prof. DODGE. Yes. I guess I also think that deferral is a solution,
but I think I might differ from the others. I would defer the taxable
event until either sale or cessation of qualified use, as opposed to
imposing a tax and then deferring the tax with interest. So I would
defer the taxable event and that would also avoid valuation issues.
You just wait and see what happens.
Senator SALAZAR. Thank you very much. My time is up.
The CHAIRMAN. Thank you, Senator.
Senator Bunning?
Senator BUNNING. Thank you, Mr. Chairman.
Professor Batchelder, in your testimony you referred to inherit-
ance income as unearned. But that term is more than a little mis-
leading. It is not only earned income, it is earned and previously
taxed. If a donor earns $100 of ordinary income and pays 40 per-
cent in Federal and State income tax, he or she is left with $60.
If the donor dies the next day and decides to leave it to his grown
child or children, under your proposal it would be taxed at 54.6
percent in 2011, that is 39.6 plus your 15-percent flat tax. That
leaves $27.24 before State death tax, sales tax, and other tax im-
posed on the child.
I understand you are proposing a $2-million exemption, but that
may not be enough if the donor is trying to transfer a farm or a
small business. What possible incentive would donors have to build
a nest egg to provide for the safety and security of their children
and grandchildren if more than 73 percent will be taxed away? I
understand your zeal to level our income, but what will you do to
14
the incentive structure that for centuries has motivated Americans
to build businesses and create jobs?
Prof. BATCHELDER. Well, I would like to make two points. First,
with respect to it being a tax on unearned income, I agree that the
donor, when we work and we save, we are taxed on that income.
They then have a choice about how to spend it. When an heir re-
ceives a windfall, which I would view extraordinarily large inherit-
ances to be, that is another person getting to choose how to spend
that income.
Senator BUNNING. What if the first person spent everything?
Prof. BATCHELDER. Then they would be taxed on it.
Senator BUNNING. Yes. Then they would not be able to provide
that second, or first, or fifth, or ninth child with one cent of inherit-
aIlC62.
Prof. BATCHELDER. Well, I sometimes find double taxes to be a
bit of a misnomer, because I think we should have one tax on each
person. So if the donor spends it on some jewelry, then the jeweler
will pay tax.
Senator BUNNING. Why does the government have a right to that
money? That is what I want to get at.
Prof. BATCHELDER. I do not think it is about a right so much as
how we should allocate tax burdens. If someone has inherited more
than $2 million over their lifetime, I think they do have a better
ability to pay taxes than someone who has not inherited anything
and has worked to earn $2 million over their lifetime. So in terms
of figuring out— .
Senator BUNNING. Well, the same thing would go with that sec-
ond person then that went out and earned that § million, or $4
million, or whatever it might be. You are going to confiscate their
inheritance for their children the same way. So what is the incen-
tive? .
Prof. BATCHELDER. The burden, as I mentioned in my testimony,
will be borne by the heir. So I think that, in allocating the tax bur-
dens between people who inherit extraordinary amounts in society
and those who do not, we should be taking into account extraor-
dinary amounts of inheritances. For normal inheritances, I fully
agree that we should be supporting and encouraging those kinds of
family bonds. But once we get above $2 million, that to me
becomes— -
Senator BUNNING. I have an example. Somebody said that you do
not lose family farms. I am going to give you a perfect example how
a $12-million estate, in 4 years, disappeared to the tax collector. A
$12-million estate. No will by the owner, no will by the spouse. The
owner dies, spouse is due for the estate tax. The spouse dies. Now
the children inherit the $12 million. Now they have to pay $4 mil-
lion in estate tax. This is just as recently as 10 years ago. They
cannot pay it. They do not have the liquid assets.
So they hock the farm to a bank, and the farm is a horse farm
that has to produce so much income to pay off the principal and
the interest that they borrowed. Well, the horse business went
south and it did not produce the principal and interest enough to
ay off that liability. The bank, 4 years later, took the whole estate,
§ million. This man worked 60 years to build this estate of $12
million, and in 4 years the Federal Government leveled it, totally
15
and completely. It is my daughter-in-law and son, if you really
want to know about it. So the Federal Government has a tax
event—I am sorry, Mr. Chairman, but this gets a little personal be-
cause my family was involved.
The CHAIRMAN. You go right ahead.
Senator BUNNING. And so the tax consequences of dying should
not be accompanied with the transfer of that money to the Federal
Government.
Prof. BATCHELDER. If I could, I am very sorry about that.
Senator BUNNING. So am I.
Prof. BATCHELDER. Under the proposal I would be advocating for
treating family farms and other illiquid assets, there would be no
tax due when the transfer occurred. So long as your daughter and
son-in-law were operating the farm, that tax liability would just be
deferred indefinitely. It would be due only if they decided, we do
not want to run it any more, we want the cash, then the tax would
be paid and due. But prior to that, there would be no tax due.
Senator BUNNING. And what happens if they run it and transfer
it to their children?
Prof. BATCHELDER. The tax liability would continue to accrue and
it would be deferred indefinitely.
Senator BUNNING. Deferred as long as a member of the family
ran the farm?
Prof. BATCHELDER. As long as it is not sold, it stays within the
family and is being run by the family, it would not. It would just
defer with interest.
Senator BUNNING. All right.
Thank you very much, Mr. Chairman.
The CHAIRMAN. Thank you.
Are you ready, Senator Lincoln’ All right. Fine. Senator Lincoln.
Senator LINCOLN. Thank you, Mr. Chairman. And thanks for
pulling us together here to have another discussion. .
Professor Batchelder, Professor Dodge, and Professor Duff, we
thank you for taking time to be here today to discuss an issue that
is of tremendous importance to me particularly on behalf of my
constituency, to reform the estate tax system.
I have been working with my colleagues here on the Senate Fi-
nance Committee for more than 5 years, at a minimum, I guess,
since 2003, to really try to address the uncertainty that is created.
The unknown for any of us is dangerous and creates a tremendous
amount of fear, but here in the estate tax system we created that
uncertainty with the 2001 law in terms of the cliff that we are
going to hit after 2009, people not understanding or being able to
plan ahead, and particularly with something that is as precious to
them as something that they have spent their life creating, wheth-
er it is a business or their family's inheritance or a family farm
that has been in the family for generations, or a business that has
been in the family for generations.
So it is something very tangible and certainly something that I
think represents a tremendous amount of who we are as Ameri-
cans, that you could work hard all your life to be able to build
Something, to pass it on to your children, and then unfortunately
find yourself in a situation where, because of the tax system we
16
have created, you would have to sell all of that in order to be able
to pay those taxes.
But for 5 years, Senator Kyl, Senator Grassley, Chairman Bau-
cus, and I, and others have been studying this issue. We have been
meeting with experts at the Joint Committee on Taxation. We have
been discussing the possible solutions that would bring about relief
for our family-owned farms and businesses. Here we are again
today, continuing that discussion about this very issue, with an-
other discussion expected sometime, I think, in the next work pe-
riod. We are going to continue to do that.
And certainly I do appreciate the chairman's dedication to this
issue, because he truly has been dedicated to it, and the commit-
tee's continuing desire to study the issue—and no one can deny
that today's hearing, with three professors on our witness panel, is
a good way to examine the topic from an academic perspective.
But I think, particularly from the perspective of my constituency,
it is time for less talk and less study and more in terms of action,
in terms of what we can do to provide more predictability and more
assurances to families who are working hard every day to build
that family business, the opportunity to be able to hand it off to
their children, which is what they want more than anything.
We have heard from our professors here today who say we
should think about other alternative systems. I have to say, with
all due respect, I am sorry, but my family-owned businesses in Ar-
kansas could really care less whether it is called an estate tax, an
inheritance tax, or take-the-money-and-run tax, or whatever we are
going to call it. Whatever name we want to put on it and whatever
system that you use to collect it, it is all the same for our family-
owned businesses and farms that have to pay it.
Maybe you have a difference of opinion, and I would certainly be
glad to hear that. But whether it is a farmer or a farmer's son that
will inherit the business and keep it running, whether it is a meat-
packing business, whether it is a small equipment business, what-
ever, one of them has to pay the tax and neither of them has the
liquidity to be able to deal with that, the liquid capital that they
need in order to be able to do that. So changing the method of col-
lection is not, in my opinion, going to make that problem go away
for a family-owned business.
Maybe there are tweaks or bells or whistles that you all have
come up with, or ideas—I apologize for being late—that you may
have expressed, and we are certainly glad to listen to those. But
I do strongly believe that now is the time for action. Two thousand
nine is our last year under the 2001 changes before we eliminate
the estate tax, and certainly in 2011, we go right back to where we
started.
I believe that we have the capacity and the capability to reflect
our American values in our tax system in a way that is going to
be balanced, fair, and is going to help us continue these kind of
businesses that are the generators of the good jobs that exist out
there in America, not to mention the investment that it makes in
this country. So I look forward to working with my colleagues who
care about this issue in the weeks and the months ahead to take
some real action to address the issue, and I look forward to, again,
your perspectives and suggestions.
17
Maybe, Professor Dodge, you would like to start. You were shak-
ing your head “no,” that somebody is not going to have to pay that
tax if it is an inheritance.
Prof. DODGE. Well, it is a fundamentally different tax. It is not
the same tax with a different name. Under the current system, the
taxable event is the time of the gift or the date of death, and you
just have to have that be the taxable event and you have to value
the property at that time.
But under either the accessions tax or the income inclusion pro-
posal, or even under the deemed realization system, the taxable
event can be whenever you decide, because they are transferee-
oriented systems.
So in the case of family farms and closely held business interests,
I would propose an inherent or integral part of the transferee-
oriented tax—which, by the way, is similar to the realization prin-
ciple of the income tax, that the receipt of an interest in a trust
or a family business or an illiquid asset is just not a taxable event.
Senator LINCOLN. Well, if revenue is coming in, somebody is pay-
ing it.
Prof. DODGE. What?
Senator LINCOLN. If revenue is coming in, someone is paying it.
Prof. DODGE. Well, there are other aspects of the tax. This would
only be a part of it. Deferral, if these businesses are successful, the
tax base will be larger at such time later on that it is taxed. If they
are unsuccessful—as in Senator Bunning's case, you will not have
a tax liability that is greater than the value of the business.
Senator LINCOLN. So you are suggesting that it be deferred to see
if the business is going to be successful?
Prof. DODGE. No. It has nothing to do with—that is just random.
But it would be deferred until such time as the business is either
sold or it ceases its qualified use.
Senator LINCOLN. What about prepayment?
Prof. DODGE. Well, people could elect to prepay, possibly.
Senator LINCOLN. For a lower rate.
Prof. DODGE. You could build an election. Sometimes people
would find it advantageous to accelerate the taxable event. I see no
reason not to have that option built into the system.
Senator LINCOLN. Professor Batchelder?
Prof. BATCHELDER. Yes. First, in terms of the difference between
an inheritance tax and an estate tax, I would be happy to sort of
explain why I think it actually would matter, practically, at the
level of who is burdened by the tax. But in terms of illiquid assets
in family farms and family-owned businesses, it seems like there
are several different approaches we could take. One would be to
stick with the sort of patchwork of rules that we have.
There was a quote in a book on estate tax repeal that found that
both the American Farm Bureau and the New York Times had
never identified a single family farm that had been sold to pay the
estate tax. We just heard a story of one that had been, so I think
it certainly may exist and is a theoretical possibility under the ex-
isting rules.
And two other possibilities have been discussed. Professor Dodge
has discussed the possibility of just not imposing the tax at all
18
until the business is sold, and then imposing it on the value of the
business at that time.
I would actually prefer an approach where you would determine
the tax liability at the time of the transfer, but then defer it indefi-
nitely with interest until it was sold. So as long as it is not sold,
there would be no tax liability. - -
Senator LINCOLN. But there would be tax liability eventually,
with interest, which puts the pressure on the business that is mov-
ing from one entity to another in terms of management. I mean,
if we use the example of Wall Street and publicly traded compa-
nies, when the CEO dies, there is no shift there. The liquidity is
there in order for those businesses to continue.
When you take a shift here from one generation to the next in
a family-owned business, a farming operation, or a ranching oper-
ation, I mean, all of a sudden you have to come up with the liquid-
ity to pay a tax, as well as assuming the management risk and
ºther,things like that. How can they be competitive in that sce-
Ila YIO (
Prof. BATCHELDER. Well, the concept would be that they would
not owe any tax at that time, so there would be no need for liquid-
ity because you would owe no tax. It would be deferred until, if the
heirs eventually decide they want to cash out, they do not want to
run the family business. Then they would be taxed on their inherit-
ance to the extent that it exceeds a really high exemption, but if
they do not take the cash out they would not be taxed.
Senator LINCOLN. Does it make a difference who they sell it to?
Prof. BATCHELDER. No, I do not think it necessarily should.
Senator LINCOLN. No. We have lost tremendous family-owned
businesses, which people here in Washington love to talk about
how important family-owned businesses are. We have seen tremen-
dous sales of family-owned businesses to major corporations be-
cause they cannot survive under the kind of pressures that both
these types of tax systems and regulations have on them as small
businesses without the capital to be able to survive.
I mean, I do not know. If our objective here in this country is
to not only create, but perpetuate the American dream that you
can build a family-owned business, how are we providing the fertile
environment in order for that to continue? If we continue to put the
kind of restrictive, both tax laws, but also the same kind of regu-
latory burdens that exist for small businesses, I do not know.
I am truly an advocate for family-owned businesses because I see
the productivity in them and I see the job creation that they pro-
vide this country. So, I do not know. I do not see where you are
doing anything but putting off the pain.
Prof. BATCHELDER. Well, I think it means that there is no liquid-
ity crunch. I guess the other point I would make is, I would hate
for us to lose sight of the potentially valuable role that making
wealth transfer taxes part of the tax system can create in terms
of ensuring that economic mobility is distributed more evenly. I
would hate for us to be distracted from that by this problem.
Just to cite one statistic, the Tax Policy Center has estimated
that business and farm assets compose more than half of the estate
value for only 2.8 percent of taxable returns, so 97 percent of tax-
able returns really do not have a problem right now.
19
I think it is important to remember those 97 percent and think
about, do we want this kind of tax within our fiscal system, do we
think it is important to recognize the extent to which inheritances
can affect someone's ability to pay, just like earning income from
work or savings can affect their ability to pay?
Senator LINCOLN. So are you saying that 97 percent are not af-
fected because they do not reach the amount or is it because they
have planned for it?
Prof. BATCHELDER. It is because—
Senator LINCOLN. There are a lot of resources that, unfortu-
nately, family businesses have to spend and devote to mitigating
their risk in terms of estate taxes and what their families and their
future generations will have to deal with.
Prof. BATCHELDER. Yes. So this statistic was that over half of
taxable estate values are liquid assets. Ninety-seven percent of
them have over half of their estate as liquid assets. So I do not
know what those liquid assets are, but generally one would think
then liquidity is not the issue, that one should be able to pay any
associated tax liability and continue the family business, if you so
choose, without the tax system preventing you from doing so.
The CHAIRMAN. Professor Dodge, you look like you want to get
in here.
Prof. DODGE. Well, it is hard to tell just from the statistics about
liquidity. As Senator Lincoln suggests, there might be pressure to
sell to large corporations or there may be purchases of life insur-
ance. I do not think the tax law should distort economic decisions
such as the purchase of life insurance just to fund the liquidity for
the tax. So it is hard to tell. I would not be able to, I submit.
Besides, this is obviously an issue of intense interest to the com-
mittee. I do not think we need to be absolute purists. So again, I
would say that, given the big picture, I think the accessions tax or
the income inclusion system is better than the existing system,
partly because it is a transferee tax. Again, I would say in the case
of illiquid property, that the answer is deferral of the taxable
event.
That would have two ancillary benefits. First, there would not be
any interest charge involved. Second, you would not have to value
a closely held business interest. Under present law, valuing closely
held business interest is where all kind of estate planning gim-
micks are, family-limited partnerships and all that sort of thing.
Senator LINCOLN. But would that mean that you would not have
a step up in basis when they pass down within the family? You
would have to, would you not?
Prof. DODGE. Well, if you were going to defer the no, that is an
income tax issue. So the accessions tax is a separate tax. Income
tax issues are separate.
The CHAIRMAN. Let me just ask a question here. Why not, just
as these three countries, just abolish the wealth transfer tax and
the government just gets the revenue it wants with income tax, or
capital gains, or whatnot, as I suppose Australia, Canada, and New
Zealand do. I do not know what their taxation system is that real-
izes the income.
Before I ask you two that question, let me ask Professor Duff. S
how do these countries make up for lost revenue? +
20
Prof. DUFF. Well, as I said, in these countries capital gains tax
did not exist beforehand, so they introduced capital gains tax and
that really was the
The CHAIRMAN. Is it higher or lower than the U.S.”
Prof. DUFF. It is slightly different. In Canada, we include half the
gain in income and then subject it to the ordinary rate, so it is ef-
fectively half the ordinary rate. Probably comparable to the U.S.,
our capital gains tax rate. Maybe a little bit higher.
The CHAIRMAN. All right.
Prof. DUFF. Our tax rates are a bit higher.
The CHAIRMAN. But again, why not—
Prof. DUFF. Can I actually address that? Because I do not think
those taxes address the key issue, the philosophical issue, about
why I think it is legitimate and desirable to tax these transfers of
wealth. As I said before Senator Lincoln was here, I think there
needs to be balance in a tax system, I think balance in the values
that a society has. One value is the value of building up an enter-
prise, transferring it to your children, and I think that value is an
incredibly important value that should be respected and encour-
aged. But it has to be balanced against the concerns about moder-
ating significant disparities in wealth and opportunity.
The CHAIRMAN. Would you advise those countries to redress that
balance? Is there imbalance in those three countries?
Prof. DUFF. I think in terms of the transfer of wealth from one
generation to the next, there is. - - -
The CHAIRMAN. In those three countries. Yes. Well, that might
answer your question then, your answer—both your answers—as to
why not abolish and address it the way these three countries do,
that is, lost revenue.
Prof. BATCHELDER. I would just add that, currently, that income
tax taxes all the receipts that we have, from work, from saving,
from lottery winnings, if you find a fancy painting on the street.
That is all income.
The one major thing that is included is income from gifts and be-
quests. I think that, if we are going to do that within income tax,
we should be thinking about how to make sure that that kind of
income is still counted in allocating tax burdens, and either an es-
tate tax or an inheritance tax is one way to do that.
I am less concerned about sort of ordinary inheritances. So most
people receive inheritances well below, actually, $100,000. Once
you get up to, say, $2 million, that is the top 1 percent of the inher-
itance distribution and they are receiving these really extraor-
dinarily large inheritances that are not considered at all in allo-
cating income tax burdens. -
So, if we were to repeal the estate tax and not replace it with
anything else that looked at inheritances, we would really be giving
a free ride to people who, in my view, are very fortunate to receive
such a large inheritance and be born into a family that can afford
to give it to them. I am not saying we should tax it all away, but
when it really exceeds some extraordinary threshold, we should
have them share their good fortune, as Professor Duff said, with
everyone else.
The CHAIRMAN. So both Professors Dodge and Duff would agree
with that general concept? That is, extraordinary wealth should be
21
taxed, that the transferee should pay some tax on extraordinary be-
quests.
Prof. DODGE. Yes. But it is ultimately a political question, be-
cause the idea of an accessions tax is, in a way, kind of different
from fixing holes in the income tax. You could do both simulta-
neously. Like, you could have a system that, under the income tax,
taxed gains and losses at gift or death, and on top of that have an
accessions tax with a large exemption. They are just two different
taxes.
The CHAIRMAN. What do European countries do? -
Prof. DUFF. Most European countries levy inheritance type taxes.
I am not as familiar with what they do with capital gains at death,
whether they have carry-over basis, whether they have deemed re-
alizations. I think some have one, some have the other.
I think the U.S. is pretty unique in having stepped-up basis
around the world, but most continental European countries have a
recipient-based tax. The donor-based taxes tend to be something
that the English-speaking world has adopted, so England, as I said,
Australia, Canada, New Zealand, had them. The U.S. has that ap-
proach. It was probably related somehow to common law systems
versus civil law systems.
The CHAIRMAN. I understand.
Senator LINCOLN. Could I ask just a couple?
The CHAIRMAN. Yes, go ahead.
Senator LINCOLN. So, Professor Dodge and Professor Duff—I’m
assuming, I guess, Professor Batchelder, too—you really think gov-
ernment then should play the role of determining how personal in-
come should be divided? I mean, if you are saying that it is redis-
tribution and those who are fortunate enough to have worked hard
all their life to build something, I mean, the incentive was there
that if we build this business we will be able to hand it off to our
heirs, our children. But then at that point the government decides
whether or not you are going to be able to do that because we are
going to redistribute your personal income, your personal wealth in
a way that we see fit?
Prof. DUFF. As I said, I think there needs to be balance, right?
These values are very important, and so, as we have talked about
this, I think all of us have said that, for closely held enterprises—
farms, certain kinds of family heirlooms—that kind of value is real-
ly important and needs to be respected. The best way to, I think,
address that is through either deferring the moment of the tax or
deferring the tax itself. But it has to be balanced against other val-
ues that I think democratic societies hold, which are that when
there are extreme inequalities of wealth and opportunities, that is
not a healthy thing for a society.
Senator LINCOLN. Can you not do that by limits?
ºf DUFF. What do you mean by limits? I think that is
What—
Senator LINCOLN. Amounts.
Prof. DUFF. That is what exemptions are about. A basic exemp-
tion that says only taxing above very large, substantial gifts and
inheritances is, I think, exactly that: a limit. It does not say, well,
you cannot do beyond that. It is just, there is a price to be paid
beyond that, and the price is to share with the rest of society. You
22
might even say, well, all right, so government requires that shar-
ing. Then, of course, people always say, well, it disappears into gov-
ernment, right? So then make the sharing explicit. Take the reve-
nues and dedicate them to education for people from disadvantaged
backgrounds, things that will give people a leg up who do not have
that leg up otherwise. -
Senator LINCOLN. Right. I do not disagree with you, necessarily.
I certainly believe that, as Americans, we all have a huge responsi-
bility to give back to this great country that has given us so much
in terms of opportunities, and those very opportunities to build a
business from nothing or from scratch. But then comes the big
question that we always fall over ourselves about here, and that is,
where are those limits? How do you determine? -
I visited with a man who has spent his life building a small busi-
ness, investing in infrastructure and machinery. He has four sons.
To say he is limited to an exemption of $1.5 million or $3.5 million
does not get him to where he needs to be. He is still going to have
to dissolve. Better yet, he will be bought out by some big major,
huge corporation because he cannot pass it down to his sons with-
out coming up with the liquidity that he needs to do that.
Prof. DUFF. This is one of the advantages, of course, of the inher-
itance type or accessions approach: four sons, four exemptions, as
opposed to four sons, one exemption under the estate tax. You dis-
tribute to your four sons, each of them gets, under Professor
Batchelder's proposal, a $2-million exemption. That is $8 million of
exemption rather than, the current system is what next year?
Three or something? -
Prof. BATCHELDER. Next year would be $3.5 million. Right now,
it is $2 million.
Senator LINCOLN. And then back to $1.5 million in 2011, which
would be one. -
You mentioned the deferral, Professor Dodge, that you thought
that might be something that would be very helpful. Of course, we
want to create something that not only is going to be, I think, ad-
vantageous to making sure that family businesses can continue,
but we also want to simplify as we go. I know the chairman has
worked tirelessly, working on simplification of the tax code.
We do not want to make it any more complicated. But with defer-
ral, I am not aware of all of the administrative burdens, but I do
understand there are some in terms of the IRS reporting require-
ments and other things like that. Is there any issue there? Have
you done the research in terms of how that can be simplified?
Prof. DODGE. Well, under the accessions tax, that is completely
separate from issues like whether there is a carry-over basis or a
stepped-up basis. So whatever the basis is for income tax purposes,
under accessions tax deferral there would be no valuation at the
time of gift or death.
There would just not be a taxable event until it is basically con-
verted away from the qualified use; that is what you are trying to
protect, keeping the business in the family. So, if they sold it, then
the proceeds of sale would be subject to accessions tax. If it were
a farm and they ceased operating it as a farm and decided to sub-
divide it and sell off the lots, well, that would be the triggering
event.
23
Senator LINCOLN. What about if it went into conservation?
Prof. DODGE. I do not see any administrative problem. All you
would have to do is identify property out there that is subject to
this system.
Senator LINCOLN. Right. So you do not see any worries about ad-
ditional reporting or IRS complications or greater need for over-
sight.
Prof. DODGE. No, that is the problem under the carry-over basis
system, because you have an event that supposedly fixes basis, but
it does not bear fruit for many years later. But I do not see that
as a problem under the accessions tax.
The CHAIRMAN. As I understand it though, with the other sys-
tems, with inheritance systems, there could well be a lot of com-
plexity there, too. You do have issues of step-up or carry-over, a
number of exemptions. A lot of people do not like the current sys-
tem because they do not like paying taxes.
But, second, they do not like paying taxes on something they
build up, as has been discussed here. The third, it is extremely
complex. Estate planning is very, very complex. The question is, if
we were to have a system where wealth was transferred on the
basis of inheritance, would we necessarily have a much less com-
plex system or not? I am just only on complexity at this point.
Prof. DUFF. Professor Batchelder has actually talked about this.
I think there are lots of advantages to a recipient-based tax over
an estate-based tax in terms of simplicity, particularly when you
come to dealing with trusts and the generation-skipping tax that
exists in the U.S. All that complexity comes from trying to tax on
the donor side rather than the recipient side. Actually, I will hand
it over to Professor Batchelder because she has written about this.
Prof. BATCHELDER. Yes. I actually think there are a number of
simplification advantages to an inheritance tax, and also a number
of ways that we could simplify current law. Some of the advantages
of an inheritance tax you can only get within an inheritance tax.
The big issue, I think, is that, whenever you have a tax that is
applied to extraordinarily wealthy people with very sophisticated
tax advisors, you are going to need some complicated rules because
their tax advisors are going to spend a lot of time trying to figure
out how to game them.
The way to prevent that is to treat economically similar trans-
actions alike, so that, even if you restructure a transfer, it is all
going to be taxed the same way and then there is really no way
around it.
An inheritance tax, I think, would allow more of that. A par-
ticular area that it would is, there are some very complicated rules
under current law about split and contingent interests—this is
when sort of the ultimate beneficiary is unclear. You create a trust
and maybe a portion of it is going to go to the spouse and be ex-
empt, or a portion will go to a charity and be exempt, and then a
portion is going to go to a taxable beneficiary. We have these very
complicated rules to figure out, all right, we think 53 percent is
going to go to the tax-exempt beneficiary. An inheritance tax would
let you just wait and see, and ultimately whatever goes to the
spouse or charity, that is subject to the exemption. Whatever goes
to the taxable heir
24
The CHAIRMAN. I am going to have to conclude this hearing,
unless— -
Senator LINCOLN. Can I just ask one last question, please?
The CHAIRMAN. Senator Lincoln has one question.
Senator LINCOLN. Thank you, Mr. Chairman. -
There are not many times that I wish I was a tax attorney, but
with this issue, I do. Fortunately I am surrounded by some very,
very thoughtful tax attorneys, and grateful for their counsel. But
you are right, they are very smart people and they do figure out
an awful lot on that chessboard in terms of ways to deal with it.
The last thing I would just like to ask is, you all talked consist-
ently about deferral in terms of the payment. One of the issues we
deal with—I mean, family businesses can defer, I think, already in
many instances. But the way we work around here are in 10-year
budgets, so we have to understand what something is going to cost.
The repeal of the estate tax is very costly, in the sense that it is
a lost revenue to the Treasury. If this inheritance tax continues to
be deferred, does this proposal or idea that you are advocating not
score as costly as repeal if all we are doing is deferring that tax?
Prof. BATCHELDER. Well, again, the deferral option that I was de-
scribing would only apply if you do not have the liquid assets to
pay the tax. So as I mentioned, 97 percent, at least, of estates do.
Presumably about that many would under an inheritance tax.
Senator LINCOLN. Of course, the nitty-gritty detail there is what
you are describing as liquid. I mean, you can always sell land. It
becomes liquid if it has to.
Prof. BATCHELDER. Right. Right.
Senator LINCOLN. Yes. So I know that certainly the chairman
has been an incredible tutor in terms of figuring out, when there
is a cost with something, it has to be dealt with. Obviously, the cost
of full repeal is tremendous. We realize that that is problematic.
But if we are continually deferring the inheritance tax, then I
think it probably scores enormously costly as well and is something
we have to deal with in terms of figuring out how we change things
and make them better.
So, Mr. Chairman, thank you very much. I do hope that we can
come to a resolution, because the unknown has become enormously
frightening to many of my small businesses, farmers, and ranchers.
I know if we all put our heads together we can come up with some-
thing that gives them more certainty in terms of what they can ex-
pect, and certainly greater simplification. So I appreciate the chair-
man's leadership. º
Thank you all. - - -
The CHAIRMAN. I thank you all. This has been a very provocative
hearing. It is kind of mind-bending, in some respects. Thank you
very much.
The hearing is adjourned.
[Whereupon, at 11:30 a.m., the hearing was concluded.]
A P P E N D IX
ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
REFORM OPTIONS FOR THE ESTATE TAXSYSTEM:
TARGETING UNEARNED INCOME
Lily L. Batchelder'
Associate Professor of Law & Public Policy, NYU School of Law
Testimony Before the United States Senate Committee on Finance
March 12, 2008
Good morning, Mr. Chairman, Ranking Member Grassley, and Members of the
Committee. My name is Lily Batchelder and I am an associate professor at NYU School
of Law. Thank you for the opportunity to testify before you today on alternatives to the
current federal estate tax system. My testimony makes three main points:
First, inheritances tend to exacerbate existing economic disparities and may be
the most important barrier to intergenerational economic mobility. These
tendencies are most pronounced at the top of the income distribution.
Inheritances are a significant component of household income. They are also
the source of about 40 percent of all household wealth. While inherited
income is distributed fairly evenly across most of the population, it rises
sharply at the very top. Among households receiving a bequest in a given
year, the average inheritance of those in the top 1 percent of the inheritance
distribution is 34 times larger than the average inherited income of everyone
else.
Second, the estate tax system is the most important mechanism by which the
current fiscal system mitigates the effect of inheritances on economic
disparities and intergenerational mobility. The burden of the estate and gift
taxes falls largely on heirs, not donors. On average, it also rises rapidly with
the amount the heir inherits and his economic income.” Nevertheless, the
relationship between the heir’s financial circumstances and his or her estate
tax burden is relatively imprecise. Some individuals who receive
extraordinarily large inheritances bear little or no tax burden, while a small
number who inherit relatively small amounts bear substantial tax burdens.
Finally, the scheduled repeal of the estate tax in 2010 and reinstatement at
higher levels in 2011 create an opportunity to better focus the estate tax
'The views expressed in this testimony are those of the author alone and do not necessarily represent those
of NYU School of Law. Portions of this testimony draw upon Lily L. Batchelder, Taxing Privilege More
Effectively: Replacing the Estate Tax with an Inheritance Tax, in THE PATH TO PROSPERITY: HAMILTON
PROJECT IDEAS ON INCOME SECURITY, EDUCATION AND TAXES (Jason Furman and Jason Bordoff, eds.)
(Brookings Institution Press, forthcoming), Lily L. Batchelder and Surachai Khitatrakun, Dead or Alive: An
Investigation of the Incidence of Estate Taxes versus Inheritance Taxes (work-in-progress), and Lily L.
Batchelder, Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax,
BROOKINGS INST. HAMILTON PROJECT DISCUSSION PAPER 2007-07 (June, 2007). My co-author also should
not be held responsible for the views expressed in this testimony.
* This is the case regardless of whether economic income is defined as income from work and saving plus
the amount inherited, one-fifth of the amount inherited, or the annuitized value of the amount inherited.
(25)
26
system on unearned income that inheritances represent. We should use that
opportunity to reform, not repeal, the estate tax system so that we continue to
tax inherited income, but in a more equitable manner. I will discuss two
potential reform options.
o The first would replace the estate tax system with a comprehensive
inheritance tax, under which an individual inheriting an extraordinary
amount over his lifetime would pay income tax and a flat 15 percent
tax on a portion of his inheritance. Relative to the 2009 law, this
reform could be implemented on a revenue-neutral basis if
approximately the first $2 million in lifetime inheritances were tax-
exempt. In effect, extraordinary amounts of inherited income would be
taxed at about the same rate that families pay on earned income under
the income and payroll taxes. This reform would substantially alter tax
burdens, and improve the fairness of the current system by more
accurately targeting the unfair advantages that exceptionally large
inheritances create.
o If this reform is considered too ambitious, a second alternative would
be to retain and improve the estate tax system by better focusing it on
the amount transferred as a proxy for the amount inherited.
Specifically, I will discuss a package of simplification reforms that
would limit the extent to which the tax burden on heirs depends on
their access to sophisticated tax advice.
I. Background on Wealth Transfers
Gifts and bequests affect economic opportunities and outcomes in important
ways. They tend to magnify income and wealth disparities. They also create barriers to
intergenerational economic mobility.
In 2009, annual bequest flows in the U.S. will total about $400 billion, excluding
transfers to spouses and charitable organizations.” Bequests will represent about 4 percent
of all household income and, among households receiving a bequest that year, about half
of their receipts from labor, saving and bequests. In addition, gifts and bequests (which I
will refer to as inheritances or wealth transfers) are a tremendously important determinant
*Unless otherwise noted, all estimates in this testimony are based on 2009 law and data, and are derived
from Batchelder and Khitatrakun, supra note 1, or Batchelder (2008), supra note 1. These estimates are
very rough because of data limitations that require multiple levels of imputation and because they rely in
part on data from 1992.
Including taxable gifts made by the donor during life would increase the $400 billion figure by an unclear
amount. Taxable gifts exclude gifts to spouses and charities, support expenses for minor children, payments
for education or health care, and, currently, the first $12,000 in otherwise taxable gifts to a given
beneficiary each year ($24,000 per couple). Taxable gifts comprise about 15 percent of the lifetime wealth
transfers of donors taxed under the estate tax system. However, the likelihood that a donor will make a
taxable gift rises dramatically if the donor is exceptionally wealthy. David Joulfaian & Kathleen McGarry
Estate and Gift Tax Incentives and Inter Vivos Giving, 57 NAT’LTAXJ. 429, 439thl.5 (June, 2004).
27
of household wealth. According to the best estimates, between 35 and 45 percent of all
household wealth is inherited.”
Inheritances are distributed fairly evenly across most of the income distribution,
but rise sharply at the very top. As illustrated in Figure 1, tax units in roughly the top 1
percent of the earned income distribution (earning more than $500,000) receive about
four times as much income from bequests as other households do on average. Moreover,
some individuals—whether highly-compensated workers or not—inherit extraordinarily
large amounts. For example, Figure 2 shows that among tax units receiving a bequest in a
given year, the average inherited income of those in the top 1 percent of the inheritance
distribution is 34 times larger than the averaged inherited income of everyone else.
Inheritances thus tend to magnify economic inequality. -
Figure 1: Estimated Average Annual Income from Bequests by Earned Income of All Tax Units in
2009
$40,000
$35,000
i
* $30,000
$
2
5,
{}
0.
{}
$20,000
$15,000
$10,000
$5,000
$0
$0- $10- $20- $30- $40- $50- $75- $400– $200- $0.5- $1- $5M+
4OK 20K 3OK 40K 50K 75K 100K 200K 500K 1 M 5M
Earned income
In addition, inheritances are perhaps the most important barrier to
intergenerational economic mobility, or the ability of a child to achieve a different
standard of living than that of his parents. The income that a child earns over his lifetime
continues to be heavily influenced by the income of his parents, and this correlation is
even higher at the ends of the income distribution.” For example, on average, children
* James B Davies & Anthony F. Shorrocks, The Distribution of Wealth, in HANDBOOK OF INCOME
DISTRIBUTION (Anthony B. Atkinson and Francois Bourguignon, eds.) (2001); Wojciech Kopczuk &
Joseph P. Lupton, To Leave or Not to Leave: The Distribution of Bequest Motives, 74 REV. ECON. 207, note
2 (2007).
* Thomas Piketty, Theories of Persistent Inequality and Intergenerational Mobility, in HANDBOOK OF
INCOME DISTRIBUTION $$ 2.1, 3 (A. Atkinson and F. Bourguignon, eds., 1998). For example, half of sons
of fathers in the bottom income decile have earnings below the 30th percentile, while half of sons of fathers
in the top decile have earnings above the 80" percentile. Bhashkar Mazumder, The Apple Falls Even Closer
to the Tree than We Thought: New and Revised Estimates of the Intergenerational Inheritance of Earnings,
in UNEQUAL CHANCES: FAMILY BACKGROUND AND ECONOMIC SUCCESS 80 (Samuel Bowles et al, eds.,
2005). - -

28
born to the top decile of the income distribution are 53 times more likely to end up in the
top decile than children born to the bottom."
Figure 2: Average Annual Income from Bequests by Inheritance Size among Tax Units Receiving a
Bequest in 2009
$2,500,000
$2,200,938
$2,000,000
$1,500,000
$1,000,000
$500,000
$65,703
Bottom 99% Top 1%
inheritance Size of Heir
There are many sources of these barriers to economic mobility. Most are factors
Society would find difficult to mitigate. For example, existing evidence suggests that
about 18 percent of the intergenerational correlation of income is explained by the
correlation between parent and child IQ, personality and schooling." However,
inheritances can be adjusted in a relatively straightforward manner through fiscal policy.
Moreover, disparities in inheritances appear to be the most significant barrier to
mobility—accounting for about 30 percent of the correlation between parent and child
economic outcomes.
II. Magnitude and Distribution of Estate Tax Burdens
Currently the estate tax system adjusts the amount individuals inherit through
three interconnected taxes: the estate tax, the gift tax, and the generation-skipping transfer
(GST) tax. This estate tax system is effective at narrowing the distribution of inheritances
by imposing higher tax burdens on those who inherit more over their lifetime. But it does
so in a relatively rough manner,
* Tom Hertz, Rags, Riches and Race: The Intergenerational Economic Mobility of Black and White
Families in the United States, in UNEQUAL CHANCES: FAMILY BACKGROUND AND ECONOMICSUCCESS 165,
184 (Samuel Bowles et al, eds., 2005).
' Samuel Bowles, et al, Introduction 1, 18-19, in UNEQUAL CHANCES: FAMILY BACKGROUND AND
ECONOMICSUCCESS 1, 20 (Samuel Bowles et al, eds., 2005).
*Id; Piketty, supra note 5; Mazumder, supra note 5 at 94.


29
Background on the Estate Tax System
In 2008, the estate tax system operates as follows. An individual can transfer $2
million in gifts and bequests ($4 million in the case of a couple) tax-free. Any portion of
a bequest above this threshold is taxed at a 45 percent rate under the estate tax.
In order to prevent donors from avoiding the estate tax by making transfers during
their life, the estate tax is coupled with a gift tax. Under the gift tax, gifts transferred prior
to death that exceed $1 million over the donor’s lifetime ($2 million in the case of a
couple) are taxed at a 41 to 45 percent rate. A third tax, the GST tax, prevents donors
from achieving lower tax rates by transferring wealth directly to their grandchildren
instead of through their children. -
In addition to the lifetime exemptions of the estate tax system, a number of other
wealth transfers are tax-free. Each year a donor can completely disregard $12,000 of gifts
to each of his or her beneficiaries ($24,000 in the case of a couple). All transfers to
spouses and charities are disregarded. And all payments for education and health care are
also tax-exempt.
The estate tax system only applies to the amount of gifts and bequests that a donor
transfers. There is no separate tax on the amount of gifts and bequests that an heir
receives. Importantly, under the income tax, gifts and bequests are not considered income
of the heir, and are thus tax-free.
Figure 3: Estate and Gift Taxes as a Share of Federal Revenues, 1946-2007”
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
(C) (...) ~r Ç Çºf © go <!- jº. * lſº Cº. Yºry fº- wº- łº,
<!" \º {ſº} lſº C º Nº. * Pºe CO CO QC, cº, sº Ç) Kº
O) Ǻ tº «» gº) Cry O). C2 cº º O) Cº. Q Ö3. C.) Ç
T- v- * ~ •r- <-- ** wº- * * wº- ~ * * CN: CN
The estate tax system has been a small but stable source of revenue ever since the
estate tax was enacted in 1916, generally raising between 1 and 2.5 percent of federal
revenues as illustrated in Figure 3. Most revenue comes from the estate tax itself." In
* Id, this, 2.1 & 2.5 at 31,45 (2008). Federal revenues include on-budget and off-budget receipts.
" In 2006, the estate tax raised $24,653 billion, the gift tax $1.628 billion and the generation-skipping
transfer tax $0.126 billion. Internal Revenue Service, Statistics on Income, Estate Tax Returns By Tax
Status and Size of Gross Estate, 2006, available at http://www.irs.gov/pub/irs-soi/06es01fy.xls; Internal
Revenue Service, Statistics on Income, Total Gifts of Donor, Total Gifts, Deductions, Credits, and Net Gift
Tax, 2006, available at http://www.irs.gov/pub/irs-Soiſ06gfö1gr.xls.

30
2007, the estate tax system raised about $26 billion." Repeal of the estate tax would
likely lose significantly more revenue.” -
The Distribution of Estate Tax Burdens
On average, the estate tax system is effective at mitigating the effect of
inheritances on economic disparities and intergenerational mobility. This is the result of
two factors. First, the economic burden of the estate tax system falls predominantly on
heirs, not donors. Second, the tax burden rises steeply with the amount the heir inherits
and his or her economic income. . -
The reason the burdens of the estate tax fall predominantly on heirs is that the tax
typically reduces the amount that an heir receives. For example, suppose a mother would
like to bequeath $10 million to her only son. If an estate tax is enacted that would tax
such a transfer at 33 percent, she has three options. She can transfer $10 million as
planned, leaving her son with $6.7 million after-tax. She can consume more and save
less, leaving her son with an after-tax inheritance of less than $6.7 million. Or she can
consume less and save more; for example, she could increase her saving to $15 million,
leaving her son with $10 million after-tax. So long as she does not save more in response
to the tax, her son will bear the tax burden in the form of a smaller inheritance.” In
practice, wealthy donors appear to transfer the same amount or slightly less in response to
the estate tax system (implying that it has a small effect or no effect on private savings)."
As a result, heirs generally bear most of the tax burden.
Most analyses of the distribution of estate tax burdens historically have assumed
that it burdens donors, not heirs. This has been due to limited data on the financial
" OFFICE OF MANAGEMENT AND BUDGET, HISTORICAL TABLES, BUDGET OF THE UNITED STATES
GOVERNMENT, FY2008, thi, 2.5 at 45 (2008).
* This is because the estate tax serves as an important “backstop” to the income and gift taxes; the Joint
Committee on Taxation estimates that estate tax repeal would also lead to income and gift tax revenue
losses. See Joint Committee on Taxation, History, Present Law and Analysis of the Federal Wealth
Transfer Tax System (JCX 108-07) (Nov. 13, 2007); NONA A. NOTTO, ESTATE AND GIFT TAx REVENUES:
PAST AND PROJECTED 13 (Congressional Research Service Report for Congress, Aug. 24, 2007).
* Even if all donors respond to wealth transfer taxes by increasing their consumption, they may still bear
some burden to the extent they value the after-tax amount their heirs receive. However, a surprisingly large
share of wealth transfers appear to stem from the donor saving for reasons unrelated to their heirs. Recent
studies estimate that these other motives for accumulating wealth that is bequeathed (e.g., precautionary
saving for retirement expenses) account for the vast majority of bequests. See e.g., Wojciech Kipczuk &
Joseph P. Lupton, To Leave or Not to Leave: The Distribution of Bequest Motives, 74 REv. ECON. 207
(2007); John Laitner & F. Thomas Juster, New Evidence of Altruism: A Study of TIAA-CREF Retirees, 86
AM. ECON, REV. 893 (Sept., 2006). In a review of the empirical literature, Douglas Holtz-Eakin concluded
that there is no single “smoking gun” explanation for why donors accumulate wealth that is bequeathed,
including the explanation that the donor values how much his or her heirs receives. Douglas Holtz-Eakin,
The Uneasy Empirical Case for Abolishing the Estate Tax, 51 TAX L. REV. 495, 511 (1996).
"See David Joulfaian, The Behavioral Response of Wealth Accumulation to Estate Taxation: Time Series
Evidence, 59 NAT’LTAX J. 253 (June, 2006); Wojciech Kopczuk & Joel Siemrod, The Impact of the Estate
Tax on Wealth Accumulation and Avoidance Behavior, in RETHINKING ESTATE AND GIFT TAXATION 299
(William G. Gale, James R. Hines Jr., and Joel Siemrod, eds, 2001) . Kopczuk and Slemrod note any
negative relationship between the size of reported estates and the estate tax rate may reflect evasion
activity, rather than a change in the amount transferred. .
31
circumstances of heirs inheriting from large estates, not to a belief among economists that
donors truly bear the tax burden. Indeed, the President’s former chairman of the Council
of Economic Advisors, Gregory Mankiw, has stated that he believes that the burden of
the estate tax system falls on heirs and not donors and decedents.”
The fact that heirs appear to bear most of the burden of taxes on gifts and bequests
has important implications for how such taxes should be conceptualized and designed. To
the extent that the burden of wealth transfer taxes is borne by heirs, they are not double
“death” taxes on the decedent, who may have worked hard to accumulate his or her
wealth. They are taxes on the unearned windfalls that children who are fortunate enough
to be born into wealthy households receive. As such, we may wish to tax inheritances in
the same way that we tax other unearned windfalls, like lottery winnings or sunken
treasure—by including them in taxable income. Moreover, because wealth transfer taxes
tend to be borne largely by heirs, we may want the tax rate to depend on, and rise with,
the financial circumstances of the heir, not the donor. -
Figure 4: Estimated Average 2009 Estate Tax Burden on All Inheritances, by Inheritance Size
50%
45%
40%
35%
30%
25%
20%
15%
10%.
5%
0%
$0- $50- $100- $250- $0.5- $1- $2.5- $5- $10- $20- $50M+
50K 100K 250K 500K 4M 2.5M 5M 10M 20M 50M
Size of inheritance
Under the current estate tax system, the tax rate does not directly turn on, or rise
with, the amount the heir receives, but rather with the amount the donor transfers. In
practice, estate tax burdens do, on average, rise steeply with the amount the heir inherits
and his economic income, as illustrated in Figures 4 and 5." Overall, 98 percent of estate
tax revenue comes from heirs with economic income above $200,000, while 96 percent
of estate tax revenue comes from taxes on inheritances of more than $1 million. This is
the case because, on average, the size of an inheritance rises with the wealth transfers of
* Gregory N. Mankiw, Remarks by Dr. N. Gregory Mankiw, Chairman, Council of Economic Advisers at
the National Bureau of Economic Research Tax Policy and the Economy Meeting (Washington DC:
|National Press Club) (Nov. 4, 2003), available af
http://www.whitehouse.gov/ceaſMPressClub20031104.html. . -
* In F igure 4, economic income includes the heir’s income from work and saving, and the amount the heir
inherits which is spread over five years in order to account for the fact that inheritances typically are not
received in equal amounts every year. The figure looks directionally similar if the inheritance is spread over
the heir’s remaining life expectancy instead.

32
the donor and, on average, children born into high-income households are higher-income.
But the relationship between the tax rate and the heir’s financial circumstances is
necessarily imprecise because the two are only linked indirectly,
Figure 5: Estimated Average 2009 Estate Tax Burden on All Inheritances, by Heir Economic
Income
45%
40%
35%
30%
25%
20%
45%
10%
5%
0%
$0- $10- $20- $30- $40- $50- $75- $100- $200- $0.5- $1-5M $5M+
10K 20K 30K 40K 50K 75K 100K 200K 500K $1M
Heir Economic Income
Indeed, under the current estate tax system, some heirs inheriting extraordinarily
large amounts bear little or no tax burden, while others inheriting relatively small
amounts bear large tax burdens. As Table 1 shows, in 2009 only about 5 in 1,000 people
who receive an inheritance will bear any estate tax burden. In part, this is because more
than 30 percent of heirs inheriting between $2.5 and $5 million are not burdened by the
estate tax at all. Generally these heirs have inherited all or part of an estate just below the
exemption threshold. Meanwhile about 4 percent of those inheriting between $500,000
and $1 million are burdened by the estate tax, often at quite high rates. Typically these
heirs have inherited a much smaller amount from an even larger estate.
In short, the strength of the current estate tax system from a fairness perspective is
its ability to effectively narrow disparities in inherited income on average. Its weakness is
that it is inconsistent in doing so in individual cases.
Table 1: Estimated Number of Heirs Burdened by 2009 Estate Tax in 2009
Size of inheritance Number of Heirs . : * Tax Percentage
$0+-100K 3,898,970 422 0%
$100–250K 532,391 961 0%
$250-500K 179,450 3,408 2%
$0.5-1M 90,693 3,246 4%
$1-2.5M 39,328 7,578 19%
$2.5-5M. 5,049 3,495 69%
$5M+ 2,410 2,410 100%

33
III. Reforms worth Consideration
The goal of any reform of the estate tax system should be to more effectively
target the tax on the unearned income that inheritances represent. Doing so will ensure
that it is based on the ability to pay of the person who actually bears the tax: the heir. It
will also ensure that the tax more effectively mitigates the income and wealth disparities
and barriers to intergenerational economic mobility that extraordinarily large inheritances
exacerbate. If a reform can further this objective while reducing administrative and
compliance costs, or strengthening the efficiency of the tax system in other ways, all the
better. - - -
As illustrated in Table 2, over the next several years, the estate tax is scheduled to
decline in 2009, disappear in 2010, and then return to life with a much lower exemption
and higher rate in 2011 and thereafter. The result is sharp changes in the law, vast
uncertainty for taxpayers, and gruesome incentives for prospective heirs on the eve of
2011. This untenable situation does, however, create a window of opportunity for reform.
I will discuss two promising approaches to improving the current system.
Table 2: Scheduled Changes to the Estate Tax System

Tax Rate £xclusions
Estate & Gift Annual Lifetime Lifetime : Basis Provisions
GST Gift" Estate 8 GST Gift . . . . .
** - tº an. Gifts: Carryover
O 0.
2008 || 45% 41-45% $12,000 $2 million $1 million | Bequests: Stepped-up
2009 45% 44-45% $12,000 $3.5 miſſion $1 million | Same
; : * Gifts & Bequests: Carryover. Up to
2010 || 0% - 35% sizodo NA $1 million $4.3M capital gains tax-exempt.
2011 of 18 * * * * Gifts: Carryover
& on 41-55% $12,000 $1 million $1 million Bequests: Stepped-up
A Comprehensive Inheritance Tax
The first option, which would be the most ambitious and effective, would be to
replace the estate tax system with what I refer to as a “comprehensive inheritance tax.”
Under a comprehensive inheritance tax, any individual inheriting an extraordinary
amount over his lifetime must pay income tax and an additional “surtax” on the portion
of his inheritance that exceeds a large lifetime exemption. This reform could be
implemented on a revenue-neutral basis by adjusting the exemption amount and surtax
level.
Surachai Khitatrakun and I have estimated that a comprehensive inheritance tax
would be revenue-neutral relative to 2009 estate tax law (a $3.5 million lifetime
exemption) if the first $1.9 million in lifetime inheritances were tax-exempt, and
"The exclusion is inflation-adjusted so it may rise above $12,000 after 2008.
“For estates between $1 million and $3 million, the marginal tax rate rises from 41% to 55%. For estates
above $3 million, the marginal tax rate generally is 55%. However a surtax that eliminates the lower
brackets technically results in an effective marginal tax rate of 60% on taxable estates between $10 million
and $17.184 million. -
34
inheritances thereafter were included in income and subject to a flat 15 percent tax. In
effect, extraordinary amounts of inherited income would then be taxed at the same rate
that families pay on earned income under the income and payroll taxes.
To state the obvious, $1.9 million is a lot of money. An individual who inherits
$1.9 million at age eighteen can live off his inheritance for the rest of his life without
either he or his spouse ever working, and his annual household income will still be higher
than that of nine out often American families.” Accordingly, a lower exemption amount
could be adopted to raise more revenue, or to maintain revenue-neutrality relative to a
different baseline. Table 3 summarizes some alternate possibilities. These estimates
assume that any portion of a bequest that is included in income can be spread out over the
current year and the previous four years. They also assume that each year $12,000 in gifts
and $60,000 in bequests can be disregarded entirely, and do not count toward the lifetime
exemption. All of these estimates are very rough and would differ from an actual revenue
estimate because they assume no behavioral response. ” For example, the Joint
Committee on Taxation estimates that 2009 estate tax law will raise $21.8 billion and
2011 law will raise $50.7 billion.”
Table 3: Estimated Revenue Effects of Estate Tax System and Comprehensive Inheritance Tax
under Different Revenue Baselines

fevenue-Neutral
Estate Tax º: inheritance Tax Revenue
tlaw Exemption Rate Tax Cuts Exemption surtax (billions)
(millions) (millions)
2009 $3.5 45% Yes $1.9 15% $17.5
2009 : $3.5 45% Yes $1.6 40% $47.5
2008 $2.0 45% Yes $1.4 tºº, $26.2
2008 $2,0 45% Yes $1.0 10% $26.2
2011 $4.0 41-55%.” No $0.5 15% $50.2
2011 $1.0 41-55%.” No $0.4 10% $50.2
2011 $1.0 41-55%.” Some” $0.5 15% $50,2
* Phase-out of lower brackets disregarded. “Tax cuts to top two income tax brackets eliminated.
To understand how this tax would work, imagine a person receives a bequest of
$3 million above the annual exemption and has not received inheritances exceeding the
annual exemption in any prior year. If the lifetime exemption is $1.9 million and the
surtax is 15 percent, this person would only have to include $1.1 million of the bequest in
his taxable income. This portion of his inheritance would be taxed under the same rate
structure as his other ordinary income plus 15 percentage points. Because the income tax
brackets rise with income, this might mean that the taxable portion of his bequest would
fall within a higher tax bracket than his earned income because he received it all at once.
”Author's calculations based on a 7 percent interest rate and U.S. Census Bureau, Current Population
Survey 1968 to 2006 Annual Social and Economic Supplements thi. A-3, available at
www.census.gov/hhes/www/income/histincſp60no231 tablea?.pdf.
*The estimates are very rough due to data limitations, outdated data, and the assumption of no behavioral
response to the tax. To the extent that donors respond to the different incentives created by the tax, it is
likely that the revenue-neutral exemption would be lower and, as discussed below, that disparities in
inherited income on a pre-tax basis would be narrower.
* Joint Committee on Taxation, supra note 12, thi.5 at 29.
35
To limit this effect, he could elect to file as if he received $220,000 of taxable inheritance
in the current year and the same amount in the previous four years.” -
From an administrative perspective, the heir should be responsible for filing an
annual return reporting cumulative gifts and bequests exceeding the annual exemptions.
Because third party reporting is essential for maximizing compliance, donors or their
estates should also have to report information on transfers above these annual exemptions
and remit a withholding tax. The heir would be responsible for claiming any excess tax
withheld and paying any excess tax due if his lifetime reportable inheritances exceeded
the lifetime exemption.
Advantages and Estimated Effects
A comprehensive inheritance tax would be substantially more targeted on
inherited income than the current estate tax system because the tax rate would turn
directly on the amount received. It would also be better attuned to the ability to pay of the
individual who bears most of the burden of either tax—the heir.
Theoretically, if an estate and inheritance tax both had the same flat tax rate, there.
would be no difference in their distributional effects. Because all inheritances come from
estates, the aggregate amount subject to tax would be the same, and any differences in
how estates were distributed would be irrelevant because of the flat tax rate. Similarly, if
all estates were distributed to only one taxable beneficiary and the inheritance tax rate
depended solely on the amount inherited, there would be no distributional difference
between the two approaches. In practice, however, the estate tax system has a progressive
rate structure (due to the lifetime exemption) and estates frequently have more than one
taxable beneficiary. As a result, a comprehensive inheritance tax should burden people
differently. -
Figures 6 through 9 illustrate that a comprehensive inheritance tax would indeed
result in different tax burdens, and to a surprisingly large degree. If the 2009 estate tax
was replaced with the revenue-neutral comprehensive inheritance tax outlined (with a
$1.9 million exemption and 15 percent surtax), the distribution of tax burdens under the
new tax would be similar in aggregate. This is true regardless of whether one considers
the distribution of burdens by the amount inherited, the heir’s economic income, or even
the estate size or decedent’s income (Figures 6 and 7).
But at an individual level, the new tax would allocate burdens very differently.
For example, Figure 8 shows that of all the heirs who would be burdened by either tax in
2009, only 30 percent would be burdened by both. Indeed, a full 63 percent of heirs who
are burdened by the estate tax would not bear any tax burden whatsoever under the
comprehensive inheritance tax. The essential reason why these differences arise is that all
*Inherited income should be spread over prior years in order to limit incentives for the heir to work less in
order to obtain a lower tax rate. - -
36
large inheritances do not come from the largest estates, and all smaller inheritances do
not come from smaller ones.”
Figure 6: Estimated Average Tax Burden on All Inheritances under 2009 Estate Tax and Revenue-
Neutral Comprehensive Inheritance Tax by Inheritance and Estate Size
5
0%
%
*
40% +- -By inheritance Size: Estate Tax ,’__:”
- By inheritance Size: Inheritance Tax ,” / z
-By Estate Size: Estate Tax / Af
- By Estate Size: Inheritance Tax 7. A
/ /
-*-
23
OO
%%
º
10
%
/
/
/
27
0%
W t —t * n H l I n
$0- $50- $100- $250- $500- $.675- $1- $2.5- $5- $10- $20- $50M+
50K 100K 250K 500K 675K #M 2.5M; 5M #6M 20M 50M
Inheritance 1 Estate Size
Figure 7: Estimated Average Tax Burden on All Inheritances under 2009 Estate Tax and Revenue-
Neutral Comprehensive Inheritance Tax by Heir and Decedent Economic Income
50%
-By Heir Economic Income: Estate Tax
- By Heir Economic Income: inheritance Tax
-By Decedent income: Estate Tax
- By Decedent income: Inheritance Tax
40% +-
30%
20%
10%
0% I- rº-mº –2' f
$0- $10– $20- $30- $40- $50- $75- $100- $200- $0.5- $1-5M $5M+
10K 20K 30K 40K 50K 75K 100K 200K 500K $1M
Heir 1 Decedent Economic income
* For example, consider two taxable estates of $9 million where the donors have not made any prior gifts.
Both would be subject to an average estate tax rate of 28 percent. However, one could be left entirely to
one heir who is in the top income tax bracket and has received $1 million in prior inheritances, while the
other could be left pro rata to six heirs with no prior inheritances. In the former case, the inheritance tax
rate would be 45%, but in the latter it would be zero. As a further example taking the opposite perspective,
suppose two heirs both have economic income of $1.2 million if one-fifth of bequests are included when
measuring economic income. One might have earned $200,000 in income and inherited $5 million from an
estate worth $5 million. The other might have the same amount of earned income and inheritance, but have
inherited from an estate worth $30 million. Both would bear the same inheritance tax burden of 31 percent.
But the estate tax rate on the former would be 14 percent while the latter’s would be 40 percent. In
aggregate, if there were roughly the same amount of heirs of both types, the estate and inheritance tax rates
would be quite similar, but at an individual level, their tax rates would vary dramatically,

37
Figure 8: Number of Heirs Burdened by 2009 Estate Tax and Revenue-Neutral Comprehensive
Inheritance Tax : - ! - - . . . . .
2^
Aſ
; -
ſ Estate Tax Estate Tax and Inheritance
Only inheritance Tax Tax Only
13,547. # ". 7,972 5,000
$.
^.
3.
k.
*
*.
".
%.
*
'N
*.
The differences between the estate tax system and this new tax can be understood
still further by considering heirs who would be burdened by both taxes. These heirs do
account for the lion’s share of revenue raised under either tax (about 90 percent).
However, many would be subject to a very different tax rate under the comprehensive
inheritance tax. As a result, 30 percent of the burden of the new tax in dollar terms would
fall on different heirs. This variance in tax burdens can be seen in Figure 9, which focuses
on those heirs who would be burdened by either tax (i.e., in one of the circles in Figure 8)
and plots the average estate tax rate and comprehensive inheritance tax rate that each heir
would face.” On average, the estate tax rate rises with the inheritance tax rate, and vice
versa. But Figure 9 illustrates that individual heirs who are burdened by both tax systems
often face dramatically different rates under one versus the other.
These substantial distributional differences in the burdens of a comprehensive
inheritance tax essentially quantify its fairness benefits relative to the estate tax system.
Each time the comprehensive inheritance tax applies a higher or lower tax rate to an heir,
it is more accurately measuring inherited income and, in doing so, more effectively
narrowing the disparities in economic opportunities and outcomes that stem from
extraordinary large inheritances.
* Each point represents an heir and each circle represents multiple heirs. Along the y-axis are heirs who are
burdened only the inheritance tax, and along the x-axis are heirs who are burdened only by the estate tax.
Every point in between represents the 30 percent of burdened heirs, who account for 90 percent of the
revenue, and are burdened by both taxes. The correlation statistic for Figure 9 is 0.71. If the figure is not
weighted by inheritance size, the correlation statistic is 0.33. -

38
Figure 9: Average Tax Rate on Inheritance of Individual Heirs under 2009 Estate Tax and Revenue-
Neutral Comprehensive Inheritance Tax (Weighted by Inheritance Size)
6 -
1
s
.2 .3 .4
average federal estate tax rate
A comprehensive inheritance tax is only one of several alternatives to an estate
tax system. As illustrated in Figure 10, jurisdictions currently apply five general
approaches to taxing wealth transfers. Some, like the United States, have an estate and
gift tax. Others have no wealth transfer tax and therefore disregard inherited income
entirely in allocating tax burdens. Most, however, have an inheritance tax of which there
are three types. The rate schedule of an “accessions tax” turns solely on the amount the
heir inherits over a long period of time, typically his lifetime. The rate schedule of an
“annual inheritance tax” instead turns on the amount inherited each year. Finally, an
inclusion tax requires the heir to include inheritances in his income tax base, and the rate
schedule therefore turns on both the amount inherited and the heir’s other income.
All three traditional types of inheritance taxes have their advantages and have
been proposed by a number of commentators.” Nevertheless, a comprehensive
inheritance tax would be the best approach. Under the current income tax rate schedule,
an inclusion tax would result in lower tax burdens on the largest inheritances and thus
would be less effective at mitigating the effects of extraordinary large inheritances. Both
an inclusion tax and an annual inheritance tax would permit extensive gaming by
applying much lower rates if inheritances are spread out over an heir’s lifetime. Finally,
*See e.g., Anne L. Alstott, Equal Opportunity and Inheritance Taxation, 121 HARV. L. Rev. (2007); Maya
MacGuineas & Ian Davidoff, Tax Inheritance, Not “Death", WASH. POST (July 4, 2006); Gary Becker,
Should the Estate Tax Go?, (May 15, 2005), available at www.becker-posmer-
blog.com/archives/2005/05/should the esta.html; David G. Duff, Taxing Inherited Wealth: A
Philosophical Argument. 6 CAN. J. L. AND JURISPRUDENCE 3 (1993); Joseph M. Dodge, Beyond Estate and
Gift Tax Reform: Including Gifts and Bequests in Income, 91 HARV. L. REv. 1177 (1978); William D.
Andrews, The Accessions Tax Proposal, 22 TAx L. REv. 589 (1967); HENRY C. SIMONS, PERSONAL
INCOME TAxATION (1938); Franklin D. Roosevelt, Message to the Congress on Tax Revision (June 19,
1935), in Public Papers and Addresses of Franklin D. Roosevelt. Vol. 4. (1938); Edwin R. A. Seligman, “A
National Inheritance Tax,” The New Republic (March 25, 1916).

39
an annual inheritance tax and accessions tax would not link the tax rate to the ability to
pay of the heir, who might have very little earning potential due to a disability or other
condition. A comprehensive inheritance tax essentially combines the best features of all
three. -- r
Figure 10: Type of Wealth Transfer Tax in 34 Countries”
20
º
£ 16
É
3 12
Sºme
# 8
#
E 4 -
2.
O -
None Estate and Gift Annual Accessions inclusion Tax
Tax inheritance Tax
Tax
Potential Concerns and Responses
Replacing the estate tax system with a different tax system should raise a number
of concerns. While the estate tax system is a rough tool for mitigating disparities in
inherited income, it is reasonably effective nonetheless. The fairness advantages of a
comprehensive inheritance tax should be weighed against the costs of enacting such far-
reaching reform. On balance, my view is that these costs are worth the benefits of a more
equitable system. Moreover, a comprehensive inheritance tax has advantages along other
dimensions by reducing incentives in the current system to engage in costly and
complicated tax planning.
Family Farms and Other Illiquid Assets. One concern that may arise is the effect
of a comprehensive inheritance tax on family-owned businesses and other illiquid assets.
All of the current relief provisions for such property, and others, could be part of a
comprehensive inheritance tax. -
Given the tendency of this issue to dominate discussion of wealth transfer taxes,
one idea worth consideration is replacing the current relief provisions with a single one
that would completely eliminate the possibility that an heir would need to sell an
inherited family business immediately in order to pay the associated tax liability. This
could be accomplished by providing that, to the extent that the tax due on inherited assets
exceeded the liquid assets an heir inherited, the heir could defer the tax due on his
* International Bureau of Fiscal Documentation, Asia-Pacific Tax Surveys (2006); International Bureau of
Fiscal Documentation, European Tax Surveys (2006); HUGH J. AULT & BRIAN J. ARNOLD, COMPARATIVE
INCOME TAXATION: A STRUCTURAL ANALYSIS (2nd ed., 2004); Ministry of Finance and Economy, Korean
Taxation (2007), available at http://english.mofe.go.kr/issues/laws/financial list.php?sect=laws tax. The
countries included are: Australia, Austria, Belgium, Bulgaria, Canada, Czech Republic, Denmark, Estonia,
Finland, France Germany, Greece, Hungary, Iceland, Italy, Ireland, Japan, Korea, Lithuania, Luxembourg,
Netherlands, New Zealand, Norway, Poland, Portugal, Russia, Serbia, Slovenia, Spain, Sweden,
Switzerland, Turkey, U.K. and the U.S.

40
inherited illiquid assets with interest at a market rate until he sold them. This would
eliminate disincentives and (unlike current law) incentives to hold wealth in illiquid
forms. However, the advisability of this relief provision would depend critically on it
charging interest on any deferred tax, and at a market rate.
State Wealth Transfer Taxes. A second potential concern is the effect of a
comprehensive inheritance tax on state wealth transfer taxes and revenue sharing. Prior to
2005 (and under 2011 law and thereafter), the federal government effectively shared
estate tax revenues with the states through a wealth transfer tax credit. Under a
comprehensive inheritance tax, this and any other form of revenue sharing could also be
replicated.
Moreover, if full federal revenue sharing were not reinstated, a comprehensive
inheritance tax could leave states freer to retain wealth transfer taxes if they so wish.
States would likely act to conform their wealth transfer tax to the inheritance tax model in
order to piggyback on the new federal reporting requirements, as they did under the
federal estate tax credit (even the states that had an inheritance tax). Because it is
generally easier for a retired individual to move to a state with no estate tax than it is for
all of her potential heirs to move to states without inheritance taxes, such a shift could
reduce the pressure on states to eliminate wealth transfer taxes when competing for
wealthy residents.
Giving Patterns and Charitable Contributions. A third potential concern is the
effect of shifting to a comprehensive inheritance tax on giving patterns and charitable
transfers. While such a shift should not have a large effect on the magnitude of wealth
transfers if implemented on a revenue-neutral basis, it could change the identity of
individuals receiving inheritances and the amount of charitable contributions.
A comprehensive inheritance tax should induce donors to give slightly more
broadly, especially to lower-income heirs or those to whom the donor would not have
given previously. These incentives would arise because the tax rate would turn in part on
the heir’s income tax rate, and because transfers to additional heirs would be exempt if
below the heir’s remaining lifetime exemption. How much donors would respond to these
changed incentives is unclear. Nevertheless, to the extent donors did respond, the fairness
benefits of the reform would be magnified as it would further narrow disparities in
inherited income. Notably, neither of these incentives exists under current law. A wealthy
donor can give to 100 heirs or 1, to Paris Hilton or a foster child, and the tax rate is
unaffected,
On the other hand, the reform could affect charitable bequests. In some respects, it
would strengthen incentives for charitable giving. For example, contributions to
nonprofits that are ineligible for the charitable deduction under the income and estate
taxes (e.g., 501(c)(4)s) would be tax-exempt. But the fact that the donor could potentially
make more tax-free transfers by giving to more individuals might weaken incentives to
make charitable transfers on net. Once again, how much donors would respond to these
changed incentives is unclear.” To the extent that donors did make fewer charitable
* Joint Committee on Taxation, supra note 12, at 45.
41
transfers, however, it would generally be because they were spreading their wealth
transfers out over more individuals, -
Administrability and Transition Costs. A fourth potential concern is that replacing
the estate tax system with a comprehensive inheritance tax would entail unacceptably
high transition costs, or result in an unadministrable system. Experience in other
jurisdictions suggests that a comprehensive inheritance tax would be administrable. Each
element of the tax has been implemented at a state level or in other countries. Indeed,
seven U.S. states have some type of inheritance tax in place, and Figure 10 shows that
inheritance taxes are much more common than estate taxes cross-nationally.
Moreover, shifting from the estate tax system to a comprehensive inheritance tax
would not require reinventing the wheel. A valuable infrastructure of legal rules and
administrative practices has arisen under the estate tax, all of which help to prevent
evasion and to promote compliance. Virtually all of these rules and practices could be
retained. For example, the existing rules governing when a transfer has occurred, how i
is valued, and what transfers are taxable could remain unchanged. -
Any large shift in tax policy can result in transition winners and losers. This
tendency could be minimized by making the new tax fully effective (with no look-backs)
on a date before enactment, such as the date the bill was introduced. Ireland, which is the
only jurisdiction I have identified that moved directly from an estate tax to an inheritance
tax, applied these transition rules. This approach would limit gaming around the
transition by preventing donors from making transfers up to the lifetime gift tax
exemption once enactment appears likely. It would also be reasonably equitable. Most
individuals receive only one substantial inheritance over their lifetime so disregarding
prior inheritances and estate taxes should have little effect. For example, among those
who receive a bequest greater than $1.7 million, on average that bequest represents 94
percent of their lifetime inheritances to date.
Compliance Costs and Tax Planning. Finally, one might worry that moving to a
comprehensive inheritance tax would increase compliance costs and tax planning after
the transition. A wealth transfer tax system can impose direct compliance costs on
taxpayers, for example, by requiring them to spend multiple hours reading instructions
and filing returns. It also may impose indirect compliance burdens—which are typically
more costly—by creating incentives to engage in gaming and tax planning by structuring
transfers in ways that are economically identical but taxed more lightly.
If anything, a comprehensive inheritance tax would likely reduce gaming and tax
planning incentives relative to the current system for three general reasons. First, it would
eliminate the need for careful planning of spousal transfers. Currently spouses can reduce
their joint tax liability by making sure that each transfers to their heirs an amount equal to
the lifetime exemption, for example, through a credit shelter trust. Some well-advised
wealthy donors take advantage of this opportunity; others do not. But under a
comprehensive inheritance tax, it would not matter which spouse transfers what. Any tax
would be based on the amount the heir receives, regardless of whether it was from the
mother or father.
42
Second, the comprehensive inheritance tax outlined would significantly narrow
the current substantial differences in how gifts and bequests are taxed. Unlike the current
estate and gift taxes, the same lifetime exemption and the tax rate would apply to the pre-
tax inheritance. Additional features worth consideration could further narrow these
differences. For example, indexing the lifetime exemption to inflation would reduce the
incentive to transfer (or appear to transfer) wealth earlier in time, when the present value
of the exemption is higher. Replacing stepped-up basis for bequests with carryover basis
would eliminate the incentive to hold on to appreciated assets until death in order to
eliminate the capital gains tax liability—and ensure that all capital income is taxed once
regardless of the donor’s access to sophisticated tax advice. The associated compliance
costs would be minimized if stepped-up basis still applied to bequeathed assets worth less
than a certain amount (e.g., $10,000) and not held for the production of income (e.g.,
jewelry and furniture). Moreover, given that Germany, Japan and Australia have
successfully applied carryover basis to bequests, it should be administrable.”
Finally, moving to a comprehensive inheritance tax would permit a different and
simpler method for taxing split or contingent transfers made, for instance, through trusts.
In particular, the new tax system could wait to see who gets what before taxing transfers
for which the taxable status of the beneficiary is unclear. In the meantime, it could
impose a withholding tax. When an heir eventually received his inheritance, he would
receive a refund if the amount withheld on his share of the funds was more in present-
value terms than the tax he actually owed (using an interest rate equal to the rate of return
earned on the transferred assets). Family-owned businesses and other illiquid assets could
be treated in a manner I describe below. Essentially, this approach would be
economically equivalent to the tax system having perfect foresight regarding which
potential beneficiaries will receive what.
This approach would reduce current tax incentives to engage in valuation games.
While it would create more valuation points, it would limit incentives to try to shift value
to tax-exempt spouses and charities when the ultimate beneficiary is unclear by waiting
to see how much is received by whom. As a result, a wide swath of current rules could be
eliminated. Indeed, the current rules to address valuation games—including those
governing marital trusts, charitable trusts, grantor trusts, and Crummey trusts—compose
one-quarter of a leading casebook.” An estate tax system cannot adopt this wait-and-see
approach. Because its tax rate is based on the amount transferred and not on the amount
received, it has to be levied at the time of transfer.
The advantages of shifting to a comprehensive inheritance tax with respect to tax
planning should only be partially offset by changes in direct compliance costs. A
comprehensive inheritance tax would probably result in about twice as many taxable
returns because there are more heirs than estates and the tax filer would be the heir. If it
entailed a $1.9 million lifetime exemption and 15 percent surtax, however, there would
only be about 13,000 taxable returns annually. The more important source of new direct
compliance costs would be information reporting requirements as heirs and donors
* Ault and Arnold, supra note 26, at 184,
* PAUL R. MCDANIEL, JAMEs R. REPETTI & PAUL R. CARON, FEDERAL WEALTH TRANSFERTAXATION (5"
ed., 2003).
43
should have to report (but not pay tax on) gifts and bequests falling above the annual
exclusions but below the lifetime exemption.
The reduction in tax planning costs under a comprehensive inheritance tax should
substantially exceed any new information reporting and filing costs. Moreover, this
reduction should be mirrored at the governmental level. With fewer rules to enforce and
fewer tax planning strategies to address, administrative burdens should decline.
A comprehensive inheritance tax would thus strengthen the ability of the estate
tax system to achieve its underlying goals with fairly limited downsides. It would be
more effective at reducing disparities in inherited income. The tax rate would be based on
the ability to pay of the person predominantly bearing the tax: the heir. It could also
enhance efficiency and tax simplification. Finally, it would make the income tax more
equitable by adopting a more comprehensive measure of the taxpayer's receipts.
Estate Tax Reform
Replacing the estate tax system with a comprehensive inheritance tax has many
advantages that cannot be achieved by reforming the current system. Inherently, the
estate tax system can only roughly target the unearned income that inheritances represent
because the tax rate is based on the amount transferred. It cannot link the tax rate to the
amount inherited or to the earnings capacity of the heir. Indeed, even if donors received
additional exemptions based on the number of children they have, the estate tax system
would not be better targeted on inherited income because the number of donor children is
actually a poor proxy for the total number of the donor’s heirs and their economic
circumstances. -
Nevertheless, there are a number of ways in which the estate tax system could be
improved if replacing it with an inheritance tax is considered too ambitious. In particular,
several of the simplification benefits of a comprehensive inheritance tax that I have
discussed could be replicated within the estate tax system. Adopting these simplification
options and others would better focus the current system on the amount transferred, and
limit the extent to which the tax burden depends on the donor’s access to sophisticated
tax advice. This, in turn, should make the current system better targeted on inherited
income because the amount a donor transfers is a proxy, albeit an imperfect one, for the
heir’s inherited income.
Five simplification options worth consideration are as follows. Each could be
adopted on a revenue-neutral basis, and the rate structure could be adjusted to ensure that
adoption does not alter the distribution of tax burdens in aggregate.
• First, and most importantly, the tax rate on wealth transfers over the next
several years should be smoothed in order to limit tax planning. The dramatic
changes to the top marginal tax rate and exemption amount create incentives
for donors and heirs to spend enormous amounts of time and resources
making it appear that a gift or bequest occurred in a low-tax year.
* Batchelder & Khitatrakun, supra note 1.
44
• Second, the benefits of a comprehensive inheritance tax with respect to
spousal tax planning could be replicated by permitting a surviving spouse to
use any unused lifetime exemption of his or her deceased spouse. Then the tax
rate on an inheritance would not depend on whether the donor couple was
savvy enough to split their transfers or use spousal trusts in order take full
advantage of their lifetime exemptions.
• Third, the complex relief provisions for family-owned businesses could be
simplified and made more efficient if replaced with a single new relief
provision for all illiquid assets. Specifically, to the extent that the tax due on
illiquid assets exceeded the liquid assets that an heir inherited, he could be
allowed to defer the tax due with interest at a market rate until he sold the
illiquid assets. Such a provision might address concerns about the forced sale
of family-owned businesses more effectively even if, as the evidence suggests,
no such forced sale has ever occurred.” In addition, if the interest rate were
set correctly, it would eliminate both incentives and disincentives to hold
wealth in illiquid forms. It is only worth consideration, however, if interest
were applied and at a market rate. Otherwise, it could result in substantial
gaming by sophisticated donors and heirs who do not need protection.
• Fourth, replacing stepped-up basis for bequests with carryover basis would
remove one of the most common traps for the unwary. Many elderly investors
sell underperforming appreciated assets without realizing that, in doing so,
they are reducing the value of their estate by paying the associated capital
gains tax liability. Under current law, the tax due can be avoided forever if the
donor instead bequeaths the asset and the heir sells it. -
• Finally, the countervailing incentives to inherit wealth transfers as gifts under
current law could be mitigated through several changes. Indexing the lifetime
exemption to inflation would reduce the incentive to receive inheritances
earlier in time when the present value of the exemption is higher. Applying
the gift tax on a tax-inclusive basis (like the estate tax) and unifying the gift
tax and estate tax lifetime exemptions would further limit tax planning. In
addition, reducing the annual gift tax exclusion would limit the incentive to
set up complicated tax planning vehicles, such as Crummey trusts, in order to
take advantage of each year’s exemption.
IV. Conclusion
Inherited income tends to exacerbate existing economic disparities and may be the
most important barrier to intergenerational economic mobility. As a result, any equitable
tax system should account for whether a household has inherited an extraordinarily large
amount when allocating tax burdens. As Franklin D. Roosevelt declared: “inherited
economic power is as inconsistent with the ideals of this generation, as inherited political
* For instance, neither the American Farm Bureau nor the New York Times has been able to identify a
single instance of a family farm being sold to pay estate taxes. MICHAEL J. GRAETZ & IAN SHAPIRO, DEATH
BY ATHOUSAND CUTS: THE FIGHT OVERTAXING INHERITED WEALTH 126 (2005).
45
power was inconsistent with the ideals of the generation which established our
government.”
Presently, the estate tax system is the most important mechanism by which our
fiscal system mitigates the effect of inheritances on economic disparities and
intergenerational mobility. It is borne largely by a small number of heirs, and, on average,
its burdens rise rapidly with the amount inherited. However, the relationship between the
heir’s financial circumstances and his or her estate tax burden is relatively imprecise.
Some individuals who receive extraordinarily large inheritances bear little or no tax
burden, while a small number who inherit relatively small amounts bear a substantial tax
burden.
The scheduled repeal of the estate tax in 2010 and reinstatement at higher levels
in 2011 create an opportunity to better focus the estate tax system on the unearned
income that inheritances represent—an opportunity that should not be missed. One
reform option worth consideration is simplifying the estate tax system so that it better
targets the amount transferred as a proxy for the amount inherited. An even better option
would be to replace it with a comprehensive inheritance tax that directly taxes
extraordinary amounts of inherited income at the same or higher rates than earned
RHCOPYRC. sº
Either way, we should use the upcoming opportunity for change—not to increase
inherited economic power by repealing the estate tax or reducing the share of revenue it
raises—but to reform it so as to tax inherited income in a more equitable way.
* Franklin D. Roosevelt, Message to the Congress on Tax Revision (June 19, 1935), in PUBLICPAPERS AND
ADDRESSES OFFRANKLIN D. ROOSEVELT. Vol. 4. (1938).
46
United States Senate Committee on Finance Hearing
Alternatives to the Current Federal Estate Tax System
March 12, 2008
Responses to Questions Submitted for the Record
Lily L. Batchelder
NYU School of Law
June 24, 2008
Senator Baucus
1.) Professor Batchelder, some wealth transfer tax systems tax the transferee of a gift
or bequest. Some believe this type of wealth transfer tax system is more equitable.
Rather than taxing the donor, it taxes the income of the beneficiary.
a. Would the effect of your proposal simply be to shift the payment, planning
and recordkeeping burden to the beneficiary, as opposed to the estate?
The proposal would do much more than shift compliance burdens on to heirs. It
would improve the fairness of wealth transfer taxes—and the tax system as a
whole—by better linking tax burdens to the ability to pay of the person burdened
by the tax, the heir. At the same time, it would make the tax system more
transparent and simple.
As explained in my written testimony, both the estate tax and the proposed
inheritance tax are generally borne by heirs receiving extraordinarily large
inheritances, not donors or heirs receiving small inheritances. According to my
estimates with Surachai Khitatrakun, approximately 96 percent of estate tax
revenue in 2009 will be derived from individuals inheriting more than $1 million.
Currently the estate tax is the only tax that applies to these extraordinarily large
inheritances because gifts and bequests received are exempt from the income and
payroll taxes. Such a tax exemption may be appropriate for ordinary inheritances,
which are often associated with the family bonds that we should and do value. But
it is not for extraordinarily large inheritances, which confer an unearned
advantage on those fortunate enough to be born into wealthy households.
If the estate tax were repealed so that such extraordinarily large inheritances were
, also tax-free, the government would effectively be conferring a further advantage
on such heirs. At the same time, it would be penalizing those who work for their
wealth because the revenue to finance estate tax repeal would have to come from
non-heirs. The estate tax thus plays a critical role in ensuring the fairness of the
tax system overall because it is the only tax that applies to inheritances so large
that they are a major source of income for the taxpayer.
47
While the estate tax does a very good job of targeting extraordinarily large
inheritances, however, it can create substantial inequities in individual cases. The
fact that the estate tax centers by design on the donor means, in practice, that it
burdens some heirs receiving relatively small inheritances quite heavily, and
burdens others receiving extremely large inheritances quite lightly. For example,
according to our estimates, 22 percent of heirs burdened by the estate tax have
inherited less than $500,000, while 21 percent of heirs inheriting more than
$2,500,000 bear no estate tax burden.
The proposed inheritance tax would eliminate these inequities. All heirs inheriting
less than roughly $2 million would bear no tax burden on their inheritances, while
all heirs inheriting more would bear some tax burden. As a result, it would better
link wealth transfer tax burdens—and tax burdens overall—to the ability to pay of
the taxpayer.
A further benefit of the proposal is that it would improve public understanding of
the wealth transfer tax system. The fact that the estate tax focuses by design on
the donor tends to lead the public to believe that its economic burdens fall on
donors in practice as well. Moreover, many erroneously believe that heirs are
taxed on their inherited income under the income tax because all other major
sources of income are so taxed. -
These understandable misconceptions have been exploited by advocates of estate
tax repeal who have framed the estate tax as a double tax on frugal, hard-working,
generous donors who are taxed at the moment of death. Instead, the estate tax is a
single tax (and the only tax) imposed on the fortunate few in our society who
inherit amounts so extraordinarily large that they can elect not to work their entire
lives and still support a family at a standard of living better than nine out of ten
American families.
The proposed inheritance tax can help correct these misperceptions because it
falls on heirs both by design and in practice. Moreover, it explicitly subjects a
portion of extraordinarily large inheritances to the income tax. As a result, under
the proposal, the public would probably be able make a more informed decision
about whether to exempt such extraordinarily large inheritances from taxation or
not.
The final advantage of the proposal is that it would simplify the wealth transfer
tax system, for the reasons outlined next.
b. If so, would your proposal actually simplify the U.S. wealth transfer tax
system?
I believe the proposal would simplify the U.S. wealth transfer tax system. Tax
experts tend to distinguish between three kinds of tax complexity: rule
complexity, compliance complexity, and transactional complexity.' I expect that
' DAVID BRADFORD, UNTANGLING THE INCOMETAX 266-67 (1999).
48
the proposal would alter the mix of these types of complexity, but simplify the
law on net. -
Under the proposal, rule complexity, or the costs generated by uncertain legal
rules, should decline. Many of the existing estate tax rules—such as those
governing when a transfer has occurred, how it is valued, and what transfers are
taxable—could be improved or simply remain part of the law. But many others,
for reasons explained below, could be eliminated entirely.
Compliance complexity should increase slightly due to the shift of some
recordkeeping and filing burdens to heirs, but the overall burden should remain
quite small. We estimate that 0.3 percent of heirs (12,972) would be subject to
and burdened by the inheritance tax in 2009. By comparison, the 2009 estate tax
would impose payment obligations on about 0.3 percent of estates (6,795) and
burden about 0.5 percent of heirs (21,519).
Most importantly, the proposal should reduce transactional complexity—or the
tax planning costs incurred when tax law treats economically-similar
arrangements differently. It should do so in three ways.
First, the proposal would eliminate the need for careful planning of spousal
transfers. Currently spouses can reduce their joint tax liability by making sure that
each transfers an amount equal to the lifetime exemption to their heirs. Under the
proposal, this would no longer be necessary. The tax would be based on the
amount the heir receives, regardless of whether it was from his mother or father.
In addition, the proposal would significantly reduce current incentives to
characterize wealth transfers as gifts rather than bequests. Unlike current law, it
would apply the same lifetime exemption and effective tax rate to gifts and
bequests. Moreover, if the lifetime exemptions were indexed to inflation, it would
also reduce the incentive to transfer (or appear to transfer) wealth earlier in time,
when the present value of the exemption is higher.
Finally, the proposal should reduce the tax benefits of engaging in valuation
games. While it would create more valuation points, it would reduce incentives to
shift value to tax-exempt spouses and charities when the ultimate beneficiary is
unclear because it could wait to see how much is received by whom before
applying the final tax. As a result, a wide swath of current rules could be
eliminated.
Transactional complexity tends to be the most costly kind of complexity. While
many of these simplification reforms could be adopted under the estate tax, the
final category could not be. Thus, shifting to the proposed inheritance tax should
simplify the law overall. - -
2.) Professor Batchelder, you describe a tax deferral proposal for heirs inheriting
illiquid assets. You state that this would prevent an heir from having to sell off the
family business to pay the taxes, at least until the heir sold the assets.
49
a. What would be the filing requirement for the heir? Would the heir be
required to get the property appraised or valued? If so, how often? Wouldn’t
this create a huge burden on the taxpayer? -
If such a proposal were considered politically necessary, I would suggest
requiring heirs to submit a form annually to the IRS stating whether the heir had
received any distributions from the business or sold all or a portion of it, probably
with confirmation from the business. The definitions of distributions and sales
could parallel those in Section 6166(g). However, it is critical that, unlike under
Section 6166, interest should accrue at a market rate, and the taxpayer should be
required to use all distributions and sale proceeds first to satisfy the accrued tax
liability and interest.
The annual filing requirement should not be a huge burden on the taxpayer and
businesses as it simply requires confirmation of a fact of which both should be
well aware—whether the heir has sold or received cash from the business.
Moreover, the number of heirs who could conceivably need to sell part of an
inherited business in order to pay the proposed inheritance tax absent this
provision—and thus the number eligible for the tax deferral proposal—should be
miniscule.
Specifically, we have estimated that less than 3 in 1,000 heirs (12,972) would be
subject to the inheritance tax. In addition, the Tax Policy Center has estimated
that fewer than 3 percent of taxable estates are composed of more than 50 percent
business assets. Thus, it is likely that far fewer than 400 heirs would be eligible
for the deferral provision if it were considered politically necessary.
I do not think it would be necessary for the heir or IRS to appraise the business
annually after it was inherited, although the IRS should be able to do so as part of
an audit if the IRS thought that the taxpayer was evading the tax by failing to
report sales or distributions. *
b. What happens in the event that the heir never sells the asset? When and
how would the tax be collected?
If the heir never sold the asset or business, the tax liability and interest payments
would continue to accrue at a market rate indefinitely. However, to the extent that
the heir withdrew funds from the business through distributions or partial sales, he
should be required to use those funds to satisfy the tax liability and interest.
If the heir did not report distributions and sales proceeds sufficient to satisfy the
tax liability and interest for a number of years, the question would arise of
whether he was evading the tax by withdrawing cash for personal consumption in
other ways. For example, if an heir controlled the inherited business, he could be
*Three percent of 12,972 is about 400. The number of heirs eligible should be much less than 400 because
only heirs inheriting assets worth over $190 million (fewer than 70 annually) would be subject to a 50
percent effective tax rate under the proposal.
50
forcing it to sell assets to another business he controlled at a nominal price, and
then forcing that second non-inherited business to distribute the proceeds to him.
Alternatively, if an heir controlled an inherited business, he could cause it to pay
him an extraordinarily high salary without performing commensurate services in
exchange. One way to address these potential tax shelters would be to grant to the
IRS a lien or right to foreclose upon the business in such circumstances. Another
option, which would never entail forced sales, would be to treat compensation
above a certain level, and sales to other businesses controlled by the heir, as de
facto distributions to the heir after a period of time.
3.) Professor Batchelder, you have testified about different forms of wealth transfer tax
systems.
a. What are the disadvantages to these different systems?
The disadvantages of each approach to taxing wealth transfers are generally the
advantages of the others. -
The first option is to impose no tax on extraordinarily large wealth transfers. In
my view, the disadvantages of this approach are the greatest. Assuming income
from gifts and bequests continues to be tax-free under the income and payroll
taxes, this option would entirely exempt a major source of income from
taxation—and the only source of income directly attributable to privilege. As a
result, holding revenue constant, it would necessarily result in a lower tax burden
on those who have benefited from extraordinarily large inheritances and a higher
tax burden on those whose income is the result of their own saving and hard work.
Essentially, it would permit extraordinarily wealthy heirs to live off their
inheritance without ever working and to pay taxes at a lower rate than their
housekeeper or personal assistant. - -
Further drawbacks of this approach arise once one considers how the lost revenue
would be replaced. If the revenue were not replaced, it would likely result in
larger deficits and cuts to programs that middle- and low-income Americans rely
upon. If it were replaced with less progressive taxes, it would magnify economic
disparities and increase tax burdens on middle- and low-income Americans. And
if it were replaced with taxes that were comparably progressive on an aggregate
level, it could result in significantly higher marginal tax rates on those whose
earned (as opposed to inherited) income places them in the top 1 percent of the
economic income distribution, thereby resulting in greater distortions to work and
saving decisions relative to the status quo. Moreover, all three possibilities would
send a perverse signal about the value society places on able-bodied adults
supporting themselves. -
Lastly, exempting large inheritances from tax would magnify current incentives to
shelter income by making it appear that it was earned by a relative in a lower tax
bracket. It could therefore result in more tax planning costs and tax evasion.
51
The second option is to apply an estate and gift tax to wealth transfers, as under
current law. I confess that I see no disadvantages of an estate tax relative to
having no wealth transfer tax at all. Some argue that estate taxes are relatively
inefficient because they may depress private savings but the evidence is weak and
can be explained by avoidance activities.” Moreover, others contend that estate
taxes may be one of the most efficient types of taxes—and more efficient than
income, payroll, and consumption taxes—because a very large share of wealth
transfers is unresponsive to the tax rate."
Relative to an inheritance tax, the principal disadvantages of an estate tax are
inequities in individual cases, a lack of transparency, and greater transactional
complexity, as described in my response to Question 1(a). On average, the estate
tax does quite a good job of correcting for the income tax and payroll tax
exemptions for extraordinarily large amounts of inherited income—and of basing
tax burdens on the ability to pay and privilege of the person bearing the tax, the
heir. Nevertheless, because the tax rate is not directly linked to the ability to pay
or privilege of the heir bearing the tax, it can result in substantial overtaxation or
undertaxation in individual cases, as described above. It also contributes to the
public misconception that the burden of wealth transfer taxes falls on the donor,
not the heir. Perhaps for this reason, a number of countries that had estate taxes
have repealed them, while inheritance taxes have been much more political stable.
The third option is an inclusion-type inheritance tax, under which gifts and
bequests (perhaps above an exempt amount) are included in annual income under
the income tax. One drawback of this approach is that, depending on the year, it
would result in a 10 to 15 percentage point cut to the top marginal rate applied to
wealth transfers—and in labor income being subject to higher tax rates than
extraordinarily large inheritances. This rate cut in turn would necessitate a much
lower exemption than the estate tax or the other inheritance tax alternatives in
order to raise the same amount of revenue. As a result, far more taxpayers would
be subject to recordkeeping and filing burdens. A further drawback is the annual
(as opposed to lifetime) exemption of an inclusion tax. It would create significant
tax planning incentives for families to spread out their wealth transfers over time.
As a result, heirs from families that obtained good tax advice would be taxed at
much lower rates than those from less savvy families. For these reasons, I view
this approach as superior to having no wealth transfer tax, but inferior to an estate
tax or the other inheritance tax options.
*See William G. Gale and Maria Perozek, Do Estate Taxes Reduce Savings?, in RETHINKING ESTATE AND
GIFT TAXATION 216 (William G. Gale et al, eds, 2001); David Joulfaian, The Behavioral Response of
Wealth Accumulation to Estate Taxation: Time Series Evidence, 59 Nat’l Tax J. 253 (June, 2006);
Wojciech Kopczuk and Joel Siemrod, The Impact of the Estate Tax on the Wealth Accumulation and
Avoidance Behavior of Donors, in RETHINKING ESTATE AND GIFT TAXATION 299 (William G. Gale et al,
eds, 2001).
* See, e.g., Wojciech Kopczuk and Joseph P. Lupton, To Leave or Not to Leave: The Distribution of
Bequest Motives, 74 REV. ECON, 207 (2007).
52
The fourth option is to adopt an accessions-type inheritance tax, which taxes gifts
and bequests received (above a very large lifetime exemption) at a tax rate
separate from that of the income tax. The principle drawback of this approach is
that the tax rate would not be as equitable as that of a comprehensive inheritance
tax because the tax rate would not take into account the heir’s other income. For
example, unlike a comprehensive inheritance tax, it would tax a disabled person
inheriting $3 million at the same rate as a hedge fund manager inheriting $3
million. It would also entail slightly more recordkeeping burdens than an estate
tax, although the burdens under both would be very small.
The final option is a comprehensive inheritance tax, which taxes amounts
inherited (above a very large lifetime exemption) at the heir’s income tax rate plus
an additional tax. Like an accessions tax, it would entail slightly higher
recordkeeping burdens than an estate tax. The main disadvantage relative to an
accessions tax is that it requires a lower exemption. However, this is the price of
taking into account the other income of the heir when allocating the tax burden.
Consequently, I view this approach as entailing the greatest benefits and fewest
drawbacks on balance.
b. What effect would these alternative tax systems have on small businesses?
The effect of an estate tax and the different types of inheritance taxes on small
businesses depends on how large the exemption is and what rules apply to small
businesses and other illiquid assets. If each alternative were implemented on a
revenue-neutral basis, the only inherent difference between an estate and
inheritance tax is that a small business would be more likely to exceed the
inheritance tax exemption if it were given to one heir, and more likely to exceed
the estate tax exemption if it were given to multiple heirs.
As noted in my response to Question 1(a), very few family businesses should be
affected by either the estate tax or an inheritance tax at existing revenue levels.
Indeed, neither the American Farm Bureau nor New York Times were able to
identify a single family farm that had been sold to pay the estate tax.’
That said, the current provisions governing gifts and bequests of illiquid assets
should certainly be improved, as explained above. In my view, the goal should be
to eliminate biases both in favor of and against investing in family businesses.
c. What type of transition rules would have to be developed to change a system
from taxing the donor to taxing the beneficiary?
d. What steps would the Government have to take to make these changes?
Regarding questions (c) and (d), there is only one critical transition rule that
would need to be established if a comprehensive inheritance tax or accessions tax
* MICHAELJ. GRAETz ANDIAN SHAPIRO, DEATH BY ATHOUSAND CUTS: THE FIGHT OVERTAXING
INHERITED WEALTH 126 (2005).
53
were adopted. Namely, (1) inheritances received after a date prior to enactment
(such as the date the bill was introduced) should count towards the new lifetime
exemption under the inheritance tax, and (2) heirs should be able to claim a credit
for any estate or gift taxes paid on inheritances received after that date. If this rule
were not established, each heir could effectively claim two lifetime exemptions,
rather than one. He could do so by having his donor first transfer an amount equal
to the gift tax lifetime exemption once enactment seemed likely, and then transfer
an amount equal to the inheritance tax lifetime exemption once the new regime
was actually enacted.
Beyond this fundamental rule, there are two principle approaches Congress could
take when developing transition rules. The first would be to exempt all
inheritances prior to the introduction date from the lifetime inheritance tax
exemption and give heirs no credit for estate and gift taxes paid on those
inheritances. Effectively, the transition date would then be the introduction date.
The second option would be to count all prior inheritances an heir had received
towards his lifetime inheritance tax exemption, and simultaneously give him
credit for any prior estate and gift taxes paid on amounts he inherited. Effectively,
the transition date would then be the heir’s date of birth.
The advantage of the first approach is that there would be no need for the heir,
donor or IRS to track down records regarding wealth transfers that occurred many
years in the past. In particular, the heir would not need to know whether any
estate tax was paid on the transfer, and the IRS would not need to have records of
inheritances on which no tax was due. The first approach would also prevent heirs
who do have good records from “whipsawing” the government and reporting
prior inheritances on which estate and gift taxes were paid, while failing to report
inheritances that were tax-free. The advantage of the second approach is that it is
more precise.
While I tend to favor the first approach, either is reasonable and the stakes should
be relatively small. Data from the Survey of Consumer Finances suggest that
among children who receive a bequest greater than $1.7 million, the bequest on
average represents 94 percent of their lifetime inheritances to date. As a result,
relatively few inequities should result if the first approach were adopted, and
relatively little evasion if the second were embraced.
The transition to an inclusion-style inheritance tax would be more complicated.
Although inclusion taxes traditionally involve an annual exemption, I would
recommend applying a lifetime exemption as well in order to limit inequities and
wasteful tax planning. In other words, inheritances below a small annual
exemption would not be reportable as under current law, and inheritances below a
much larger lifetime exemption would not be taxed even if reportable.
Inheritances exceeding both exemptions would be included in income. If this
recommendation were adopted, prior inheritances and estate and gift taxes paid
could count under the new regime in the manner described above.
54
e. How would the Government administer the new system?
If an heir has received a “reportable inheritance” (i.e., a gift or bequest exceeding
the annual exemption amount) at some point, I would suggest requiring the heir to
file an annual information return reporting his cumulative reportable inheritances.
Alternatively, if the IRS information technology infrastructure is improved as
planned, the requirement could simply be for the heir to submit an updated
information return each time he receives a reportable inheritance. Either way,
most individuals never will have to file an information return because two-thirds
of bequests received are worth less than $50,000. -
Because third party reporting and withholding are essential for maximizing
compliance, donors or their estates should also be required to file information
returns on reportable inheritances and remit a withholding tax on them. The heir
would be responsible for claiming any excess tax withheld or paying any excess
tax due if his lifetime reportable inheritances exceed the lifetime exemption.
If the beneficiaries of a wealth transfer are unclear, the donor or estate should still
remit the withholding tax. However, the heir should only be able to claim a credit
for the taxes withheld when he receives a distribution or it became clear what his
share will be. As I have explained in prior work, this credit could be calculated in
such a manner that it accrues interest at a rate equal to the rate of return earned by
the assets in the interim.” - - • -
Senator Grassley
1.) Professor Batchelder, in reviewing your testimony as well as your writings we
determined that the transition to the potential new inheritance based system would
be immediate and would not provide any credit for gift or estate taxes paid unless
an estate had been closed prior to the effective date in question. How did you make
this decision, and how could we justify to our constituents a system that does not
provide any credit or exemptions for payments that individuals have already made
to the government within the structure of the current wealth transfer system?
I apologize that my testimony and writings were unclear. If the proposed
inheritance tax were adopted, my intention was not to count inheritances
previously received towards the new lifetime exemption while disregarding estate
and gift taxes paid on prior inheritances. Instead, as explained in my reply to
Questions 3(c) and 3(d) from Senator Baucus, I believe that some or all estate and
gift taxes paid on inheritances received prior to the date of enactment should be
counted, but only if such inheritances count towards the new lifetime exemption
as well. -
To be more specific, the only transition rule that I consider essential is to provide
that (1) inheritances received after a date prior to enactment (such as the date the
° Lily L. Batchelder, Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax
25, Box 1 (Hamilton Project Discussion Paper 2007-07, June, 2007). -
55
bill was introduced) should count towards the new lifetime exemption under the
inheritance tax, and (2) heirs should be able to claim a credit for any estate or gift
taxes paid on inheritances received after that date. This rule is critical because
otherwise each heir could effectively claim two lifetime exemptions, rather than
one. He could do so by having his donor first transfer an amount equal to the gift
tax lifetime exemption once enactment seemed likely, and then transfer an amount
equal to the inheritance tax lifetime exemption once the new regime was actually
enacted.
Beyond this fundamental rule, there are two approaches Congress could take in
developing further transition rules. The first would be to exempt all inheritances
received prior to, for example, the introduction date, from the lifetime inheritance
tax exemption, while giving heirs no credit for estate and gift taxes paid on those
inheritances. Effectively, the transition date would then be the introduction date.
The second option would be to count all inheritances an heir has ever received
towards his new lifetime inheritance tax exemption, and simultaneously give him
credit for any estate and gift taxes paid on amounts he has ever inherited.
Effectively, the transition date would then be the heir’s date of birth. I do not have
strong feelings about which approach is better. While I tend to favor the first,
either is reasonable and the stakes should not be very large for the reasons
explained in my response to Senator Baucus' questions.
2.) In your opinion, would the value of the prevention of potential “gaming” of the
system outweigh the value of the gift taxes submitted by many Americans based on
attempts at sound estate planning?
Again, I apologize for my lack of clarity. I do not think prior gift taxes paid
should be disregarded to the extent that the inheritance on which gift tax was paid
is counted under the inheritance tax as well. The only gaming I am concerned
about is the possibility of heirs claiming credit for gift taxes paid on inheritances
that they are not obliged to report. --
Senator Hatch
1.) Professor Batchelder, in your written testimony you mentioned either an
inheritance tax or an accessions tax. Please outline for me the differences between
the two and contrast the benefits and disadvantages of each to our current system.
In my view, there are actually three kinds of inheritance taxes: an inclusion tax, an
accessions tax, and a comprehensive inheritance tax. Under an inclusion tax, gifts
and bequests (above an annual exemption) are included in annual income under
the income tax. Under an accessions tax, gifts and bequests received (above both
an annual exemption and a very large lifetime exemption) are taxed at a rate
separate from that of the income tax. Finally, under a comprehensive inheritance
tax, gifts and bequests received (again, above both an annual exemption and a
very large lifetime exemption) are taxed at the heir’s income tax rate plus an
additional tax. I believe both an accessions tax and a comprehensive inheritance
56
tax would be superior to the current wealth transfer tax system, although a
comprehensive inheritance tax would be the best. .
The principle difference between an accessions tax and a comprehensive
inheritance tax is that the tax rate under the former is based solely on the amount
inherited, while the tax rate under the latter is based on both the amount inherited
and the heir’s other income. For example, an accessions tax would tax a disabled
person inheriting $3 million at the same rate as a hedge fund manager inheriting
$3 million. By contrast, a comprehensive inheritance tax would tax the disabled
individual less heavily and at a rate based on his income tax rate. A
comprehensive inheritance tax would also be integrated with the income tax,
thereby making the current income tax exclusion for inherited income apparent. I
prefer a comprehensive inheritance tax for these reasons.
Relative to the current system, the principal advantages of both an accessions tax
and a comprehensive inheritance tax are greater equity in individual cases, greater
transparency, and less complexity, as described in my responses to Questions 1(a)
and 1(b) from Senator Baucus. - - -
In particular, as explained in my written testimony, both the estate tax and the
proposed inheritance tax are generally borne by heirs receiving extraordinarily
large inheritances—not by donors or heirs receiving small inheritances. For
example, according to my estimates with Surachai Khitatrakun, approximately 96
percent of estate tax revenue in 2009 will be derived from individuals inheriting
more than $1 million. Currently the estate tax is the only tax that applies to these
extraordinarily large inheritances because gifts and bequests received are exempt
from the income and payroll taxes. The estate tax thus plays a critical role in
ensuring the fairness of the tax system overall because it is the only tax that
applies to inheritances so large that they are a major income source over one’s
lifetime. *
Nevertheless, while the estate tax does a very good job of targeting
extraordinarily large inheritances, it can create substantial inequities in individual
cases. The fact that the estate tax centers on the donor by design means, in
practice, that it burdens some heirs receiving relatively small inheritances quite
heavily, and burdens others receiving extremely large inheritances quite lightly.
For example, according to our estimates, 22 percent of heirs burdened by the
estate tax have inherited less than $500,000, while 21 percent of heirs inheriting
more than $2,500,000 bear no estate tax burden.
An accessions tax or comprehensive inheritance tax would eliminate these
inequities. For example, under the proposed comprehensive inheritance tax, all
heirs inheriting less than roughly $2 million would bear no tax burden on their
inheritance, while all heirs inheriting more would bear some tax burden. As a
result, the proposal would better link wealth transfer tax burdens—and tax
burdens overall—to the ability to pay of the taxpayer.
57
A further benefit of both an accessions tax and a comprehensive inheritance tax is
that each would improve public understanding of the tax system. The fact that the
estate tax focuses on the donor by design tends to lead the public to believe that
its economic burdens fall on donors in practice as well. Moreover, because the
income tax generally taxes income from all sources, many believe that heirs are
taxed on their inherited income. These understandable misconceptions have been
exploited by advocates of estate tax repeal who have framed the estate tax as a
double tax on frugal, hard-working, generous donors who are taxed at the moment
of death. Instead, the estate tax is a single tax—and the only tax— imposed on the
fortunate few in our society who inherit amounts so extraordinarily large that they
can elect not to work their entire lives and still support a family at a standard of
living better than nine out often American families.
Both an accessions tax and a comprehensive inheritance tax can help correct these
misperceptions because they fall on heirs both by design and in practice.
Moreover, a comprehensive inheritance tax has the further benefit of explicitly
taxing a portion of extraordinarily large inheritances under the income tax. As a
result, both approaches—but especially a comprehensive inheritance tax—could
help the public make more informed decisions about whether we should continue
to tax extraordinarily large inheritances or exempt them from all federal taxes.
Finally, for the reasons outlined in my response to Question 1(b) from Senator
Baucus, both an accessions tax and a comprehensive inheritance tax should be
simpler than the current system. While both would probably increase the number
of people required to file returns if implemented on a revenue-neutral basis, both
would reduce the number of rules the IRS enforces and decrease incentives for tax
planning—the most costly type of tax complexity. , -
2.) From my viewpoint, one of the biggest problems with any kind of wealth transfer
tax is the difficulty it poses to a family business being passed from one generation
to the next. As you all know, there is a high mortality rate for small businesses
anyway, and this is only exacerbated by taxes that can make an intergenerational
transfer difficult or impossible. What can be done in designing a wealth transfer
tax to mitigate these problems?
This is a difficult issue because it requires walking a delicate line when designing
a relief provision for family businesses and other illiquid assets in order to
maximize fairness and efficiency. On the one hand, the goal should be to prevent
any tax on wealth transfers from forcing the sale of a well-run family business,
thereby creating disincentives to hold wealth in this form. On the other hand, the
goal should be to prevent any relief provision from creating an incentive to hold
wealth in a family business when the donor would prefer to hold it elsewhere. If a
relief provision is either too generous or too restrictive, it will create these
incentives and disincentives. Both are bad for the donor, and the economy more
generally. Thus, in my view, the goal of any relief provision should be to
eliminate biases both in favor of and against holding wealth in family businesses.
58
The current wealth transfer tax rules governing family businesses are both overly
generous and overly restrictive. They create an incentive to hold wealth in a
family business in many cases. For example, the tax liability due on some
bequests that include a family business can be deferred for 15 years at a below-
market interest rate. The heir, then, effectively receives a below-market loan from
the government because part of his inheritance is a family business. At the same
time, the existing rules do not succeed in protecting all family business from ever
being sold to pay the estate tax—at least at a theoretical level. (In practice, there is
little evidence of family businesses being sold to pay the estate tax' and we
estimate that fewer than 400 heirs would conceivably have to do so under the
proposal if it included no relief provision, as explained in my response to
Question 2(a) from Senator Baucus.)
The solution I have proposed is to permit unlimited deferral of wealth transfer tax
liability at a market rate of interest to the extent that the tax liability exceeds the
liquid assets inherited by the heir (minus a reasonable cushion). The advantages
of this proposal are twofold. It would reduce the distortions created by the current
relief provisions, which provide preferences in favor of investing in closely-held
businesses even when the estate has plenty of liquid assets available to pay the
associated tax liability. At the same time, it would completely eliminate even the
theoretical possibility that an estate or heir would have to sell an inherited illiquid
asset, such as family businesses, in order to pay the wealth transfer tax. Instead,
that portion of the tax liability and the associated interest could be deferred
forever. Importantly, applying a true market interest rate to the deferred tax
liability is critical to ensuring these advantages and preventing revenue loss
within the budget window. -
I have provided further details on this proposed relief provision in my responses
to Questions 2(a) and 26) from Senator Baucus, Question 3 from Senator
Cantwell, and my prior writings. -
3.) Do you believe the primary goal of a wealth transfer tax is to raise revenue or to
achieve certain social goals? How might the goal of such a tax determine the best
way it is structured?
I tend to believe that the role of government is to achieve the goals that society
democratically decides upon, subject to certain fundamental rights. These goals
can be achieved through fiscal policy (i.e., taxes, tax expenditures and direct
expenditures) or regulation. As such, the fiscal system is inseparable from social
goals; we would not have a fiscal system if the public had no social goals and
believed that government should not exist. However, given that the public appears
to believe that we should have a fiscal system, its objective should be to further
our social goals in the simplest, fairest and most efficient manner. -
'MICHAELJ. GRAETZANDIAN SHAPIRO, DEATH BY ATHOUSAND CUTS: THE FIGHT OVERTAXING
INHERITED WEALTH 126 (2005). -
° Lily L. Batchelder, Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax
21–23 (Hamilton Project Discussion Paper 2007-07, June, 2007).
59
As discussed in my testimony, the burden of wealth transfer taxes generally falls
on members of society who receive extraordinarily large inheritances. Such
extraordinary amounts of inherited income are not taken into account when
allocating income and payroll tax burdens, which strikes me as unfair and
inefficient. It means that—if we didn’t have a wealth transfer tax—the most
privileged members of society would bear the lowest tax burdens. It also means
that these individuals would tend to work less or not at all because they could
support themselves and their families solely on inherited income. At the most
general level, therefore, I view wealth transfer taxes as a critical way of partially
offsetting the unfairness and inefficiency of the income and payroll tax
exemptions for inherited income.
I agree, however, that the ideal structure for a wealth transfer tax depends on
one’s social goals, and reasonable people may disagree with each other (and me)
about what these goals should be. In particular, they may believe that the fiscal
system should further at least three different goals: (1) funding programs
unrelated to economic fairness, such as national Security or a court system, (2)
providing a level playing field for each member of society, and/or (3) mitigating
poverty and economic disparities. Although each goal generally implies that the
ideal fiscal system should include a wealth transfer tax, the relative priority of
these goals should affect the ideal structure of this tax.
Starting with the first, if society’s goal is to fund programs unrelated to economic
fairness, such as national security, the goal of the fiscal system should be to raise
revenue and spend it in the most efficient manner. A wealth transfer tax can
further this goal by targeting wealth transfers that economists refer to as “life
cycle savings” or “egoistic.” Such transfers occur to the extent that a donor has
accumulated wealth solely for his consumption needs in retirement or simply
because he enjoys being wealthy—not because he wants to transfer wealth to
others. Economists generally consider a tax on such wealth transfers to be
“perfectly efficient” because the tax does not affect the donor’s work, saving, or
giving behavior. Moreover, it should result in more work by heirs, and thus more
revenue from them. Somewhat surprisingly, life cycle savings and egoistic wealth
transfers appear to comprise the majority, or vast majority, of bequests.”
Unfortunately, however, we do not yet know enough about who makes such
wealth transfers to effectively design a wealth transfer tax targeted solely upon
them.
A second possibility is that society seeks to level the playing field, implying that
the objective of the fiscal system is to redistribute from the most advantaged to
the least advantaged members of society. Wealth transfer taxes can help achieve
this goal by requiring those who receive unusually large inheritances to share their
good fortune with those who are not so privileged. Indeed, wealth transfer taxes
should be indispensible for achieving this goal because inherited wealth is
* See, e.g., Wojciech Kopczuk and Joseph P. Lupton, To Leave or Not to Leave: The Distribution of
Bequest Motives, 74 REV, ECON. 207 (2007). -
60
perhaps the most important source of advantage, as explained in my written
testimony. The ideal wealth transfer tax structure to further this objective might
be an accessions tax, where the tax rate is determined solely by the amount
inherited. Alternatively, it could be a comprehensive inheritance tax if an
individual’s non-inherited income is a good proxy for other sources of advantage
that are not taxed, such as being able to attend better schools.
The final possibility is that society is interested in using the fiscal system to
mitigate poverty and economic disparities, regardless of whether they arise from
inherited traits or bad luck. If so, a wealth transfer tax should also be critical
because inheritances affect economic disparities and whether someone is living in
poverty. The ideal wealth transfer tax structure for achieving this final goal might
be an inclusion tax, given that inheritances currently are not taken into account
under the income and payroll taxes. Then again, if receiving a large inheritance
tends to induce an heir to work less" or confers other non-pecuniary benefits, the
ideal structure might be a comprehensive inheritance tax because it weights
inheritances more heavily than other income when allocating tax burdens.
In short, regardless of one’s social goals, the ideal fiscal system should include a
wealth transfer tax and, under several goals, the ideal structure is plausibly a
comprehensive inheritance tax.
4.) Professor Batchelder, I am puzzled at something in your written statement. You
said that inheritances are perhaps the most important barrier to intergenerational
economic mobility, or the ability of a child to achieve a different standard of living
than that of his parents. Please explain to me how, particularly in the case of a
family-owned business or farm, imposing a tax on the value of that inherited
business or farm helps lower-income children achieve a higher income level than
that of their parents.
Inheritances are potentially the most important barrier to intergenerational
economic mobility because the size of a child’s inheritance tends to be correlated
with his parent’s position on the economic ladder. Put differently, a child who
inherits $10,000 likely comes from a low- or middle-income family and a child
who inherits $10 million probably comes from an extraordinarily wealthy
household. The latter heir is much more likely to end up at the top of the
economic ladder because he has $10 million in income before ever working.
Indeed, recent evidence suggests that inheritances account for about 40 percent of
the correlation between parent and child lifetime income."
"See, e.g., David Joulfaian Inheritance and Saving (Nat’l Bur of Econ. Research Working Paper No.
12569) (Oct. 2006); Jeffrey R. Brown et al, The Effect of Inheritance Receipt on Retirement (Nat’l Bur. of
Econ. Research Working Paper No. 12386) (July 2006); Douglas Holtz-Eakin et al, The Carnegie
Conjecture: Some Empirical Evidence, Q. J. ECON, 413 (May 1993).
"Samuel Bowles, et al, Introduction 1, 18-19, in UNEQUAL CHANCES: FAMILY BACKGROUND AND
ECONOMICSUCCESS 1, 18-20 (Samuel Bowles et al, eds., 2005)
61
My view that wealth transfer taxes can increase intergenerational economic
mobility rests on the assumption we will always have some level of government,
which requires some level of taxes. As a result, when we cut taxes for one group
in society, we necessarily must raise taxes on others.
Currently the estate tax is the only component of the federal tax system that takes
inheritances into account when allocating the burdens of financing government. If
the estate tax were repealed, a child who comes from a wealthy family and
receives an extraordinarily large inheritance could live off his inheritance without
ever working or contributing to the fisc for his entire life.” The tax cut this
individual would receive would further increase the likelihood that his economic
rank in society would end up being similar to that of his parents. Meanwhile,
children who are not so fortunate would have to pay more taxes in order to make
up for the lost revenue. Their increased tax burden after estate tax repeal would
create an additional barrier to them achieving a higher economic position than
their parents.
The same logic applies to a child inheriting a family-owned business or farm.
While family businesses can foster and solidify family bonds in important ways,
they also are assets that can be bought and sold. If an individual inherits a
business worth $10 million, he has the opportunity to live off the profits of a $10
investment or to sell it and spend the $10 million immediately. As a result, he is
much better off than most Americans whose networth is about $60,000.” If we
exempt this individual’s inheritance from all taxes, he will be even more likely to
end up among the super rich, presumably like his parents. Meanwhile, all
others—whose taxes must be raised to pay for his tax cut—would be less likely to
make it to the top of the economic hierarchy.
Senator Roberts
1.) When visiting farmers and small business owners I hear repeatedly that the biggest
cost of the estate tax may not be the tax bill itself, but rather the amount of time and
money they spend in estate planning. In light of the current economic climate, I
think it particularly important to consider this point. The money these individuals
have paid to accountants, lawyers, insurance companies and others in preparing
for the estate tax could have been reinvested to grow their business. I think that
begs the question: how would a move to an inheritance tax impact the planning
costs for these farms and businesses?
The effect of moving to an inheritance tax on the planning costs for family
businesses depends on whether it is coupled with reform of the wealth transfer tax
treatment of illiquid assets more generally. If it were not, the move should only
affect planning costs when the future owners of the transferred business are
* In order to avoid all income taxes, technically he would have to realize zero return or invest in tax-
exempt assets, .
”Alfred O. Gottschalck, Net Worth and the Assets of Households: 2002 (U.S. Census Bureau, Current
Population Reports, Apr., 2008), available at http://www.census.gov/prod/2008pubs/p70-115.pdf.
62
unclear (e.g., if the business is transferred in trust and the beneficiaries of the trust
are to be determined). Then, as I have explained in prior work,” the inheritance
tax should reduce planning costs by eliminating current incentives to try to shift
value to tax-exempt spouses and charities by waiting to see how much is received
by whom before applying the final tax. As a result, a wide swath of current rules
could be eliminated. Indeed, the current rules to address such valuation games—
including those governing marital trusts, charitable trusts, grantor trusts, and
Crummey trusts—compose one-fourth of a leading casebook.”
If the shift were accompanied by reform of the treatment of illiquid assets, an
inheritance tax could reduce planning.costs for family businesses even further. As
I have outlined in my responses to Question 2 from Senator Baucus and Question
2 from Senator Hatch, if it is considered politically necessary, I have proposed
permitting unlimited deferral of wealth transfer tax liability at a market rate of
interest to the extent that it exceeds the liquid assets inherited by an heir (minus a
reasonable cushion). The advantages of this provision are twofold.
First, it would eliminate the planning incentives generated by the current relief
provisions, which create incentives to shift wealth into family businesses even
when the estate has plenty of liquid assets available to pay any estate tax liability.
For example, under current Section 6166, taxes due on bequests that include a
family business can be deferred for 15 years at a below-market interest rate if the
family business composes at least 35 percent of the gross estate. The heir, then,
effectively receives a below-market loan from the government if his donor
ensures that the family business composes at least 35 percent of the value of his
bequest—and no below-market loan if he does not.
Second, this relief provision would completely eliminate even the theoretical
possibility that an estate or heir would have to sell an inherited illiquid asset in
order to pay the associated wealth transfer tax liability. Instead, that portion of the
tax liability could be deferred indefinitely. Importantly, applying a true market
interest rate to the deferred tax liability is critical to ensuring these advantages and
preventing revenue loss within the budget window.
2.) Often, farms and small businesses derive much of their financial worth from assets
such as land and equipment. For farmers and ranchers in particular, significant
increases in land values are having a marked impact on the value of their estate.
Under current law, however, the fact that many assets are not liquid does not stop
us from levying an often burdensome tax on these families. Thus, even in cases
where the next generation wishes to continue with the business or the farm, they
may be forced to break up and sell off assets—assets that are key to the operation of
their business or farm, in order to foot the tax bill.
“Lily L. Batchelder, Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax
41-46 (Hamilton Project Discussion Paper 2007-07, June, 2007).
*PAULR. MCDANIEL, JAMES R. REPETTI, AND PAULR. CARON, FEDERAL WEALTHTRANSFERTAXATION
(5th ed., 2003).
63
Can you tell me how replacing our current estate tax with an inheritance tax would
impact farmers, rangers and other small business owners whose ‘wealth’ is
primarily composed of assets like land or equipment?
I would hate for concern about this issue to distract lawmakers from the
importance of having a wealth transfer tax as part of the fiscal system in the first
place. Neither the American Farm Bureau nor the New York Times were able to
identify a single instance of a family farm being sold to pay the estate tax."
Moreover, under the inheritance tax I have proposed, we estimate that far fewer
than 400 heirs would conceivably need to sell business assets in order to pay the
proposed tax even if there were no relief provisions for illiquid assets or family
businesses.
That said, if it is considered necessary politically, the relief provision I have
proposed should fully address your concern. As noted above, it would completely
eliminate even the theoretical possibility that an heir would need to sell business
assets in order to pay the inheritance tax. Moreover, by shifting the focus of
current relief provisions to include all illiquid assets—not just those held in a
business—it would address your concerns about equipment. Further details on
this proposal are provided in my responses to Question 2 from Senator Baucus,
Question 2 from Senator Hatch, Question 3 from Senator Cantwell, and my prior
writings." - -
Senator Schumer
1.) I am intrigued by the inheritance tax proposal, but I have some questions. The
proposal would tax the individual that receives the inheritance, but doesn't that
pose a significant problem if the bulk of the assets given to a particular individual
are not cash or liquid assets? It’s not unusual to have specific bequests of property
that can’t be readily sold to pay an inheritance tax. With an estate tax, all of the
assets (liquid and non-liquid) are available to pay whatever tax is owed before the
property is distributed. I understand how your proposal would deal with businesses,
but what about other illiquid assets?
I apologize that my testimony was unclear but, to the extent that relief for
businesses is considered politically necessary, my intention is for the tax deferral
proposal to apply at the heir level and to all illiquid assets, not just businesses. For
example, if an heir inherited more than the lifetime exemption and all of the assets
he inherited were illiquid, he could defer the tax and accrued interest indefinitely
until he sold some or all of the assets or otherwise withdrew funds from them.
* MICHAELJ. GRAETZANDIAN SHAPIRO, DEATH BY ATHOUSAND CUTS: THE FIGHT OVERTAXING
INHERITED WEALTH 126 (2005).
"Lily L. Batchelder, Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax
21-23 (Hamilton Project Discussion Paper 2007-07, June, 2007).
64
Further details on this proposal are provided in my responses to Question 2 from
Senator Baucus, Question 2 from Senator Hatch, Questions 1 and 2 from Senator
Roberts, Question 3 from Senator Cantwell, and my prior writings.”
2.) Decisions of how you distribute your lifelong gain are very personal decisions.
Often there are legitimate reasons for distributing more wealth to one child or
another.
a. What are the ramifications of a reform system that punishes someone for
not spreading the value of his or her estate among as many heirs as
possible?
b. For example, consider a case where the bulk of an estate is left to a
handicapped child to provide for his or her care. Should we tax this child
more heavily because his needs are so great that the bulk of the inheritance
went to him?
This is an important issue, and I actually think that the inheritance tax proposed
may address some of your fairness concerns more effectively than the estate tax.
To begin, I tend to view the principal fairness issue when allocating wealth
transfer tax burdens not as how much donors should bear relative to each other—
but rather how much individual heirs should bear relative to each other and
individuals who inherit nothing. This view is based on two facts. First, the
incidence of wealth transfer taxes (whether structured as an estate tax or
inheritance tax) appears to fall predominantly on recipients not donors, as
explained in my written testimony and prior writings. Second, inherited income is
currently exempt from the income and payroll taxes.
Given these facts, in my view the fairest way to allocate federal tax burdens
amongst heirs—and between heirs and non-heirs—is to require inclusion of
extraordinarily large inheritances in the tax base, and to subject such inheritances
to a tax rate roughly comparable to that imposed on income from work. That is,
essentially, what the proposed comprehensive inheritance tax does. This approach
ensures that heirs are taxed on their economic income, not the wealth of their
benefactors. It also ensures that extraordinary amounts of inherited income are
taxed at the same rate as income of those who pull themselves up by their own
bootstraps by personally earning their income.
While the estate tax does a very good job of accomplishing these objectives, it can
create substantial inequities between individual heirs, as described in response to
your fifth question. These inequities would never arise under the proposal
because, unlike the estate tax, it allocates tax burdens based on the amount
inherited and the heir's tax rate on labor income by design. -
* Id.
65
It is true that the proposal creates incentives for an extremely wealthy donor to
distribute wealth more broadly and to those with less income from other sources
in certain circumstances—but in my view this is a salutary effect. I tend to view a
tax exemption as appropriate for ordinary inheritances or those meeting the basic
needs of the heir, But at some point an inheritance can become so large that it is
not furthering family bonds or meeting any conceivable financial need—instead it
is creating an entrenched economic elite. At this point, it becomes appropriate to
tax additional inherited income just like income from work, and to start creating
incentives for the donor to give further wealth to those outside her inner circle
who have not inherited so much. The $2 million lifetime exemption under the
proposal seems easily to have passed this threshold—an heir who inherits this
amount at age 18 can never work a day in his life and still support a family at a
higher standard of living than nine often American families.
One final thing to note is that the proposal would actually create an incentive to
give more to the disabled child in your example. Just as it creates an incentive to
give to those with little inherited income once one’s “regular” heirs have already
inherited extraordinary large amounts, it also creates an incentive to give more to
a “regular” heir with less earning ability. This occurs because any tax imposed on
a very large inheritance is linked to the heir’s income tax bracket. A disabled heir
would presumably fall into the zero income tax bracket prior to receiving his
inheritance because he should have little earned income and large deductions for
medical expenses. If so, he would be taxed at a lower rate than another heir who
inherited the same amount but had greater earning potential. Moreover, he would
pay no inheritance tax on the first $2 million inherited. The estate tax, by contrast,
takes no account of the needs of the recipient. Consequently, it creates no
incentive to give more to a disabled indiviudal and theoretically could impose tax
burdens on him that were quite substantial.
3.) When this Committee held a hearing on the current estate tax system last
November, the discussion focused on upcoming uncertainty due to the phase-out
and then re-instatement of the estate tax in 2009 and 2010. Witnesses also
discussed how the current system can be planned around to catch the most
favorable tax treatment. How will adopting an inheritance tax or accessions tax cut
back on strategies to game the system? - -
The scheduled one-year repeal of the estate tax in 2010 creates massive
uncertainty and tax planning opportunities, as well as fairly gruesome incentives.
The best way to address these problems is to enact legislation preserving some
kind of wealth transfer tax for the year of 2010 by the middle of 2009.
As you have noted, however, the current system also creates substantial tax
planning opportunities even when it is not being repealed and reinstated in the
course of a single year. These opportunities stem from at least five sources: (1)
differential treatment of gifts and bequests, (2) incentives for spouses to split
wealth transfers made to taxable beneficiaries, (3) valuation games involving split
or contingent transfers where some of the potential beneficiaries are tax exempt,
66
(4) preferences for holding wealth in farms or family businesses, and (5) other
opportunities to reduce the taxable value of transferred assets. The proposal
should reduce tax planning incentives on the first four dimensions and have little
effect on the fifth.
First, the proposal would significantly reduce current incentives to characterize
wealth transfers as gifts rather than bequests (or occasionally the reverse). Current
law applies different lifetime exemptions and effective tax rates to gifts and
bequests. It also creates an incentive to give earlier in time because the exemption
thresholds are not indexed, making the same nominal exemption worth more at
earlier points in time. The proposal, by contrast, would apply the same, inflation-
indexed lifetime exemption and effective tax rate to all wealth transfers,
regardless of whether the transfer is made during life or at death.
Second, the proposal would eliminate the incentive to carefully plan spousal
transfers. Currently spouses can reduce their joint tax liability by making sure that
each transfers an amount equal to the lifetime exemption to their heirs. Under the
proposal, this would no longer be necessary. The tax would be based on the
amount the heir receives, regardless of whether it was from one parent or both.
Third, the proposal would eliminate the planning opportunities created by the
current relief provisions for family businesses, which generally create incentives
to shift wealth into family businesses and farms. For example, under current
Section 6166, the tax liability due on bequests that include a family business can
be deferred for 15 years at a below-market interest rate if the family business
composes at least 35 percent of the gross estate. The heir, then, effectively
receives a below-market loan from the government if his donor ensures that the
family business composes at least 35 percent of the value of his bequest. This
creates an incentive to hold wealth in a family business, even if the donor and heir
would prefer for the wealth to be invested in more diversified assets. It also
creates an incentive to overvalue the business if it comprises less than 35 percent
of the gross estate. These incentives exist even if the estate has plenty of liquid
assets available to pay the tax liability associated with the family business.
If continued relief for family businesses were considered politically necessary, the
proposal would replace the current relief provisions with a provision permitting
unlimited deferral of wealth transfer tax liability at a market rate of interest to the
extent that the heir’s tax liability exceeds the liquid assets he has inherited (minus
a reasonable cushion). This reform would get rid of the current planning
incentives to shift wealth into family businesses, while completely eliminating
even the theoretical possibility that an estate or heir would have to sell an
inherited illiquid asset in order to pay the associated wealth transfer tax liability.
Importantly, it is critical for this proposed new provision to apply a true market
interest rate to the deferred tax liability in order to prevent it from creating new
planning opportunities.
67
Finally, the proposal should reduce the tax benefits of engaging in valuation
games. While it would create more valuation points, it would reduce the incentive
to try to shift value to tax-exempt spouses and charities when the ultimate
beneficiary is unclear by waiting to see how much is received by whom before
applying the final tax. As a result, a wide swath of current rules could be
eliminated. Indeed, the current rules addressing such valuation games—including
those governing marital trusts, charitable trusts, grantor trusts, and Crummey
trusts—compose one-fourth of a leading casebook.”
Many of these reforms could (and should) be adopted within the context of an
estate tax, but not all of them could be. Specifically, the final reform could not be
adopted under an estate tax because it requires waiting to see how much each heir
receives. As a result, the proposal should reduce tax planning opportunities
relative to both current law, and a reformed estate tax system.
4.) In his written testimony, Professor Dodge dismisses an inheritance tax as a viable
alternative to the current estate tax system, writing, “An inheritance tax distorts
bequest choices by creating tax incentives in favor of certain classes of legatees. An
inheritance tax also creates an incentive for the dispersion of wealth among
legatees, but such an incentive isn’t especially needed in contemporary American .
legal practice and culture, which has generally abandoned primogeniture.”
Professor Batchelder, you advocate adopting an inheritance tax. How would you
respond to Professor Dodge criticism that an inheritance tax would only incentivize
making several smaller bequests to help recipients avoid a large jump in their
income as a result of an inheritance? Would this really be such a bad thing?
As discussed in my response to your second question, I actually think that the
incentives an inheritance tax creates (after a certain point) to share wealth more
broadly are a positive aspect of the tax. Moreover, these incentives are a
necessary byproduct of the fact that under an inheritance tax, an heir’s tax burden
is directly based on his ability to pay tax, unlike an estate tax.
Professor Dodge's criticism of inheritance taxes as creating incentives to give to
certain legatees and to spread out transfers to a recipient over time appears to refer
to a type of inheritance tax that I would not support—an inheritance tax with an
annual exemption where the exemption depends on the heir’s and donor’s
relationship. Under the type of inheritance tax I support, individuals would
receive only one, large exemption for all inheritances they receive over their
lifetime, and it would apply regardless of the heir’s relationship to the donor
(unless the donor was the heir’s spouse). The only benefit of spreading
inheritances over time under the proposal would therefore be the possibility that
such spreading would place the heir in a lower income tax bracket. However,
even this advantage should arise relatively rarely because the proposal would
average inheritances over time when determining the heir’s income tax bracket.
* MCDANIEL, PAUL R., JAMEs R. REPETTI, AND PAUL R. CARON, FEDERAL WEALTHTRANSFERTAXATION
(5th ed., 2003). -
68
5.) Professor Batchelder, in your written testimony you point out that the current estate
tax system puts the brunt of the tax burden on the intended heir. Because an estate
is taxed before it passes to the recipient, he or she is necessarily receiving less than
the donor had granted in his or her will. However, the comprehensive inheritance
tax that you propose centers the tax by design on the recipient. What is the ultimate
benefit then of making a switch to an inheritance tax? Is this simply adopting a
more transparent and fair method of taxing inheritances?
Yes, the principal benefits of the proposal would be a fairer and more transparent
method for taxing inheritances. However, the reason I support such a shift is that I
believe these fairness and transparency differences are not simply theoretical, but
also have substantial real world consequences.
As discussed in my written testimony, the estate tax is the only tax that applies to
extraordinarily large inheritances because gifts and bequests received are exempt
from the income and payroll taxes. While the estate tax does a very good job of
targeting these extraordinarily large inheritances, however, the fact that it centers
by design on the donor means that it can create substantial inequities in practice in
individual cases. For example, according to our estimates, 22 percent of heirs
burdened by the estate tax have inherited less than $500,000, while 21 percent of
heirs inheriting more than $2,500,000 bear no estate tax burden. The proposed
inheritance tax would eliminate these inequities. All heirs inheriting less than
roughly $2 million would bear no inheritance tax burden, while all heirs inheriting
more would bear some tax burden. As a result, it would better link wealth transfer
tax burdens—and tax burdens overall—to the ability to pay of the person actually
bearing the tax (in this case, the heir).
A further benefit of the proposal is that it would improve public understanding of
the wealth transfer tax system. The fact that the estate tax focuses on the donor by
design tends to lead the public to believe that its burdens fall on donors in practice
as well. Moreover, many erroneously believe that heirs are taxed on their
inherited income under the income tax because all other major sources of income
are so taxed. These understandable misconceptions have been exploited by
advocates of estate tax repeal who have framed the estate tax as a double tax on
frugal, hard-working, generous donors who are taxed at the moment of death.
Instead, the estate tax is a single tax—and the only tax—imposed on the fortunate
few in our society who inherit amounts so extraordinarily large that they can elect
not to work their entire lives and still support a family at a standard of living
better than nine out often American families.
An inheritance tax can help correct this misperception because it falls on heirs
both by design and in practice. Thus, by more transparently taxing the heir, the
proposal should enable the public to make a more informed decision about
whether to exempt such extraordinarily large inheritances from taxation or not.
69
Finally, for the reasons outlined in response to your third question and Question
1(b) from Senator Baucus, the proposal should simplify the wealth transfer tax
system. - '-
Senator Cantwell
I.) If Congress moves away from an estate tax, either by extending repeal beyond 2010
or establishing a new inheritance tax regime, what changes to the individual
income tax and capital gains tax rules would have to simultaneously be considered
so that we can maintain progressivity in the overall tax system?
If Congress were to repeal the estate tax without replacing it with an inheritance
tax, I do not think it would be possible to maintain the current level of
progressivity in the overall tax system at an individual level. It might be possible
to maintain the same level of progressivity at an aggregate level, but doing so
would entail substantial efficiency costs and inequities.
Progressivity can be determined at an individual or aggregate level. It also can be
based on a number of measures of ability to pay but the most widely-supported
measure is economic income. Economic income, sometimes referred to as Haig-
Simons income, includes an individual’s annual consumption and change in net
worth. It therefore includes inheritances.
As explained in my written testimony, the lion’s share of estate tax burdens fall
on individuals who receive extraordinarily large inheritances and are very well-
off. For example, according to our estimates, 96 percent of estate tax revenue is
derived from the l percent of heirs who inherit more than $1 million, and 88
percent is derived from the 1 percent of heirs whose economic income exceeds
$500,000.” If the estate tax were repealed, these wealthy individuals would
receive their sizable inheritances tax-free. -
Nevertheless, while the estate tax does a very good job of targeting these
extraordinarily large inheritances and strengthening the progressivity of the tax
system at an aggregate level, it can create substantial inequities in individual
cases. This reduces (but certainly does not eliminate) its progressivity at an
individual level. For example, according to our estimates, 22 percent of heirs
burdened by the estate tax have inherited less than $500,000, while 21 percent of
heirs inheriting more than $2.5 million bear no estate tax burden. Similarly, 25
percent of heirs burdened by the estate tax have economic income of less than
$200,000, while 12 percent of heirs whose economic income exceeds $1 million
bear no estate tax burden.
If the estate tax were repealed without replacing it with an inheritance tax, the
current level of progressivity of the tax system at an individual level could not be
maintained by changing the taxation of ordinary income or capital gains.
*For this purpose, economic income is defined as the heir's income from labor and saving plus one-fifth
of his inherited income.
70
One possibility would be to tax heirs at higher rates on their income from work
and savings. But if this higher tax were imposed disproportionately on recipients
of extraordinarily large inheritances, it would essentially be a wealth transfer tax,
because the tax rate would depend on how much the individual had inherited.
Another possibility would be to change the income and capital gains tax treatment
of gifts and bequests specifically, for example by repealing the income tax
exclusion for gifts and bequests, stepped-up basis for bequests, and carryover
basis for gifts. Heirs would then be taxed on all inherited income under the
income tax, and would also be taxed immediately on any accrued gains embedded
in inherited assets. Unfortunately, while this option would target heirs
specifically, it would still be more regressive than the estate tax at an individual
(and aggregate) level because it would tax all inheritances, not just extraordinarily
large ones. The inheritances of most Americans are relatively small—we estimate
that 93 percent of heirs inherit less than $250,000. Nevertheless, inherited income
comprises a meaningful share of the lifetime economic income of most
households and accrued gains are a substantial share of the value of all
inheritances, including relatively small ones.” Thus, full wealth transfer tax
repeal necessarily involves a more regressive tax system at an individual level,
with heirs of extraordinarily large inheritances winning and all other heirs and
non-heirs losing.
If all wealth transfer taxes were repealed, Congress might at least be able to
maintain the same degree of progressivity at an aggregate level (i.e., by economic
income). However, the only way it could do so would be by raising the tax rate
(e.g., income or payroll tax rate) on those with the largest amounts of economic
income more generally. According to our estimates, less than three in 10,000 tax
units earn more than $1 million per year. Consequently, this approach could result
in significantly higher rates on those who earn such large amounts through their
own work and savings efforts in order to compensate for the new zero tax rate on
those who inherit such large amounts. Because the deadweight loss associated
with a tax on labor earnings tends to rise with the square of the tax rate, this
approach would probably result in substantial efficiency losses relative the estate
tax or any wealth transfer tax. It would also, as noted, result in serious inequities
between those who work for their wealth and those who do not.
Maintaining the progressivity of the overall tax system would be much simpler if
Congress instead replaced the estate tax with an inheritance tax. Indeed, the
overall tax system would become more progressive at an individual and aggregate
level under the inheritance tax I have proposed because tax burdens would be
more tightly linked to the economic income of the taxpayer burdened. Under the
proposal, the tax rate on inherited income would be directly based on a measure
of the heir’s economic income (one-fifth of any income from inheritances that
* Edward N. Wolff, Inheritances and Wealth Inequality, 1989-1998, 92 AM. ECON, REV. 260, thi.2 at 262
(May, 2002); James M. Poterba and Scott Weisbenner, The Distributional Burden of Taxing Estates and
Unrealized Capital Gains at Death, in RETHINKING ESTATE AND GIFTTAXATION 422,439, thi.10-10 at 443
(William G Gale et all, eds., 2001).
71
exceeds $2 million over his lifetime, plus his annual income from work and
savings). By contrast, the estate tax rate is only indirectly linked to the heir’s
economic income (because inherited income and non-inherited income tend to
rise, on average, with estate size). Moreover, the proposal should not entail any
additional efficiency losses relative to the estate tax because it is revenue neutral.
In short, replacing the estate tax with the proposed inheritance tax would
strengthen the progressivity of the overall tax system without creating new
efficiency losses. Repealing all wealth transfer taxes would necessarily reduce the
progressivity of the overall tax system at an individual level (e.g., between heirs
and non-heirs), and could only maintain the current degree of progressivity at an
aggregate level at the price of substantial new efficiency costs.
2.) Professor Batchelder, it seems somewhat punitive to treat an inheritance as income
to the beneficiary yet impose a surtax of 15 percent on top of their income tax rate.
Can you explain the rationale of imposing a 15 percent surtax on bequests that
exceed the exemption amount?
The principal rationale is that income from work is generally subject to the
income tax and a 15.3 percent FICA tax, neither of which currently apply to
income from inheritances. Admittedly, the full FICA tax does not apply to the
roughly 15 percent of wages that exceed the $102,000 payroll tax cap” so income
from work generally is not subject to a marginal tax rate of 50 percent. However,
income from work also is not eligible for a $2 million exemption.
Under the proposal I have outlined, the average tax rate on inherited income for
someone who is already in the 35 percent income tax bracket would only reach 50
percent if the individual had inherited more than $190 million. In my view, this is
such an extraordinary sum of unearned money that a 50 percent effective tax rate
is not punitive.
3.) Under your proposal for how -family-owned businesses and other illiquid asset
transfers would be treated, you recommend a deferral of the tax until the assets are
sold or there are sufficient liquid assets to pay the tax.
a. Can you elaborate on how this system would work in practice? For instance,
would the business account for this deferred obligation?
b. Would the IRS’ secured interest in the asset be related only to the portion of
the business that each individual heir owns?
c. Is there any concern that over time the tax liability itself would become so
large it would force a business to liquidate?
* Debra Whitman, Social Security: Raising or Eliminating the Taxable Earnings Base (CRS Report for
Congress, May 2, 2005). -
72
d. Would the IRS need to establish a new regime to monitor the disposition of
illiquid assets and to collect the interest?
e. Would liens be required as are required now under Section 6166?
Regarding questions (a) through (e), I would first like to provide some
background on the scope of the problem. The Tax Policy Center has estimated
that less than 3 percent of taxable estates are composed of more than 50 percent
business assets. Moreover, we have estimated that less than 3 in 1,000 heirs
(12,972) would be subject to the inheritance tax in the first place. Accordingly,
the circumstances in which an heir could conceivably need to sell part of an
inherited business in order to pay the inheritance tax absent any relief provision
for illiquid assets should be extremely rare. Indeed, we estimate that far fewer
than 400 heirs” would be eligible for the deferral provision if it were considered
politically necessary.
Nonetheless, the mere possibility that the estate tax could precipitate such sales
has been a principal argument against the estate tax. To the extent that Congress
considers it necessary to address this theoretical possibility, I have suggested
adopting a relief provision permitting indefinite deferral at a market interest rate
to the extent that an heir's tax liability exceeds the value of liquid assets that he
inherits (subject to some reasonable cushion).
Under this relief provision, the tax liability would be that of the individual heir. If
an heir inherited liquid assets sufficient to pay the tax (with an appropriate
cushion), he would pay the tax with these liquid assets and inherit the business
tax-free. If not, he would be required to use what liquid assets he did inherit
(again subject to some reasonable cushion) to pay a portion of the associated tax
liability. The remainder would accrue at a market interest rate until he sold part or
all of the business, received distributions from it, or inherited other liquid assets.
If none of these possibilities arose, the tax liability and interest would accrue
indefinitely. As a result, the heir would never have to sell the business in order to
pay the associated tax liability and interest. Because the tax due would be a
liability of the heir, I see no reason for the accruing liability and interest to be
reported on the books of the business.
This proposal would require ongoing monitoring by the IRS. I would suggest
requiring heirs to submit a form annually to the IRS stating whether the heir had
received any distributions from the business or sold all or a portion of it, perhaps
with confirmation from the business. The definition of distributions and sales
could parallel those in Section 6166(g). However, it is critical that, unlike under
Section 6166, interest should accrue at a market rate, and the taxpayer should be
required to use all distributions and proceeds from sales first to satisfy the accrued
tax liability and interest. The annual filing requirement should not be a huge
*Three percent of 12,972 is about 400. The number of heirs eligible should be much fewer than 400
because only heirs inheriting assets worth over $190 million (fewer than 70 annually) would be subject to a
50 percent effective tax rate under the proposal.
73
burden on the taxpayer and business as it simply requires confirmation of a fact of
which both should be well aware—whether he has sold or received cash from the
business.
If the heir did not report distributions and sales proceeds sufficient to satisfy the
tax liability and interest for a number of years, the question would arise of
whether he was evading the tax by withdrawing cash for personal consumption in
other ways. For example, if an heir controlled the inherited business, he could be
forcing it to sell assets to another business he controlled at a nominal price, and
then forcing that second non-inherited business to distribute the proceeds to him.
Alternatively, if an heir controlled an inherited business, he could cause it to pay
him an extraordinarily high salary without performing commensurate services in
exchange. One way to address these potential tax shelters would be to grant to the
IRS a lien or right to foreclose upon the business in such circumstances. Another
option, which would never entail forced sales, would be to treat compensation
above a certain level, and sales to other businesses controlled by the heir, as de
facto distributions to the heir after a period of years. -
74
ſºn
STATEMENT FOR SENATOR-BUNNING
SENATE COMMITTEE ON FINANCE -
“Alternatives to the Current Federal Estate Tax System”
March 12, 2008
Thank you, Mr. Chairman.
There are those that contend that the estate tax only affects our
Nation’s wealthiest and that we do not need permanent repeal or reform.
Apparently those people have never spent any time in our nation’s farming
communities. Well, I have.
My home state of Kentucky has been a land of family farms and
small, close-knit communities ever since Daniel Boone led settlers through
the Cumberland Gap. I have witnessed on a first-hand basis how estate
taxes can destroy family-owned farms when the tax, which can be as high as
45 percent, forces farmers to sell their land or equipment.
Family farms and small towns across our country have made us
strong. It’s a legacy that we must continue to nurture. We need make sure
that in the years to come the farming way of life always remains part of our
Nation’s character. Through permanent repeal or substantial reform of the
estate tax we can ensure that America’s food and fiber producers will be able
to pass along farming operations from generation to generation.
I thank the Chairman for holding this important hearing to consider
alternatives to the present death tax that is expiring. But, we must act
quickly. The year 2010 is fast approaching, and many families are
attempting to plan the transition of their farms and businesses in an uncertain
environment. If we act this year, we can live up to our responsibility as
good stewards.
I look forward to working with the Chairman to see these reforms
enacted. - -


75
Senator Maria Cantwell
Opening Statement
Senate Finance Committee Hearing
Federal Estate Tax
March 12, 2008
Mr. Chairman, thank you for holding this hearing today. As I said at the
committee’s hearing in November, I am pleased we are working to move
forward with permanent, meaningful reforms.
The prospect of returning to a tax rate of 55 percent on estates over
$1 million in 2011 is unacceptable. -
As we consider our federal policy options, I will be looking carefully at the
alternative approaches that our witnesses today will offer. Maybe it is time
to think outside the box and craft a better, more workable set of rules.
I have raised my concerns that we should preserve the viability of our small
businesses and family farms. These institutions are more valuable to all of
us if they can continue to thrive, create jobs and reinvest in those farms and
business operations.
When someone works for a lifetime to build a business and opts to leave that
business to an heir rather than sell it outright, they should have Some
comfort that the IRS is not going to step in and impose a crippling tax on
that business. We have tried hard to reach a sensible, permanent, and fiscally
responsible solution to this problem, and I will continue to work toward that
goal this year. Time is running out on us and on the businesses that are
wondering when, or if, Congress will act before the clock in 2011 turns back
to 2001.
I welcome the ideas of our witnesses today and appreciate the time that you,
Mr. Chairman, are devoting to this important issue. - -
Thank you.
76
Testimony of Joseph M. Dodge
Stearns Weaver Miller Weissler Alhadeff & Sitterson Professor of Law
Florida State University College of Law -
before
COMMITTEE ON FINANCE
U. S. SENATE
March 12, 2008
Thank you for inviting me to appear before this distinguished body to testify
concerning possible alternatives to the current federal transfer taxes. I am testifying on
my own behalf and do not speak for any other person, organization, or entity. My
extensive writings in this area are noted in an Appendix at the end. A somewhat more
formal comparison of (1) the accessions tax, (2) the income-inclusion approach, and (3)
the deemed-realization-at-gift-or-bequest approach is found in Appendix A to the Task
Force Report on Federal Transfer Taxes (item 2 of the Articles listed in the Appendix), of
which I am a co-author. (However, my comments today differ in a few respects from the
analysis in the Task Force Report.) More detailed discussions of the topics covered by
this testimony are found in items 4, 5, and 16 of the Articles listed in the Appendix. (For
some of my views on reforming the current system, see items 9 and 13 of the Articles
listed in the Appendix.)
A. Possible Alternatives to the Current Transfer Taxes
There are five possible alternatives to the current estate, gift, and generation-
skipping system:
(1) classic inheritance tax
(2) accessions tax
(3) income-inclusion approach
(4) deemed-realization-at-gift-or-bequest approach, and
(5) carryover-basis approach.
What these approaches have in common is the imposition of tax (sooner or later)
by reason of a gratuitous transfer. The first two (inheritance tax and accessions tax) are
transfer taxes. A transfer tax is a separate tax from the income tax, and a transfer tax can
operate as a “second” tax on previously-taxed income of the transferor. The last two
(deemed-realization and carryover-basis approaches) are designed to overturn the current
rule, found in § 1014, that eliminates unrealized gains of a decedent permanently from
the income tax. The motivation of either proposal is to eliminate an existing hole in the
77
income tax. Since transfer taxes can exist simultaneously with an income tax, it is
possible to combine either (1) or (2) above (or an estate tax) with either of (4) or (5).
Alternative (3) is more of a “fusion” approach: it imposes a tax on the gratuitous
transfer itself (like a transfer tax) but “within” the income tax. Alternative (3) entails
taxing a (non-charitable) gratuitous transfer to the transferee by including the transfer in
the annual income tax base, without deduction by the transferor. Since the value of the
transfer is taxed in full to the transferee, the transferor’s basis is irrelevant, and becomes
an obsolete datum of tax history. Hence alternative (3) could not be comprehensively
combined with alternatives (4) and (5), both of which play off of the transferor's income
tax basis.
A general theme of my testimony is that each “system” has an internal logic of its
own, and caution should be used in transplanting features of one system into another
system.
B. Inheritance Taxes and Carryover Basis Should Be Taken Off the Table
Alternatives (1) and (5) should be rejected. An inheritance tax is basically like an
estate and gift tax, but with a more complicated rate and exemption structure. An
inheritance tax distorts bequest choices by creating tax incentives in favor of certain
classes of legatees. An inheritance tax also creates an incentive for the dispersion of
wealth among legatees, but such an incentive isn’t especially needed in contemporary
American legal practice and culture, which has generally abandoned primogeniture.
Finally, it is hard to integrate a gift tax with an inheritance tax.
A carryover-basis rule under the income tax suffers from the following defects:
(1) it attributes gain that accrued to one party to another party, (2) it creates inequities
among legatees receiving equal-value bequests, (3) it requires keeping basis data for
excessively long periods of time, (4) it is procedurally awkward in positing a basis-
determination date that is different from the taxable event (realization by the legatee), and
(5) it has, in its 1976 and 2010 incarnations, already proven to be so complex as to be
unworkable. -
C. Mitigating Valuation Problems
Alternatives (2), (3), and (4) share a common advantage over the current transfer
tax system, which requires all relevant facts (including values) to be determined as of the
date of transfer (usually, the decedent’s death). Valuation is a costly and fact-specific
exercise that is best avoided where feasible. All of alternatives (2), (3), and (4) would
involve valuation at the time of gratuitous transfer as a general rule, but allow for deferral
of the taxable event (or even exclusion) in appropriate circumstances. For example,
under the deemed-realization approach, the general rule would be that a gratuitous
transfer of property would produce realized gain to the decedent (or donor) in an amount
equal to the difference between the asset’s basis and its fair market value at the time of
transfer. However, a transfer to one’s spouse would not be a realization event, and the
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transferor spouse’s basis would carry over to the transferee spouse, which is an extension
of current $ 1041 of the income tax. Similarly, gain with respect to a principal personal
residence could be covered by the exclusionary rule of current $ 121.
In all three systems, difficult valuation problems (as with closely-held business
interests) could be postponed, though “tailored” deferred-realization rules, as are
common under the income tax.
D. Transfer Tax Features Do Not Necessarily “Transfer” to the Income Tax
None of alternatives (3), (4), and (5), which are all located within the income tax,
should incorporate transfer tax features unless there is a compelling reason to do so.
These approaches all have internal-to-income-tax rationales. In contrast, the transfer
taxes, with high rates and large exemptions, serve the external-to-tax purpose of curbing
undue accumulations of wealth. Hence, there should be no “minimum” stepped-up basis
within the income tax designed to serve as an income-tax proxy for a lifetime transfer tax
exemption. Similarly, it should not be simply assumed that an unlimited marital
exemption is warranted. In terms of system design, each alternative should be
approached with a view to internal consistency with the aims, norms, and principles that
govern that system. -
E. Comparing the Accessions Tax with the Income-Inclusion Approach
I wish now to focus on the income-inclusion approach, with particular attention to
comparing it with an accessions tax. These two approaches might appear to be virtually
identical, except for the rate and exemption structure, but it turns out that there could be
significant differences.
1. The value of a transferee-oriented approach
Instead of the current transfer taxes, which can be perceived as a penalty on a
decedent’s success in the market economy, a transferee-oriented tax is can be sold as a
tax on “unearned windfalls” of transferees. Furthermore, a tax that bears explicitly on
transferees can be perceived as compatible with the goal of equality of opportunity.
Although carry-over basis is a transferee-oriented approach, it operates erratically
and capriciously in terms of trying to achieve any non-tax goals, because the built-in gain
bears no systematic correlation with the value of what is received. The deemed-
realization approach is not transferee-oriented at all. The inheritance tax only considers
the mostly-irrelevant factor of closeness of relationship. That leaves the income-
inclusion and accessions-tax approaches, which both explicitly impose taxes on
transferees.
Under a transferee approach, the amount subject to tax is net of transaction costs,
such as debts, funeral costs, administration expenses, and costs of obtaining gratuitous
receipts. Since the tax is imposed on the transferee with respect to the net amount
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received, the transferee tax is not itself subtracted from the tax base. In this respect, all
gratuitous receipts are treated equally, whether in the form of gifts or otherwise.
2. Rate and exemption structure
The main difference between the accessions tax and the income-inclusion
approach is the rate and exemption structure. An accessions tax would look like the
present system because there would be a cumulative lifetime tax base consisting only of
gratuitous receipts, a substantial lifetime exemption, and a potentially high rate on
accessions above the exemption. These features are appropriate to carry out the principal
purpose of such a tax, namely, to curb undue accumulations of unearned wealth by a
given individual. The accessions tax is conceived of separately from the income tax,
which is a tax on the acquisition of wealth by whatever means, with an aim to generate
substantial revenue without undue economic distortion. The income tax is an annual tax
that, ideally, does not discriminate according to source or use. The annual “exclusion”
under an income tax is basically a set of allowances that eliminate subsistence income
from the tax base. Under the income-inclusion approach, gratuitous receipts of low-
income persons would be shielded from tax by these subsistence allowances.
3. The exclusion for support and its penumbra
Under both the accessions tax and the income tax, support received in kind is
inherently excluded on the ground that it is not a true wealth transfer. Support in-kind
basically involves one person spending money in a way that benefits another. Even
support in cash can be excluded on the theory that its purpose is consumption spending of
the donee, rather than one aimed to effectuate a true wealth transfer.
If support is excluded, both the accessions tax and the income—inclusion approach
would be required to draw the line between support (which is not taxed) and gratuitous
receipts (which would be taxed). This problem already exists under the existing gift tax,
and it is probably fair to say that the annual gift tax exclusion is best rationalized as a
mechanism for managing this difficult borderline area. The fact that the exclusion is an
annual one (and on a per-donee basis) has the effect of expanding the category of support.
This same general approach could be adopted for both the accessions tax and the income
tax.
The annual exclusion concept should nevertheless be re-designed to conform to
the transferee orientation of the accessions tax and the income-inclusion approach. For
starters, there should be a single fixed-amount annual exclusion of a transferee for all
includible gratuitous receipts during the year from all living transferors. Perhaps only
transfers from persons who plausibly owe a support obligation to the transferee should be
eligible. The exclusion should be designed to exclude donor-financed donee
consumption (within reason) from being a taxable gratuitous receipt,
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4. Gratuitous accessions are income under a personal income tax
The rationale of the income inclusion approach is that gratuitous receipts really
are “income” under a personal income tax. The exclusion of current law is an historical
anachronism based on trust accounting rules and the concept that income is distinct from
“original endowment.” But there are different concepts of income that serves different
purposes, both tax and non-tax. For example, there’s “national income” (GDP). A VAT
of a certain type would be a tax on national income. Transfers are ignored under a tax on
national income. In contrast, a tax on personal income is a tax on an individual’s net
accessions to wealth “from whatever source derived.” (If that phrase sounds familiar, it
is because it is found both in the 16"Amendment to the Constitution and the § 61(a)
definition of catch-all income.) If $ 102(a) were repealed, gratuitous receipts would then
become non-excluded gross income.
A personal income tax is founded on the concept of the ability to pay of an
individual taxpayer relative to that of others. Gratuitous receipts constitute an increase in
the recipient’s ability-to-pay tax base to the same extent as wages, lottery winnings, or
any other accession to wealth. There is no reason why a gratuitous transfer should bear a
lighter tax than wages paid for a personal service (such as a home repair): in both cases,
the transferee has income and the transferor has a non-deductible expense.
Including gratuitous receipts in income, which is an annual tax, implies that there
are no lifetime exclusions or special rates. However, as with the existing income tax,
there could be special rates (as with net capital gains) or an income-averaging rule (or
maximum rate) to mitigate the “bunching effect.” Similarly, some kind of lifetime
exclusion could be incorporated into the system, although such a feature would be
inconsistent with the nature of an income tax. A lifetime exemption would require the
keeping of records over time, and this would be the only feature of an income-inclusion
approach that would create a new record-keeping obligation. (In contrast, an annual
exclusion — conceived as a way of defining “support”— is not inconsistent with an
income tax.) .
An accessions tax, being keyed to a cumulative lifetime tax base (and lifetime
exemption) mandates the long-term record-keeping obligations.
An income-inclusion approach without a large cumulative lifetime exclusion has
the potential (even with an annual exclusion) to raise a lot more tax revenue than the
existing system, even though the highest income tax rates are lower than the highest
estate tax rates. The incremental revenue yield could be used to lower rates generally, or
for any other purpose. - - -
5. Deferred-realization rules
As mentioned earlier, deferred realization rules are common in the income tax,
and can be deployed specially in the income-inclusion scheme for gratuitous-receipts.
Likely candidates for deferred realization are non-liquid assets, hard-to-value assets, and
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tax-favored assets. Assets that are likely to depreciate in value should not be eligible for
any deferred-realization rule.
Deferred realization allows avoidance of valuation until the asset is disposed of in
a market transaction or ceases to meet any applicable “qualified use” requirement.
An asset that has not yet been included in income would have a zero basis. An
asset that has been included in income takes a basis equal to the amount included.
Even where deferred realization is not allowed, modest valuation errors would be
tolerable, because the erroneous amount included, memorialized as the asset’s new basis,
is automatically “corrected” upon subsequent realization. This correction does not occur
under an accessions tax, where the value at the time of the accession is fixed.
The income-inclusion system has the big advantage of wiping out the “historical”
basis of the asset in the hands of the transferor,
An accessions tax could also have deferral rules, but they would presumably not
be modeled on the realization principle of the income tax, but would instead be confined
to tax-favored assets and transactions, such as bequests of interests in closely-held
business. Since an accessions tax is a transfer tax, valuation thereunder (whenever it
occurs) is “final,” as under the current estate tax.
The operation of an accessions tax produces no necessary consequences under an
income tax, which is a separate tax. For example, it would be hard to justify a step-up in
basis of an asset that is “subject to” the accessions tax but avoids tax on account of the
lifetime exemption. Indeed, a basis step-up for a taxed accession would undermine the
very purpose of the accessions tax: the accessions tax would be partially offset by a
reduction in the future income tax of the same person.
6. Hybrid transfers
A problem under the current system is the necessary reliance on actuarial tables to
value future interests. A related problem is created by the need to design timing rules for
“hybrid” (retained-interest-or-power) inter vivos transfers. Actuarial tables are not only
inaccurate in individual cases, but can be “gamed” by such devices as GRATs and private
annuities.
Hindsight is better than estimates and guesses. Under both the accessions tax and
income-inclusion system, the taxable event is generally the receiving of an outright
transfer or (as will be explained below) of a trust distribution. The gratuitous receipt of a
present or future interest in property (or the vesting of any such interest) would generally
not be considered to be an accession or income-realization event. There is no norm that
commands that tax law must slavishly follow property law all of the time. The income
tax has never been burdened by property-law concepts.
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7. Life insurance
The receipt of life insurance proceeds would be taxable as a gratuitous receipt
regardless of who held the incidents of ownership and regardless of the owner’s income
tax basis in the policy. If the beneficiary was also the owner, the receipt of the proceeds
would result in investment gain or loss, as opposed to being gratuitous-receipt income.
The same analysis would apply under the accessions tax.
8. Spousal transfers
A major design issue is that of inter-spousal transfers. Inter-spousal gifts would
be ignored (exempted) under both approaches, but death-triggered transfers might be
viewed differently. Since inter vivos inter-spousal transfers would be ignored, transfers
to either spouse from any third party should be attributed 50-50 to each spouse.
Under an accessions tax, each spouse would be considered a separate taxpayer,
because the purpose of the accessions tax is to curb undue concentrations of unearned
wealth. Thus, a person should not be allowed to accumulate twice as much unearned
wealth simply by reason of having been married, or three times as much unearned wealth
by reason of having been married twice. Likewise, a widow or widower should not be
favored relative, say, to a person who receives accessions from two ancestors. It follows
that there should not, in principle, be an unlimited inter-spousal exclusion over and above
the lifetime exemption, because it is the lifetime exemption that is supposed to operate as
the baseline for ascertaining what is an “undue” accumulation of unearned wealth by a
given individual. -
Wealth acquired by earnings avoids the accessions tax. Stated differently,
asserting control over one’s own wealth is not an accession. A common legal and
cultural norm is to view marriage as a kind of economic partnership. Accordingly, it is
not unreasonable to stipulate that accessions from the deceased spouse, not to exceed half
of the value of the deceased spouse's estate (or half of the combined estates), are really
“earned” wealth that is already equitably owned by the surviving spouse (and not really
an accession at all). Most current estate plans involving the wealthy do not give the
surviving spouse fee ownership of the entire marital estate, but rather create interests in
individuals other than the surviving spouse. If this pattern continues under an accessions
tax, it is unlikely that the limitation on the marital exclusion will be exceeded. Moreover,
the surviving spouse still has her own lifetime exclusion. Thus, it is quite unlikely that
the surviving spouse will receive accessions from the decedent that exceed both the
marital exclusion and the surviving spouse’s own exclusion. Accessions by third parties
from the deceased spouse will be scattered among such persons’ separate accessions tax
bases and lifetime exclusions. Even if the surviving spouse actually pays accessions tax,
there is no necessary estate planning disaster, because the surviving spouse can control
both the timing and the existence of accessions tax at the next generation, because the
surviving spouse would be able to control the disposition of virtually everything that
appears in her accessions tax base.
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Under the accessions tax, there would be no terminable interest rule to impede
qualification for the spousal exclusion, since the accession occurs upon the actual receipt
of money or property, not upon the acquisition of a future interest.
Under the income tax, a married couple is treated as a single taxable unit for many
purposes, one of which is that inter vivos inter-spousal transfers are ignored, and another
of which is that there is a common basis in spousal assets, regardless of the form of
ownership or the mode of disposition. This income tax taxable unit can be treated as
continuing beyond the death of the first spouse to the extent that the surviving spouse
ends up with the marital estate. It follows that amounts that were previously subject to
income tax prior to, or during, marriage would not be taxed again to the surviving spouse
simply by reason of the death of the deceased spouse, and unrealized gains and losses
would continue in their unrealized state. Thus, the survivor should, in principle, (1)
obtain an exemption for all cash received from the deceased spouse, (2) obtain sole
ownership of marital assets in kind without a deemed-realization event, and (3) inherit the
couple’s common basis (without adjustments). These results are wholly consistent with
current $ 1041. Again, there would be no qualification rules.
9. Treatment of trusts and beneficiaries
The accessions tax and income-inclusion approaches differ slightly in the case of
trusts. The accessions tax is potentially simpler: the trust is not a taxpayer under the
accessions tax, and distributions (whether out of income or corpus) are accessions of the
distributees in full. This approach allows for deferral, but deferral is revenue neutral
(assuming a flat rate with no exemptions) if the tax base increases at a rate no less than
the discount rate. If anything, the tax-avoidance concern would be with attempts to
accelerate accessions (say, by a sale of a remainder interest) at a time when the value of
such interest is low relative to its likely future yield.
If deferral is deemed to be a problem, a more complicated approach – that might
be suitable for large trusts - would be to impose a withholding tax on the trust when
receiving the funding gift or bequest. Thereafter, a distribution of income or corpus
would be a taxable accession to the distributee, but the distributee would receive a
(refundable) credit, without interest, against accessions tax for her appropriate share of
the earlier withholding tax.
Under the income tax, a trust is currently treated as a taxpayer. Therefore, the
receipt by the trust of funding gifts and bequests would be treated as current income of
the trust. Otherwise, a gratuitous transfer to a trust would be treated more favorably than
an equivalent transfer to an individual. Whatever deferred-realization rules that are
available to individuals would be available to trusts as well. Thereafter the rules of
Subchapter J would operate as they do at present to allocate post-transfer income and
gains of the trust to the beneficiaries or the trust. (The trust would not itself be viewed as
if it were a donor. That is, distributions would be deductible by the trust to the extent
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included by distributees. In the absence of a distribution deduction, trust transfers would
be treated worse than transfers to individuals.)
10. The effect of powers
Under the current system, possession of a general power of appointment results in
a person being treated as the owner of property and the income therefrom. If this concept
were carried over to the accessions tax and an income-inclusion system, it would result in
taxing the same gratuitous receipt to two taxpayers: the holder of the power would be
deemed to have received the distribution, and then the actual distributee would be
deemed to receive a gift from the holder of the general power. This result seems
unnecessarily harsh. At the same time, general powers should not be allowed to be used
as artificial devices to attribute gratuitous receipts from a high bracket distributee to a low
bracket power holder. Accordingly, general powers of appointment should be ignored
under both the accessions tax and the income-inclusion system, and the receipt should be
attributed only to the person who actually receives it,
A related issue is that of grantor trusts. Under the accessions tax, the grantor trust
rules would attribute income to the grantor, but any distribution to a person other than the
grantor would be an includible accession. This result would somewhat inhibit the use of
“defective grantor trusts.” -
Under the income-inclusion approach, the grantor-trust rules, unless modified,
would result in double taxation of distributions to third parties: the income would be
taxed to the donor, and the distributee would include the distribution as a gift from the
donor. One option is to allow this result to occur in all cases in which the trust or its
income is deemed to be owned by the grantor under current law, in which case the
distributee might (or might not) avoid tax (in whole or in part) under the annual
exclusion. Apart from the annual exclusion, it cannot be the case under an income-
inclusion system that a distribution is wholly excluded by a distributee simply because
the income represented by the distribution is taxed to the grantor. To avoid such a back-
handed generic (as opposed to annual) gift exclusion, the remaining option would be to
limit the double taxation result only to revocable trusts, provided that the creation of any
irrevocable trust would result in an income inclusion by the trust, followed by application
of the Subchapter J rules (rather than grantor-trust rules).
F. Conclusion
The foregoing is an overview of the obvious issues. Other issues would need to
be worked out.
The general conclusion is that income-inclusion system and the accessions tax are
superior to the other alternatives as possible replacements for the current transfer taxes.
(If Congress decides that no “replacement” is desirable, it should at least eliminate the
hole in the income tax created by § 1014.) Both the accessions tax and the income-
inclusion system offer numerous advantages relative to the existing system. The income
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tax alternative seems better than the accessions tax by being able to raise the most
revenue with the least administrative effort and minimal changes in existing law.
In any event, any replacement system should be constructed from the ground up,
as opposed to being a grafting of existing transfer tax features onto some new, but barely
visible, root stock.
APPENDIX – Writings of Joseph M. Dodge on the Federal Transfer Taxes and
Alternatives Thereto
I. Articles (in reverse chronological order)
1. Debunking the Basis Myth under the Income Tax (with Jay Soled, Rutgers
University), 81 Ind. L. J. 539 (2006) (61 pp.)
2. Alternatives to the Current Federal Wealth Transfer Tax System (with Joseph
Kartiganer and Sherwin Kamin), published as Appendix A to Task Force on Federal
Wealth Transfer Taxes, Report on Reform of Federal Wealth Transfer Taxes, 58 The Tax
Lawyer 93,279-312 (2004). .
3. Inflated Tax Basis and the Quarter-Trillion Dollar Revenue Question, 106 Tax
Notes 453 (Jan. 24, 2005) (with Jay Soled), reported in (inter alia) David Cay Johnson,
“Overstating of Assets Is Seen To Cost U.S. Billions of Dollars,” New York Times (Jan.
24, 2005), p. C-2, and Albert B. Crenshaw, “First, Go After The Tax Cheats,” The
Washington Post (Sunday, Jan. 30, 2005), p. F-1.
4. Comparing a Reformed Estate Tax with an Accessions Tax and an Income-
Inclusion System, and Abandoning the Generation-Skipping Tax, 56 S.M.U. Law Rev.
551 (2003) (49pp.) -
5. Why a Deemed-Realization Rule for Gratuitous Transfers Is Superior to
Carryover Basis and Avoids Most of the Problems of the Present Estate and Gift Tax, 54
Tax L. Rev. 421 (2001) (132pp)
6. What's Wrong with Carryover Basis, Especially the Carryover Basis
Provisions of H.R. 8, 91 Tax Notes 961 (May 7, 2001)
7. Simplifying Models for the Income Taxation of Trusts and Estates, 14 Am. J.
Tax Policy 127 (1997) (127pp), and A Pass-Through Replacement to Subchapter J-
Putting It in Perspective, 14 Am. J. Tax Policy 267 (1997) (14 pp)
8. Lifting the Shroud over Estate of Hubert: The Logic of the Income and Estate
Tax Treatment of Estate Administration Expenses, 3 Fla. Tax Rev. 647 (1998) (30pp),
and How the Treasury Should Solve the Estate of Hubert Problem, 78 Tax Notes 1715
(March 30, 1998)
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9. A Feminist Perspective on the QTIP Trust and the Unlimited Marital
Deduction, 76 N. Car. L. Rev. 1729 (1998) (30pp).
10. Taxation of Gratuitous Transfers under a Consumption Tax, 51 Tax Law Rev.
529 (1996) (70pp)
11. Further Thoughts on Realizing Gains and Losses at Death, 47 Vand. L. Rev.
1827 (1994) (34pp), excerpts reprinted in P. Caron et al., Federal Wealth Transfer Tax
Anthology 373-80 (1997).
12. Rethinking Section 2036(c), 49 Tax Notes 199 (Oct. 8, 1990) (12pp)
13. Redoing the Federal Estate and Gift Taxes Along Easy-to-Value Lines, 43 Tax
Law Review 241 (1988) (151pp), excerpts reprinted in P. Caron et al., Federal Wealth
Transfer Tax Anthology 192-96, 246-47, 284-88, and 373-80 (1997).
14. The Taxation of Wealth and Wealth Transfers: Where Do We Go After
ERTA2, 34 Rutgers L. Rev. 738 (1982) (38pp)
15. Retentions, Receipts, Transfers, and Accumulations of Income and Income
Rights: Thoughts on the Post-Byrum Role of Federal Estate Tax Sections 2036, 2037,
2039, and 2043, 58 Texas L. Rev. 1 (1979) (89pp.)
16. Beyond Estate and Gift Tax Reform: Including Gifts and Bequests in Income,
91 Harv. L. Rev. 1177 (1978) (34pp), excerpts reprinted in P. Oliver and F. Peel, Jr., Tax
Policy Readings and Materials 428-435 (1976)
17. Generation-Skipping Transfers After the Tax Reform Act of 1976, 125 U. Pa.
L. Rev. 1265 (1977) (43pp), reprinted in April, 1978, Monthly Digest of Tax Arts., p. 16
18. Substantial Ownership and Substance vs. Form: Proposals for Unification of
Federal Estate and Gift Taxes and for Taxation of Generation-Skipping Transfers, 1976
U. Ill. L. F. 657 (1976) (60pp) -
II. Monographs and Casebooks
1. Transfers with Retained Interests and Powers, 50-5th T.M. (1986) (revised
edition 1992) (Tax Management Portfolio), and Transfers Taking Effect at Death, 256
T.M. (1972) (predecessor Tax Management Portfolio)
2. Wills, Trusts, And Estate Planning (1988) (West)
3. Federal Taxation Of Estates, Trusts, And Gifts (1981) (West), with Teacher’s
Manual (1981), and Supplement (1982) - .
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Hon. Max Baucus
Senate Committee on Finance
April 9, 2008
Dear Senator Baucus:
Below are answers to the questions submitted by Senators relating to the Senate Finance
Committee Hearing of March 12, 2008, on Alternatives to the Existing Federal Transfer
Taxes. The Senators’ questions are in boldface, and my replies are in ordinary typeface.
My answers represent my own personal views, and do not represent the views of any
organization with which I am affiliated.
Respectfully submitted,
- Joseph M. Dodge
Stearns Weaver Miller Weissler Alhadeff & Sitterson Professor of Law
Florida State University College of Law
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United States Senate Committee on Finance Hearing
Alternatives to the Current Federal Estate Tax System
March 12, 2008
Questions Submitted for the Record
Questions for Professor Dodge:
Senator Baucus
(1) Professor Dodge, some wealth transfer tax systems tax the transferee of a gift or -
bequest. Some believe that this type of wealth transfer tax system is more
equitable. Rather than taxing the donor, it taxes the income of the beneficiary.
(a) Would the effect of your proposal simply be to shift the payment, planning
and recordkeeping burden to the beneficiary, as opposed to the estate?
The payment would be the responsibility of the beneficiary. A system of estate
withholding could be considered. The tax burden could not be shifted away from the
beneficiary. Non-liquid transfers would raise separate issues. Generally, no tax would be
due upon the receipt of present and future interests in trusts; only distributions from trusts
would be included, Rules can be designed so that other non-liquid assets (working farms,
closely-held business interests) would not be taxed on receipt but rather only on
conversion to a liquid asset (or cash) or cessation of qualified use.
The recipient would keep track of lifetime taxable accessions under an accessions tax
(just as a donor must keep track of lifetime gifts under the present system), but not under
the income-inclusion approach (which is an annual system).
Planning would be shared among the transferor and trustees. Presumably, a transferee-
oriented tax would create an incentive for discretionary trusts and special powers of
appointment. The amount of planning depends on how easy it is to avoid tax by means
other than directing bequests and distributions to low-bracket beneficiaries.
More generally, I don’t view the accessions tax as just a mirror of the estate tax. It’s a
different tax based on a different principle. It should be designed from the ground up.
The income-inclusion approach uses the existing income tax (especially Subchapter J) to
do most of the work.
(b) If so, would your proposal actually simplify the U.S. wealth transfer tax
system?
The existing tax is complex because of (1) over-reliance on property-law concepts, (2)
the necessity of valuing assets no later than the transferor’s death, and (3) dealing with
problems by enacting a statutory overlay rather than addressing the problems at their
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roots. It would be easier to enact a simplified transferee-oriented system than to simplify
the existing system.
There is no GST under the transferee systems. Generation-skipping is not a problem in
itself. An accession should not be more heavily taxed because it comes from a
grandparent.
Most of the serious valuation issues could be avoided, as would most issues relating to
timing (retained-interest transfers).
People would not have to plan for liquidity. Liquidity would be built into the system, like
the realization requirement under the income tax.
(2) You have testified about different forms of wealth transfer tax systems.
I assume you are referring to the accessions tax and the income-inclusion system, but not
to taxing gains at death (which is not a wealth transfer tax).
(a) What are the disadvantages to these different systems?
I think there are a lot of technical advantages. The disadvantage of the accessions tax (as
I would design it) is that there would be deferral of the taxable event in the case of trusts
and non-liquid interests. Unless the per-transferee exemption were about $1M, the
revenue would be reduced in the near term, especially considering likely transition rules
(no tax of property already taxed under the existing system). The accessions tax also
requires that persons keep track of lifetime accessions. That wouldn’t be so hard if they
file returns on receiving accessions, and can retrieve these returns from the IRS if
necessary.
Under the income-inclusion system, there is no deferral for trusts, because a receipt by a
trust would be income to the trust or beneficiaries. In fact, an income-inclusion system
has no “lifetime” exemptions or rates. Depending on the design of the annual exclusion,
there could be a large revenue-raising potential, which could reduce rates generally, etc.
(b) What effect would these alternative tax systems have on small businesses?
The taxable event can be delayed, without interest. The deferral lasts until conversion to
liquid form or cessation of qualification. In the case of conversion to liquid form, there is
no need ever to value the interest. This approach is better than having to value business
interests (which is often hard) and then charging interest, on the one hand, or a permanent
exclusion, on the other.
(c) What type of transition rules would have to be developed to change a
system from taxing the donor to taxing the beneficiary?
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Either one would exempt receipts previously subject to estate or gift tax or else one
would provide a credit for estate or gift tax attributable to a taxable receipt. The former
approach would be simpler.
(d) What steps would the Government have to take to make these changes?
In not sure what changes you are referring to. Basically, Congress would do it by
legislation. Congress did it with the GST. I think it would be better if the new system
were developed inside, with outside help, if necessary, rather than by a public
commission where various interests have to be represented. The main interests here are
family businesses (including working farms).
(e) How would the Government administer the new system?
A transferee-oriented system would require information returns supplied by estates,
trustees, third parties (such as insurance companies), and donors. A withholding system
is a possibility; transferees would then have an incentive to report items in order to obtain
credit for withheld taxes.
Senator Grassley
(1) What safeguards could be put into an accession or income inclusion system
which would protect the potentially illiquid owners of small businesses or family
farms that could be directly affected by these systems?
Qualified non-liquid assets (working farms, closely-held business interests) would not be
taxed on receipt but rather only on conversion to a liquid asset (or cash) or cessation of
qualified use. Dividends and other distributions from qualified non-liquid assets would
be taxable; profits reinvested in the qualified asset would not be taxable.
(2) Many of these theorists, such as Ms. Batcheider, have suggested that a potential
shift from stepped up basis to carryover basis for bequests would help to maintain
the taxable consequences of assets which pass following death. Would you please
expand on your opposition to this shift that you mentioned in the early portion of
your testimony and explain why that would be ill advised? The main reason I am
wondering about your opinion is that a lot of people who suggest reforms to the
estate tax start with changing stepped up basis to carry over basis and I just
wanted to hear a pragmatic argument for why you believe we should keep the
stepped up basis rules as they are currently.
I don’t favor stepped-up basis as it exists under the present system, because gain
permanently escapes the income tax without necessarily giving rise to estate tax. Dealing
with the income tax is a separate issue apart from the wealth transfer tax. I don’t know of
any theorist who favors the current stepped-up basis system.
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I have said that I would prefer taxing gains at death to carryover basis. The carryover-
basis rules slated to take effect in 2010 are especially unfortunate, in my opinion, because
they import transfer tax features (lifetime exemption, marital exclusion through stepped
up basis) that don’t belong in an income tax. Under a system that generally taxes gains at
death, there would be carryover-basis “exceptions” for transfers to spouses (thereby
extending § 1041 past death) and for qualified non-liquid assets. Where gains are taxed
at death, the successor would obtain a stepped-up basis.
Senator Hatch
(1) In your written testimony you mentioned either an inheritance tax or an
accessions tax. Please outline for me the differences between the two and contrast
the benefits and disadvantages of each to our current system.
An inheritance tax is like an estate tax except that there are different rate and exemption
structures for different classes of legatees (surviving spouses, descendants, ancestors,
collaterals, and non-relatives). The estate of each decedent is taxed independently of
other estates. Gift taxes are separate taxes.
An accessions tax is a tax, at a progressive rate with a lifetime exemption, on the
cumulative gratuitous receipts (“accessions”) of a person over his or her lifetime. All
gratuitous receipts (gifts, bequests, inheritances, life insurance proceeds, taking under
survivorship rights, etc.) go into the tax base. There would be a per-taxpayer lifetime
exclusion designed to separate accessions from non-taxable “support” (broadly defined).
(2) From my viewpoint, one of the biggest problems with any kind of wealth transfer
tax is the difficulty it poses to family business being passed from one generation
to the next. As you all know, there is a high mortality rate for small businesses
anyway, and this is only exacerbated by taxes that can make an inter-generational
transfer difficult or impossible. What can be done in designing a wealth transfer
tax to mitigate these problems?
Under an transferee tax (like an accessions tax), qualified non-liquid assets (working
farms, closely-held business interests) would not be taxed on receipt but rather only on
conversion by the recipient to a liquid asset (or cash) or cessation of qualified use.
Dividends and other distributions from qualified non-liquid assets would be taxable;
profits reinvested in the qualified asset would not then be taxable under the wealth
transfer tax.
In contrast, under the current estate tax you can’t defer the taxable event past the
decedent’s death. Either the property is taxable or it is wholly excluded. If it is taxable,
you have to deal with valuation and liquidity issues. If the tax payment is deferred, then
interest accrues. Setting the interest rate and term of deferral are a problem. The
deferred tax has to come from somewhere: either the business itself or life insurance that
would otherwise not have been purchased.
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(3) Do you believe the primary goal of a wealth transfer tax is to raise revenue or to
achieve certain social goals? How might the goal of such a tax determine the best
way it is structured?
It’s the job of Congress to set and implement goals. The ability of a wealth transfer tax to
raise revenue is limited by the fact that only a small percentage of the population dies
every year. It is further limited if the lifetime exemption is set high to exclude 99% of
decedents. Including gratuitous receipts in income (with no lifetime exemption but an
annual exclusion, and regular income tax rates) could generate a lot more revenue than a
wealth transfer tax. -
It is sometimes said that the goal is to curb undue accumulations of wealth. But an estate
tax doesn’t serve that goal particularly well, because it only acts well after the wealth has
been accumulated. Also, the income tax is the tax that operates on the accumulation
process. Finally, accumulating wealth is tied to the idea of the “American Dream,” and it
is unseemly to penalize success. I think that a better way of stating the non-revenue goal
is to state that the aim is to curb undue accumulations of unearned wealth by persons who
were not involved in earning the wealth. (We can assume that surviving spouses and
some people involved in family farms, etc., were involved in the creation of wealth, and
that can justify a marital exclusion and/or deferral of the taxable event.) Then the tax is
a tax on “unfair material advantage” of persons who had the luck to be born to rich
parents. A tax on unfair advantage is an accessions tax (or treating gratuitous receipts as
income). The accessions tax directly creates a strong incentive to disperse wealth,
(4) Professor Dodge, you outlined five alternatives to the current estate tax regime.
Which of these five most closely resembles our current system? I am not sure I
understand why you suggest that we reject an inheritance tax system.
There are pure income tax solutions (taxing gains at death or carryover basis), pure
wealth transfer tax solutions (like the accessions tax), and the solution of including
gratuitous receipts in income (which is kind of an “umbrella” solution).
I don’t know of any theorist in the U.S. that favors the inheritance tax. The inheritance
tax idea dates back to the early 19th century, and maybe earlier, and seems to be based on
the idea that the government has more claim to an estate the weaker the legatee's formal
relationship to the decedent. But this idea directly conflicts with freedom of testation.
Who is to say that my dearest friend should have a higher tax burden under my bequest
than my sibling that I’ve never gotten along with? The inheritance tax can’t really be
integrated with a gift tax or a GST. The inheritance tax serves no policy goal. The
contemporary concern is with excessive concentrations of wealth (especially unearned
wealth). The accessions tax is better tailored to that issue.
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Senator Roberts
When visiting with farmers and small business owners, I hear repeatedly that the
biggest cost of the estate tax may not be the tax bill itself, but rather the amount of
time and money they spend in estate planning. In light of the current economic
climate, I think it is particularly important for us to consider this point. The
money these individuals have paid to accountants, lawyers, insurance companies
and others in preparing for the estate tax could have been reinvested to grow their
business. I think that begs the question: how would a move to an inheritance tax
impact the planning costs for these farms and businesses?
None of us on the panel favored a traditional inheritance tax. We were talking about an
accessions tax, which is a tax on the person who receives a gratuitous receipt. An
accessions tax is a tax, at progressive rates, on the cumulative lifetime gratuitous receipts
of an individual reduced by a fixed-amount lifetime exemption. I think that an accessions
tax better deals with liquidity and planning issues than the current system.
As to liquidity, under an transferee tax (like an accessions tax) qualified non-liquid
assets (such as working farms and closely-held business interests) would not be taxed on
receipt but rather only on conversion by the recipient to a liquid asset (or cash) or
cessation of qualified use. Dividends and other distributions from qualified non-liquid
assets would be taxable; profits reinvested in the qualified asset would not then be taxable
under the accessions tax. There would be no need to borrow cash or buy life insurance.
Other advantages of an accessions tax (as I would design it) include:
(1) a spousal exclusion without difficult qualification rules;
(2) no generation-skipping tax;
(3) no advantage for gifts over bequests;
(4) no relevance of powers of appointment;
(5) vastly simpler rules relating to timing (basically, an accession occurs upon a trust
distribution, not earlier); - -
(6) rational and simple treatment of life insurance.
Senator Schumer
(1) I am intrigued by the inheritance tax proposal, but I have some questions. The
proposal would tax the individual that receives the inheritance, but doesn't that
pose a significant problem if the bulk of the assets given to a particular individual
are not cash or liquid assets? It's not unusual to have specific bequests of
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property that can't be readily sold to pay an inheritance tax. With an estate tax,
all of the assets (liquid and non-liquid) are available to pay whatever tax is owed
before the property is distributed. I understand how your proposal would deal
with businesses, but what about other illiquid assets?
The three witnesses on March 12 were all talking about an accessions tax. The term
“inheritance tax” is just a kind of shorthand for a transferee-oriented wealth tax.
I can only guess at what you mean by “other illiquid assets.” I’ll assume that you mean
such things as personal effects, collectibles, and real estate. I’d probably exclude
personal effects, within reason. Personal effects are really deferred consumption and not
real wealth. Valuation would rarely be worth the effort. My inclination would be treat
other non-business non-liquid assets as falling within a single category which can be
called "hard-to-value assets.” I view these assets as being assets that have significant
lasting value but which cannot be valued apart from appraisals and which take time to
sell (or involve transaction costs in selling), as opposed to assets that are tied up with a
“way of life.” Some of these assets (commercial real estate) throw off income. Under an
accessions tax, you can use hindsight. First, the tax would be based on a good faith
valuation upon receipt. For this purpose, “receipt” can be defined with some flexibility.
For example, in the case of an estate, it might be defined as the earlier to occur of the date
of sale or the date which is three years after the decedent’s death. (This approach is
similar to the Alternate Valuation Date approach of the current system.) In case of sale,
only the net proceeds would be taxable. In this case, there's liquidity. If there is no sale
prior to the cut-off date, then a tax would be due on the basis of a value determined at the
cut-off date. However, the tax in this type of case could be deferred with market-rate
interest. If a sale occurs after the cut-off date, the unpaid tax obligation would be
accelerated. An issue would be whether later sale would trigger an additional tax (or
refund) based on the difference between the net sales proceeds and the original value. In
valuing such assets, there would be no discounts from wrapping the assets in holding
companies or other entities or packages.
(2) Decisions of how you distribute your lifelong gain are very personal decisions.
Often there are legitimate reasons for distributing more wealth to one child or
another.
(a) What are the ramifications of a reform system that punishes someone for
not spreading the value of his or her estate among as many heirs as
possible?
The person who is punished under an accessions tax is the legatee, who is receiving an
unearned windfall. I don’t view this as “punishment,” because the person still comes out
way ahead.
(b) For example, consider a case where the bulk of an estate is left to a
handicapped child to provide for his or her care. Should we tax this child
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more heavily because his needs are so great that the bulk of the inheritance
went to him? -
This person will be a trust beneficiary. In the case of trusts, accessions occur only on
actual distributions. The accession would not occur upon acquiring an interest in the
trust, even if the interest is vested. Thus, only amounts actually distributed or use would
COunt.
This person also has a substantial lifetime exemption. If the person is receiving
transferred wealth only from the trust (which seems likely), it would take a long time to
run through the exemption.
There would be an annual exclusion for inter vivos support-type spending. This could be
extended to trust distributions from a special-needs type of trust. The idea would be
similar to present $ 2503(e): spending for health care would be excluded. The notion of
“health care” could be expanded somewhat in this context, to include, for example,
recurring costs associated with institutionalization.
(3) When this Committee held a hearing on the current estate tax system last
November, the discussion focused on upcoming uncertainty due to the phase-out
and then re-instatement of the estate tax in 2009 and 2010. Witnesses also
discussed how the current system can be planned around to catch the most
favorable tax treatment. How will adopting an inheritance tax or accession tax cut
back on strategies to game the system?
No system is perfect. But the basic planning strategy would be simple: dispersal to zero-
(or low-) bracket persons. This accords with the non-tax goal of an accessions tax, so
there is nothing illegitimate about this planning. There would be these advantages, for.
Starters:
(1) The spousal exchusion system is simpler. Basically, the spouse is not taxed on what
she actually receives, and other persons are taxed on what they actually receive, but there
is no need to qualify trust interests in advance. There would be no need to have separate
marital and by-pass trusts, and no need for formula clauses. There would be nothing
special about deferral by way of using the marital exemption, because deferral can be
obtained anyway by using trusts. - -
(2) There is no generation-skipping tax. If dynastic trusts are viewed as a problem,
Congress can deal with that separately; for example, it can require minimum distributions
from long-term trusts. -
(3) Unlike the present system, there would be no advantage for gifts over bequests.
(4) Powers of appointment would be ignored. The Crummey trust problem would
disappear. General powers could not be used to avoid tax illegitimately.
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(5) Timing rules would be much simpler, and actuarial tables would be irrelevant.
Basically, an accession occurs upon a trust distribution, not earlier. There would be no
point in creating a GRAT.
(6) Valuation would be based on what the legatee gets, not what the transferor had.
(7) Charities would be exempt beneficiaries. There would be no qualification rules for
split-interest charitable trusts. Actuarial tables would be irrelevant.
Senator Cantwell
If Congress moves away from an estate tax, either by extending repeal beyond 2010
or establishing a new inheritance tax regime, what changes to the individual income
tax and capital gains tax rules would have to simultaneously be considered so that
we can maintain progressivity in the overall tax system?
I don’t favor stepped-up basis as it exists under the present system, because gain
permanently escapes the income tax without necessarily giving rise to any wealth transfer
tax. If there is no wealth transfer tax, then the hole in the income tax is exacerbated, and
closing it would be imperative. I don’t know of any theorist who favors the current
stepped-up basis system.
I have said that I would prefer taxing gains at death to carryover basis. Carryover basis
exacerbates the lock-in effect, requires keeping records for long periods of time, and
taxes equally-situated legatees inequitably. The carryover-basis rules slated to take effect
in 2010 are especially unfortunate, in my opinion, because they import transfer tax
features (lifetime exemption and marital exclusion, both through stepped up basis) that
don’t belong in an income tax.
Under a system that generally taxes gains at death, there would be carryover-basis
“exceptions” for transfers to spouses (thereby extending § 1041 past death) and for
qualified non-liquid assets. Where gains are taxed at death, the successor would obtain a
stepped-up basis.
Dealing with the income tax is a separate issue apart from the wealth transfer tax. Thus,
one could fix the income tax loophole and have a wealth transfer tax, but presumably the
latter would only apply to the very wealthy.
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Alternatives to the Current Federal Estate Tax System
Testimony to the Senate Committee on Finance
David G. Duff
Faculty of Law, University of Toronto
March 12, 2008
Introduction
I would like to begin by thanking the Chairman and the Committee for giving me the opportunity
to speak with you today. . . . • . -
My name is David Duff, and I’m a professor of tax law and policy at the University of Toronto
Faculty of Law, where I’ve taught since 1996. Before that, I worked for a tax commission in the
Province of Ontario, and as a tax associate in a Toronto law firm. I received by law degree from
the University of Toronto in 1989, and have Masters degrees in economics, politics, and law, the
last of which I received from Harvard in 1991.
I have appended two articles to this testimony. The first presents a philosophical argument for
wealth transfer taxation in the form of an accessions tax, which would turn the current U.S.
wealth transfer tax system on its head by applying to the cumulative amount of gifts and
inheritances received by individuals over the course of their lifetimes rather than aggregate
amounts given by donors over the course of their lifetimes. The second article reviews the
abolition of wealth transfer taxes in Canada, Australia and New Zealand, and attempts to derive
lessons from this experience for the future of these taxes. My testimony is based on both articles
and addresses the rationale for an accessions tax and lessons to be derived from the abolition of
wealth transfer taxes in Canada, Australia and New Zealand. - -
Why an Accessions Tax?
Beginning with the rationale for an accessions tax, let me explain briefly why I think that that a
society should tax transfers of wealth, and why an accessions tax is a better tax for this purpose
than the current federal wealth transfer tax system in the United States.
As a philosophical matter, I believe that it is both legitimate and desirable for a society to
moderate extreme inequalities in the distribution of wealth and in the opportunities that wealth
provides, by taxing substantial gifts and inheritances above a generous exemption. While I
believe that a society should value and encourage the family bonds that can be associated with
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the transfer of assets from one generation to another, I also believe that this value needs to be
balanced against the negative social and political consequences for a democratic society that can
result from the transfer of large dynastic fortunes from one generation to the next. In addition, to
the extent that recipients have not earned the gifts and inheritances that they receive largely by
the luck of their birth, I do not think that they cannot legitimately complain about a tax that
would require them to share some of their good fortune with others who have not been so lucky.
From this perspective, it is clear why an accessions tax would be better than the current federal
wealth transfer tax system in the United States. While the current gift and estate tax applies to
aggregate amounts transferred by donors over the course of their lifetimes and at death,
regardless of how this wealth is distributed among recipients, an accessions tax would apply to
the cumulative value of gifts and inheritances that are received by beneficiaries over the course of
their lifetimes—which are the amounts that actually contribute toward inequalities in wealth and
opportunities. As well, the gift and estate tax sends exactly the wrong message about a wealth
transfer tax by taxing successful, hardworking and generous donors who have accumulated
wealth out of income on which they have often paid tax already. In contrast, an accessions tax
sends a very different and justifiable message by taxing the beneficiaries of substantial gifts and
inheritances on amounts that they have not themselves earned and on which they have not
themselves paid any tax.
Mhy Did Canada, Australia, and New Zealand Abolish their Wealth Transfer Taxes?
This brings me to the abolition of wealth transfer taxes in Canada, Australia and New Zealand,
and the lessons that may be derived from this experience. Although the story in each country is
necessarily unique, I think that three factors are common.
First, in each country legislative action or inaction led to increased burdens on small- and
medium-sized estates — either because the rates on these estates were increased, because the
value of exemptions eroded with inflation, or because of other tax changes like the introduction
of capital gains taxation in Canada which applies to transfers of property by gift or bequest. With
much higher exemptions, the U.S. wealth transfer tax system does not face the same pressure.
Canadian experience, however, suggests that attention should be paid to the combined effect of a
wealth transfer tax and capital gains taxes applied to gifts and bequests.
Second, in each country competition between jurisdictions hastened the demise of these taxes. In
Canada and Australia, this occurred at the sub-national level when the federal governments in
each country repealed their estate and gift taxes in 1972 and 1979. In New Zealand, concern
about wealthy retirees moving to Australia contributed to the government’s decision to eliminate
its estate tax in 1992. Although these kinds of competitive pressures are not as great in a large
country like the U.S., they point to a further deficiency of donor-based gift and estate taxes – that
they are easier to avoid through emigration by affluent retirees than accessions taxes that apply to
younger and less geographically-mobile recipients.
99
Third, and perhaps most importantly, the wealth transfer taxes in each of these countries took the
form of donor-based estate taxes, either on their own or integrated with donor-based gift taxes.
To the extent that these kinds of taxes send the wrong message about the taxation of wealth
transfers, it is not surprising that they failed to generate many defenders when they were under
attack. In contrast, it is worth noting that recipient-based inheritance taxes appear to have been
far more resilient over the last 30 years, accounting for a larger share of total tax revenue and
GDP in some countries today than they did in the early 1970s,
Conclusion
As a citizen and resident of Canada, I am obviously not directly affected by the decisions that the
United States makes with respect to its wealth transfer tax system.
As you know, however, many countries around the world pay close attention to the United States
when they formulate their own tax policies. This is particularly true of Canada, which shares with
the United States not only the world’s longest border between two countries, but also similar
political values and an extremely close trading relationship.
As a result, the decisions that the United States makes for its own wealth transfer tax system can
have a huge effect on the tax systems of other countries, including Canada. I hope that the United
States will set a positive example for other countries of the world by replacing the current federal
wealth transfer tax system with an accessions tax that would be a model for wealth transfer
taxation in the 21" century. -
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UNIVERSITY OF TORONTO
Faculty of Law
LEGAL STUDIES RESEARCH PAPER
No. 05-08
THE ABOLITION OF WEALTH TRANSFER
TAXES: LESSONS FROM CANADA,
AUSTRALIA AND NEW ZEALAND
DAVID G. DUFF
§
fºr
|
HEGNUM J.JRS REGNUM PACŞ
This paper can be downloaded without charge at:
The Social Science Research Network Electronic Paper Collection:
http://ssrn.com/abstract=719744

101
The Abolition of Wealth Transfer Taxes:
Lessons from Canada, Australia, and New Zealand
David G. Duff
I. Introduction
When the U.S. Congress wº to phase-out the federal estate tax by 2010 and
Presiden Bush signed the legislation in June 2001, the United States jºine a small bu.
growing number of developed countries in which taxes on the transfer of wealth have
been abolished.” In Canada, federal gift and estate taxes were repealed in 1972 and
provincial wealth transfer taxes were abolished in the 1970s and 1980s. In Australia,
State and Commonwealth wealth transfer taxes were repealed in the late 1970s and early
1980s. New Zealand followed suit in the 1990s, reducing estate tax rates to zero in 1992
and repealing the tax in 1999. While the United Kingdom continues to collect taxes on
the transfer of wealth, the role of these taxes has declined substantially over the last 30
Associate Professor, Faculty of Law, University of Toronto. I am indebted to Alan Macnaughton, Richard
Schmalbeck and Larry Zelenak for helpful comments on earlier drafts. I am also indebted to Doug
Robertson, a J.D. student at the University of Toronto Faculty of Law, for excellent research assistance, and
to the Social Science and Humanities Research Council of Canada for financial support.
! Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107-16, § 501, 115 Stat. 38,69
(2001). The phase-out is accomplished by increasing the exclusion amount and reducing rates between
2002 and 2009, culminating in repeal for the year 2010. Under a sunset provision, however, the legislation
providing for this phase-out and repeal is itself repealed after December 31, 2010 – resulting in the
restoration of the tax in 2011. For a detailed description of this legislation, see Tye J. Klooster, “Repeal of
the Death Tax? Shoving Aside the Rhetoric to Determine the Consequences of the Economic Growth and
Tax Relief Reconciliation Act of 2001” (2003), 51 Drake L. Rev. 633-65. According to one commentator,
“[t]he fact that there will be two presidential and four congressional elections before the estate tax is fully
repealed means that it is possible that the repeal will never happen at all or that the sunset provision will
stand and the estate tax will return in 2011.” Mary R. Wampler, “Repealing the Federal Estate Tax: Death
to the Death Tax, or Will Reform Save the Day?” (2001), 25 Seton Hall L.J. 525 at 534.
* For an excellent account of the events leading up to repeal in the U.S., see Michael J. Graetz and lan
Shapiro, Death by a Thousand Cuts: The Fight over Taxing Inherited Wealth, (Princeton: Princeton
University Press, 2005). For a recent argument that Congress might benefit from uncertainty regarding
repeal of the federal gift and estate taxes, see Edward J. McCaffery and Linda R. Cohen, “Shakedown at
Gucci Gulch: A Tale of Death, Money and Taxes” University of Southern California Law and Economics
Research Paper No. 04-20, available at http://ssrn.com/abstract=581084.
102
years,’ and calls for repeal are often heard." As a result, U.S. repeal should no be viewed
as an isolated event but as part of a broader international trend.
Whatever the advantages or disadvantages of these taxes,” commentators are often
puzzled by the apparent political vulnerability of wealth transfer taxes since they
generally apply only to a small percentage of substantial estates.” For some, political
opposition to these taxes stems from psychological factors, such as the association
between the tax and death,' or an irrational optimism on the part of many people that they
will actually be subject to the tax." For others, it is largely ideological, reflecting a
conservative emphasis on individual enterprise and an increased hostility to redistributive
* See Organisation for Economic Cooperation and Development, Revenue Statistics of OECD, Countries,
(2003), available online at http://hermia.ingentaseiect.com/vi-4595239/ci-65/nw-l/rpsv/iiſoecdstats/
16081099/v55ml/contp1-1.htm (in 1972, estate and gift taxes accounted for 2.3 percent of total revenues in
the U.K. and 0.7 percent of gross domestic product; in 2002, these figures were 0.6 percent and 0.2 percent
respectively).
* See, e.g., Barry Bracewell-Milnes, Euthanasia for Death Duties: Putting Inheritance Tax Out of its
Misery, (London: Institute of Economic Affairs, 2002). The Conservative Party's 2005 election platform
calls for cuts to the U.K. Inheritance Tax, but not repeal.
* The merits of these taxes are widely disputed. Advocates tend to emphasize their contribution to tax
progressivity, their social role to lessen inequalities and unequal opportunities, and their assumed economic
superiority to income taxes. See, e.g., Michael J. Graetz, “To Praise the Estate Tax, Not to Bury It” (1983),
93 Yale L.J. 259; Eric Rakowski, “Transferring Wealth Liberally” (1996), 51 Tax L. Rev. 419; and Joseph
A. Pechman, Federal Tax Policy, 5* ed., (Washington, D.C.: Brookings Institution, 1987) at 234
(commenting that wealth transfer taxes have “less adverse effects on incentives than do income taxes of
equal yield”). Critics, on the other hand, condemn their relatively low revenue yield, high collection costs,
avoidability, and alleged impact on savings and entrepreneurship. See, e.g., Richard E. Wagner, Death and
Taxes: Some Perspectives on Inheritance, Inequality, and Progressive Taxation, (Washington, D.C.:
American Enterprise Institute, 1973); Joel C. Dobris, “A Brief for the Abolition of All Transfer Taxes”
(1984), 35 Syracuse L. rev. 1215; Edward J. McCaffery, “The Uneasy Case for Wealth Transfer Taxation”
(1994), 104 Yale L.J. 283; and Edward J. McCaffery, “The Political Liberal Case Against the Estate Tax”
(1994), 23 Phil & Pub. Aff 281. For my own views on wealth transfer taxation, see David G. Duff,
“Taxing inherited Wealth: A Philosophical Argument” (1993), 6 Can. J. L. & Juris. 3,
“In the United States, for example, only 4.3 percent of decedents were required to file estate tax returns in
1998, and only half of these were required to pay any tax. See William G. Gale and Joel Slemrod,
“Overview” in William G. Gale, James R. Hines Jr., and Joel Siemrod, eds., Rethinking Estate and Gift
Taxation, (Washingston, D.C.: Brookings Institution, 2001) 1-64 at 7-9. In the United Kingdom, it is
estimated that only 3.5 to 4 percent of estates pay inheritance tax. See Domenic Maxwell, Fair Dues:
Towards a more progressive inheritance tax, (London: Institute for Public Policy Research, 2004) at 11.
'See, e.g., Richard Bird, “The Taxation of Personal Wealth in International Perspective” (1991), 17 Can
Pub. Poly 322 at 330 (pointing to “the conjuncture of two events [death and taxes] that few people
contemplate with pleasure”).
* See, e.g., Graetz, supra note 5 at 285.
103
taxation.” Although conservative electoral victories have certainly contributed to the
decline of wealth transfer taxes," however, more progressive political parties have also
been willing to abandon these taxes and have been reluctant to restore them once
repealed."
In addition to these explanations for the decline and repeal of wealth transfer
taxes, public choice theory provides an alternative account, emphasizing the political
costs and benefits of different tax policies and the tendency for electoral competition to
promote “political efficiency” in the revenue structures adopted by governments over
time.” To the extent that wealth transfer taxes entail greater political costs and fewer
perceived benefits than other tax measures yielding comparable revenue yields, it is not
surprising that they might be politically vulnerable.
This paper examines the abolition of wealth transfer taxes in Canada, Australia
and New Zealand, relying on public choice theories of politically efficient revenue
structures to help explain the repeal of these taxes in each country. Part II wins the
essential elements of this theoretical approach and its implications for tax policy. Part III
* See, e.g., Keith G. Banting, “The Politics of Wealth Taxes” (1991), 17 Can. Pub. Poly 351 at 364. See
also Edward J. McCaffery, Fair Not Flat. How to Make the Tax System Better and Simpler, (Chicago:
University of Chicago Press, 2003) at 66 (suggesting that wealth transfer taxes contradict “common-sense
morality”). For a detailed study of the relationship between ideological perspectives and wealth transfer
taxes in Canada, see Lisa Philipps, Taxing Inherited Wealth: Ideologies About Property and the Family in
Canada, LL.M. Thesis, Osgoode Hall Law School (1992).
"In the United States, for example, Republican control of the Congress and the White House precipitated
repeal of the federal estate tax in 2001. See Graetz and Shapiro, supra note 2. Likewise, in Australia,
electoral victory by the Liberal Party under Malcolm Fraser preceded the repeal of the federal estate tax
effective 1 July 1979.
"In Canada, for example, it was the Liberal Party under Prime Minister Pierre Trudeau which repealed the
federal gift and estate taxes in 1971, notwithstanding that Trudeau had campaigned and won the 1968
election by promising a “just Society”. Similarly in Australia, Labour Prime Minister Gough Whitlam
promised to abolish federal death duties in 1975 in an unsuccessful bid to stay in office. In the U.S. as well,
as Graetz and Shapiro document, Democrats have been reluctant to defend the estate tax. See Graetz and
Shapiro, supra note 2. . -
* See, e.g., Walter Hettich and Stanley L. Winer, Democratic Choice and Taxation: A Theoretical and
Empirical Analysis, (Cambridge: Cambridge University Press, 1999); and W. Irwin Gillespie, Tax, Borrow
104
surveys the history of wealth transfer taxes in Canada, Australia and New Zealand,
examining in detail the events leading up to the repeal of these taxes, and illustrating the
relevance of public choice theory to their abolition in each country. Part IV offers brief
conclusions on the significance of this experience for the future of wealth transfer
taxation.
II. Public Choice Theory and Tax Policy
In the fields of public finance and tax policy, much writing is essentially
normative, establishing criteria for an ideal tax structure and evaluating actual tax
regimes against this ideal.” In contrast, public choice theories of politically efficient
revenue structures are largely positive, attempting to explain the kinds of tax structures
and tax reforms that actually exist in modern democratic societies." The following
sections provide a brief introduction to this theoretical approach, explaining the main
determinants of political efficiency within this framework and the manner in which
political efficiency is apt to be pursued through tax policy.
A. Public Choice and Political Efficiency
and Spend Financing Federal Spending in Canada., 1867-1900, (Ottawa: Carleton University Press,
1991).
* This is true of traditional public finance as well as more recent theories of optimal taxation. See, e.g.,
Richard A. Musgrave, Peggy B. Musgrave, and Richard M. Bird, Public Finance in Theory and Practice,
(Toronto: McGraw-Hill Ryerson Ltd., 1987); and James A. Mirrlees, “An Exploration in the Theory of
Optimum Income Taxation” (1971), 38 Rev. Econ. Stud i75. It is also true of much legal tax scholarship,
particularly scholarship based on the Haig-Simons concept of income, and the concept of tax expenditures
pioneered by Stanley Surrey. See Henry C. Simons, Personal Income Taxation: The Definition of Income
as a Problem of Fiscal Policy, (Chicago: University of Chicago Press, 1938); and Stanley S. Surrey,
Pathways to Tax Reform: The Concept of Tax Expenditures, (Cambridge, MA: Harvard University Press,
1973).
“Gillespie, supra note 12 at 14-17. Not surprisingly, of course, these positive theories may have normative
implications regarding, for example, constitutional arrangements regarding the manner in which revenue
decisions are made. See, e.g., James M. Buchanan and Gordon Tullock, The Calculus of Consent: Logical
Foundations of Constitutional Democracy, (Ann Arbor: University of Michigan Press, 1962). See also
105
Public choice theory has been defined as “the economic study of nonmarket
”* As such, it
decision making” or “the application of economics to political science.
concerns itself with traditional topics of political science such as voting behaviour, party
politics, and interest group activities, but examines these phenomena through the lens of
economic methodology premised on rational choice subject to constraints." As economic
analysis predicts that a perfectly competitive market tends toward an equilibrium at
which economic resources are efficiently allocated, so public choice theory predicts that
competition among political parties tends toward a political equilibrium where public
policies assume a politically efficient form." In order to understand this concept of
political efficiency and the form that it is likely to take, it is useful to examine the
motivations and constraints that public choice theory assigns to the central actors in the
political process: voters, politicians and political parties, and organized interest groups."
1. Voters
The starting point for a public choice theory of political efficiency is a set of
assumptions regarding voters and the reason why they vote. Sharing with economic
theory the premise that individuals are rational utility maximizers,” public choice theory
postulates that voters will generally cast their ballots for candidates and political parties
Gillespie, supra note 12 at 17 (suggesting that “a positive model of revenue structure could assist those of
us who advise governments on the tax changes that ought to be made”).
º º: C. Mueller, Public Choice II, (Cambridge: Cambridge University Press, 1989) at 1.
id. at 1-2. - -
"See, e.g., Hettich and Winer, supra note 12 at 2; and Gillespie, supra note 12 at 16. -
* Although it is not essential for the purpose of this paper, many public choice theories also consider th
behaviour of the bureaucracy and the mass media. See, e.g., Douglas G. Hartle, The Expenditure Budget
Process of the Government of Canada: A Public Choice-Rent Seeking Perspective, Canadian Tax Paper
No. 81 (Toronto: Canadian Tax Foundation, 1988) at 35-68. T - -
”See, e.g., Mueller, supra note 15 at 2. -
106
whose policies are expected to maximize their net utility.” In the context of government
expenditure and revenue policies, public choice theories generally assume that voters will
favour candidates and political parties whose policies are expected to maximize the
benefits that they receive from government expenditures while minimizing the taxes that
they are required to pay.” Voters may also favour certain kinds of taxes over others,
notwithstanding that amounts owing are the same, suggesting that differential preferences
for different kinds of taxes may also play a role in voting decisions.”
In addition to the hypothesis that voters will select candidates and political parties
whose policies are expected to maximize their net utility, public choice theory also
predicts that voting decisions are generally based on limited knowledge of actual policies
and their likely consequences. Since the time and effort to obtain this information is
considerable, and the probability of one’s vote affecting the outcome of an election is
negligible, public choice theory predicts that most voters will remain “rationally
ignorant” of most policies – ignoring specific details and basing their choices on
perceived impacts on net utility as well as more general perceptions of trustworthiness
* For an early expression of this rational voter hypothesis, see Anthony Downs, An Economic Theory of
Democracy, (New York: Harper and Row, 1957). See also Gordon Tullock, Towards a Mathematics of
Politics, (Ann Arbor: University of Michigan Press, 1967) at 110-114; and William Riker and Peter
Ordeshook, Introduction to Positive Political Theory, (Englewood Cliffs, N.J.; Prentice-Hall, 1973). While
the concept of “utility” for this purpose might be broadly defined to include an inter-subjective interest in
the welfare of others or a Kantian concern with just social institutions, public choice theory tends to ignore
this possibility by assuming an egoistic conception of human beings and a narrow and self-interested notion
of utility.
* See, e.g., Gillespie, supra note 12 at 17 (explaining that political parties in the pursuit of electoral victory
attempt to “maximize the political benefits from spending and minimize the political costs of financing the
spending”). -
* Ibid. at 26-27. To the extent that differential preferences for different kinds of taxes reflect notions of tax
fairness, the recognition of these tax preferences as a factor in voting decisions suggests that voters may be
motivated by something other than self-interest narrowly understood. For an attempt to rationalize ideas of
tax fairness in terms of utility maximization, see Douglas G. Hartle, Political Economy of Tax Reform: Six
Case Studies, Discussion Paper No. 290 (Ottawa: Economic Council of Canada, 1985) at 52-54.
107
and feelings of emotional attachment.” In the field of tax policy, this phenomenon is
likely to be particularly pronounced given the complexity of the issues involved.” Since
the expected benefits of acquiring information are greater where policies touch on one’s
most immediate interests, however, voters are likely to devote more resources to inform
themselves about these measures.” As a result, affluent individuals and corporations can
be expected to be much better informed and well-advised than most about the taxes they
pay and about the tax policies proposed by politicians and political parties.”
Not surprisingly, critics have challenged as limited and unrealistic both the self-
interested view of voting that public choice theory assumes and the egoistic conception of
human beings on which it is based.” Indeed, since it is irrational to expect that a single
vote will affect the outcome of an election, the very act of voting itself suggests that
voters must be motivated by considerations other than self-interested utility maximization
narrowly defined.” While one might attempt to rescue the theory of self-interested voting
by assuming a psychological benefit from the act of voting,” or distinguishing the
* See, e.g., Downs, supra note 20, chapters 11-13.
* See, e.g., Douglas G. Hartle, “Some Analytical, Political and Normative Lessons from Carter” in W. Neil
Brooks, ed., The Quest for Tax Reform, (Toronto: Carswell, 1988) at 415 (suggesting that most voters’
perceptions of their own interests are “more likely than not, seriously flawed when it comes to the details of
the tax structure as a whole”); and Banting, supra note 9 (emphasizing that “[m]ost voters are not well-
informed about the complex world of taxation” and that “[t]here is limited understanding not only of
technical language and abstract concepts such as equity, but also of elementary issues such as whether one
would benefit from a specific proposal”).
* Hartle, supra note 22 at 25. -
* See, e.g., Banting, supra note 9 at 353 (observing that “those with a large stake in tax battles inform
themselves and equip themselves with a phalanx of professional advisors”).
* See, e.g., Joseph P. Kalt and Mark A. Zupan, “Capture and Ideology in the Economic Theory of Politics”
(1984), 74 Am. Econ. Rev. 279; and Herbert Hovenkamp, “Legislation, Well-Being and Public Choice”
(1990), 57 U. Chi. L. Rev. 63. For more general criticisms of public choice theory, see Mark Kelman, “On
Democracy-Bashing: A Skeptical Look at the Theoretical and “Empirical’ Practice of the Public Choice
Movement” (1988), 74 Va. L. Rev. 199; and Daniel A. Farber and Philip P. Frickey, Law and Public
Choice: A Critical Introduction, (Chicago: University of Chicago Press, 1991).
*See the discussion of this “paradox” of voting, see Mueller, supra note 15 at 348-69.
* See, e.g., Daniel Shaviro, “Beyond Public Choice and Public Interest: A Study of the Legislative Process
as Illustrated by Tax Legislation in the 1990s” (1990), 139 U. Penn L. Rev. 1 at 77 (suggesting that the act
of voting can be understood as a source of utility in itself, “involving symbolic or expressive behavior”).
108
(unselfish) decision to vote from the (selfish) choice of candidate or political party, it
seems more realistic to admit that altruistic and ethical motivations are likely to mix with
more selfish considerations when voters case their ballots.” At the same time, the theory
that most voters remain rationally ignorant of actual policies calls into question the
significance of their votes for public policy more generally.”
While these criticisms undoubtedly lessen the predictive power of public choice
theory to some extent, they do not render it worthless. On the contrary, although it is
probably mistaken to assume that altruistic and anaimºnions play no role in voting
decisions, it is also likely that selfish considerations have a significant effect on the
choices that are ultimately made. simily. while imperfect information weakens the link
between voting decisions and public policy outcomes, it seems unlikely that voters will
systematically ignore their own interests on a consistent basis, and it is important to
recognize that voters are likely to be more knowledgeable about policies affecting their
most immediate interests. For these reasons, the basic premise of public choice theory
that voters will tend to favour candidates and political parties whose policies are
perceived to maximize their net utility is likely to have considerable predictive value,
notwithstanding the phenomenon of rational ignorance and the narrow conception of
human motivation on which public choice theory is based.
2. Politicians and Political Parties
”See, e.g., Robert E. Goodin and Kevin W.S. Roberts, “The Ethical Voter” (1975), 69 Amer Pol Sci Rev.
926; Howard Margolis, Selfishness, Altruism, and Rationality, (Cambridge: Cambridge University Press,
1982); and Amitai Etzioni, “The Case for a Multiple Utility Conception” (1986), 2 Econ. & Phil, 159.
* See, e.g., Geoffrey Brennan and James M. Buchanan, “Voter Choice: Evaluating Political Alternatives”
(1984), 28 American Behavioral Scientist 185 (arguing that voting decisions are primarily expressive or
symbolic rather than instrumental). . - -
109
For public choice theory, politicians and political parties, like voters, are also
assumed to be rational utility maximizers.” Unlike voters, however, who pursue this goal
by casting ballots for candidates and political parties whose policies are perceived to
maximize their net utility, politicians and political parties are presumed to maximize their
utility by winning elections.” Since voters are assumed to favour candidates and political
parties whose policies are expected to maximize their net utility, moreover, it follows that
elections are most likely to be won by politicians and political parties whose platforms
are perceived to maximize the net utility of the largest number of voters.” However,
because voter preferences are not immediately transparent to politicians and political
parties, and voters themselves are generally unfamiliar with specific policies, public
choice theories also predict that politicians and political parties can increase the
likelihood of electoral success by employing strategies and obtaining resources that
enable them to better discern voter preferences (e.g., by consulting with interest groups,
polling, and pre-testing policies with focus groups) and to promote their policies and
images (e.g., through media exposure and advertising).”
As with public choice theories of voting behaviour, critics have also questioned
the assumption that politicians and political parties are driven solely by the goal of
* Ideological objectives, for example, are undoubtedly also present, as
electoral success.
politicians and political parties certainly seek to influence voters’ perceptions of their
own best interests in order to win elections and to shape public policy outcomes
* Mueller, supra note 15 at 179.
”See, e.g., Downs, supra note 20 at 28.
* See, e.g., Mueller, supra note 15 at 214 (suggesting that “competition for votes between candidates leads
them “as if by an invisible hand” to platforms that maximize social welfare”).
* See the discussion of “probabilistic voting” in ibid. at 196-216.
* See, e.g., Shaviro, supra note 29 at 81-87.
110
according to their ideological preferences once in government or in opposition.” More
sophisticated public choice theories of politicians and political parties should also
account for different institutions and electoral rules which may create different strategies
for electoral success.” s In countries with proportional representation, for example, parties
and politicians may pursue a narrow voting base instead of a majority block.
Notwithstanding other motivations, however, the logic of electoral competition
suggests that politicians and political parties will over time not only seek electoral
success, but will also devise campaign strategies and political platforms designed to
appeal to the largest number of voters.” Through a process of “natural selection”,
therefore, one can expect that public policies in a democratic society will tend toward
political efficiency.”
3. Organized Interest Groups
Interest groups constitute a third group of political actors who are central to public
choice theories of political efficiency. Unlike voters and politicians, who are assumed to
maximize their own individual utilities, interest groups are assumed to promote the
common interests of their members." This is accomplished by informing members about
public policy issues affecting their interests,” lobbying politicians and political parties in
”See the analysis of ideology in Mueller, supra note 15 at 286-301.
*See the discussion in ibid. at 217-28.
* See, e.g., Hartle, supra note 18 at xviii-xix (noting that when policies are politically inefficient, “there is
an opportunity afforded the opposition parties to form a new coalition that will gain power at the expense
of the ruling coalition).
* See, e.g., Shaviro, supra note 29 at 88 (referring to a process of “natural selection” that can play a role
notwithstanding the motivations of some politicians or political parties).
* See, e.g., Mancur Olson, The Logic of Collective Action: Public Goods and the Theory of Groups,
(Cambridge, MA; Harvard University Press, 1971) at 5-8. -
* See, e.g., Hartle, supra note 18 at 62-63 (referring to this as the “intelligence function” of organized
interest groups). .
111
order to obtain policies favourable to members,” and promoting policies that advance the
common interests of members through direct advertising and the mass media.” As a
general rule, these services take the form of public or collective goods the benefits from
which cannot easily be limited to those who are willing to incur their costs through
membership.”
Of particular importance to public choice theory is the existence of information
and transactions costs and collective action (free-rider) problems that affect the likelihood
that persons with common interests will establish and maintain an organized entity to
promote their interests. Because persons are expected to be better informed about matters
affecting their most immediate interests than about more general or public interests,
public choice theory predicts that narrow or special interests will be better represented by
organized interest groups than more general and public interests. Moreover, since the
costs to establish and maintain an organized group and the incidence of free-riders are
likely to increase as the number of potential members increases, public choice theory also
predicts that relatively small numbers of persons with common interests are more likely
to be represented by organized interest groups than large numbers of persons with
common interests.” In the field of tax policy, these considerations suggest that relatively
small groups of taxpayers with common interests are much more likely to exercise
* Ibid. at 61 (observing that this lobbying generally involves the provision of information or funding). See
also Mueller, supra note 15 at 205 (noting that interest groups “try to increase the welfare of their
membership by reducing candidate uncertainty over how their membership votes”).
* See, e.g., ibid, at 61 (referring to “costly publicity campaigns designed to convince tens of thousands of
voters to support a desired candidate or party on a desired policy decision); and Hartle, supra note 24 at
414 (emphasizing the “capacity of special interest groups to influence the mass media”).
* Olson, supra note 41 at 15.
* See, e.g., ibid. at 46-52 (describing large unorganized interest groups as “latent” groups),
1 :
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political influence through organized interest groups than large groups of taxpayers with
more diffuse interests.”
4. Public Policy and Political Efficiency
The motivations and constraints that public choice theory assigns to the central
actors in the political process influence not only their expected behaviour within this
framework, but also the kinds of public policies that are likely to maximize political
efficiency. Since voters are predicted to be better informed about matters that touch on
their immediate interests and less knowledgeable about other issues, for example, public
choice theory suggests that political efficiency may be achieved by targeting government
benefits to groups of voters who are apt to be well-informed about the benefits that they
receive while distributing the related costs widely among groups of voters who are less
likely to perceive the burdens that they bear.” The more complex the nature of the
specific policy, moreover, the less likely it is that those who bear these costs will perceive
the burden, lessening further the political costs of the policy.” Differential transactions
costs and collective action problems suggest a similar strategy for politically efficient
public policies, involving the conferral of benefits on selected groups of voters who are
well-represented by organized interest groups, and the allocation of related costs among
more diffuse groups of voters for whom the financial and organizational barriers to
collective political action are much greater.” As a result, as Mancur Olson emphasized,
"See, e.g., Banting, supra note 9 at 353; and Hartle, supra note 24 at 413-15 (emphasizing the influence of
narrow and special interest groups in tax policy).
* See, e.g., Hartle, supra note 18 at 67.
* Ibid. at 67-68.
* Ibid.
12
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differential information and organizational costs create “a systematic tendency for
exploitation of the great by the small!”
B. Political Efficiency and Tax Policy
If voters regard benefits from government expenditures as utility enhancing and
taxes as utility reducing, the pursuit of political efficiency suggests that governments will
attempt to maximize the political benefits from spending programs and minimize the
political costs from the taxes necessary to finance these programs.” For a given level of
government expenditure, therefore, a politically efficient revenue structure will minimize
the political costs associated with each tax – utilizing each revenue source, as one theorist
explains, “up to the point at which the marginal political cost is equal for all such
sources.” Over time, moreover, a tendency toward political efficiency suggests that
governments will increase and decrease tax rates on specific revenue sources as their
relative political costs change, introduce new taxes when the political costs of so doing
are less than the political costs from increasing the rate of an existing tax, and repeal old
taxes when their political costs exceed those associated with other taxes.” The key
questions for a public choice theory of tax policy, therefore, concern the factors that
affect the political costs of different taxes and the reasons why these political costs
change over time.
” Olson, supra note 41 at 29 [emphasis in original].
* Gillespie, supra note 12 at 17, Jean Baptiste Colbert made a similar point long ago, explaining that: “The
art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least
amount of hissing.” -
*Ibid. at 18.
* Ibid. '
114
Beginning with the factors affecting the political costs of different taxes, many
can be identified.” Most obviously, perhaps, the political costs of a tax can be expected
to increase as its rate increases, since organized opposition to the tax is increasingly cost-
justified as tax burdens increase.” The same reason also suggests that the political costs
of a tax will increase as the costs to comply with the tax increase.” Political costs are also
likely to increase as costs to administer the tax increase, since diminished net revenues
attributable to higher administrative costs necessitate higher tax rates or other taxes to
maintain revenues – both of which involve political costs.” Conversely, the polica
costs of a tax tend to be lower where the number of taxpayers is large, since the burden is
spread widely and the costs of organized opposition substantial.” As the number of
taxpayers affected by an established tax increases, however, political costs can be
expected to increase because ww. opposing the tax are likely to attract new members.”
other important determinants of the political costs of taxes include vertical tax
competition (the occupation of the same revenue source by different levels of government
in a federal system), horizontal tax competition (the pursuit of mobile revenue sources by
different national or sub-national governments), and base elasticity (the extent to which
* For more general discussions, see ibid. at 20–32; and Hartle, supra note 22 at 41-54. The factors
considered in the text are by no means comprehensive, omitting for example several of those discussed in
Gillespie, supra note 12. Indeed, Gillespie himself emphasizes that “[t]here may well be” determinants of
political costs other than those that he identifies, explaining that “[t]he model is general enough to permit
the appropriate adaptations.” Ibid. at 31. For the purpose of this paper, I discuss only those factors that
seem most relevant to the decline and abolition of wealth transfer taxes, particularly in Canada, Australia
and New Zealand.
* Gillespie, supra note 12 at 21. To the extent that adverse economic consequences associated with
different taxes increase as rates increase, this effect is a further reason why the political costs of a tax are
likely to increase at its rate increases.
”Ibid. at 29-30; and Hartle, supra note 22 at 52 (observing that higher compliance costs “can be thought of
as an increase in the tax burden”).
* Gillespie, supra note 12 at 29-30; and Hartle, supra note 22 at 52.
”Gillespie, supra note 12 at 22-23; and Hartle, supra note 22 at 48. The political costs of a tax may also be
reduced by introducing concessions for narrow and special interest groups who are generally well-informed
115
revenues automatically increase with economic growth). In principle, the occupation of a
revenue source by one level of government tends to increase the political cost of its
imposition by another level of government, since at least some organized opposition to
the tax is likely to exist already, the collection of tax by the second government increases
the effective rate of the tax, and the first government itself can be expected to oppose the
measure" Political costs are also high for mobile revenue sources, since those subject to
the uxmy threaten to or actually relocate these sources to jurisdictions with tower taxes,
thereby depriving the higher-tax jurisdiction of revenue and economic activity.” Base
elasticity, on the other hand, decreases the political costs of a tax, since economic growth
allows governments to increase spending without having to increase effective tax rates.”
A final factor affecting the political costs of taxes is what W. Irwin Gillespie
describes as “tax preference” – a preference for one kind of tax versus another
notwithstanding that amounts owing under each tax would be identical.” While different
tax preferences might turn on compliance costs or other non-revenue impacts,” they
might also depend on judgements about the appropriateness or fairness of alternative
about taxes that affect them and already represented by organized interest groups. On the politically
efficient use of tax concessions, see ibid. at 37-39. .
* Gillespie, supra note 12 at 22-23. .
* Ibid. at 27-28. See also Hartle, supra note 22 at 49 (explaining that governments are likely to oppose
occupation of the same revenue source by another level of government because “taxpayers may incorrectly
assign the ‘blame” to the ‘wrong’ government; second, taxpayer opposition probably mounts exponentially
as effective rates rise on a given base [so that] the political costs of future revenue increases by the ‘prior'
occupant are raised even further; [and] thirdly, with higher tax rates evasion and avoidance becomes
increasingly attractive and enforcement costs are raised”). -
* Gillespie, supra note 12 at 28-29.
° Ibid. at 30.
“Ibid. at 26 (hypothesizing that voters “may not be indifferent between two revenue sources, for each of
which the tax per dollar’s worth of tax base could be equal for a given taxpayer”).
* See, e.g., ibid. (suggesting that different tax preferences “could arise because verification of one revenue
source interferes more directly in the conduct of a citizen’s affairs (say, a direct tax on incomes, compared
with an indirect tax on imports)”).
116
revenue sources.” As Gillespie explains, a preference for one tax over another “could
arise because one revenue source is judged by citizens to be the product of their own,
meritorious efforts (say, labour income), whereas another revenue source is judged not to
be the result of hard work (say, an inheritance, a gift or a lottery win).” Alternatively, he
suggests, different tax preferences might exist “because one revenue source is judged by
taxpayers to have unhealthy, immoral or sinful connotations (expenditures on alcoholic
beverages and tobacco products), whereas the connotations of another revenue source are
seen as healthy, moral or meritorious (expenditures on milk, footwear and clothing for
children and expenditures on charitable donations).” Whatever the reasons for these tax
preferences, the political cost to introduce, maintain or increase a tax for which a large
number of voters have a lower preference will be greater than the political cost to
introduce, maintain or increase a tax for which a large number of voters have a greater
tax preference.”
Having identified some of the key factors affecting the political costs of different
taxes, it is possible to speculate on various reasons why these political costs might change
over time. Changes in government expenditures, for example, are likely to affect the
political costs of taxes – increasing these costs where rates are increased or exemptions
reduced in order to finance increased spending, and decreasing these costs where
spending reductions allow taxes to be cut. Actions by other governments can also affect
the rolia costs of different taxes – increasing these costs where other levels of
government introduce or increase taxes on the same revenue source, but decreasing these
* Ibid. at 27 (noting that voters may be less politically opposed to taxes that are perceived to be fair than
they are to taxes that are perceived to be unfair).
* Ibid. at 26.
*Ibid.
16
117
costs where neighbouring governments at the same level introduce or increase taxes on
the same revenue source. Another reason why the political costs of different taxes might
change involves broader economic changes, as increasing economic integration has
undoubtedly increased the political costs of taxes on mobile revenue sources. Inflation
can also increase the political costs of a tax, if exemptions are not indexed or adjusted to
offset their declining real value. Finally, ideological shifts are likely to change the
political costs of different taxes to the extent that they influence people’s preferences for
different kinds of taxes. For public choice theories of political efficient revenue
structures, however, the reasons for changes in the political costs of different taxes are
considered exogenous and not themselves subjects of inquiry.
III. Wealth Transfer Taxes in Canada, Australia and New Zealand
Wealth transfer taxes were first introduced in the Australian colonies and New
Zealand in the second half of the nineteenth century,” and by all Canadian provinces
between the years 1892 and 1903 ." In Australia and New Zealand, these taxes were
generally based on the estates of persons domiciled in the taxing jurisdiction, though
Queensland and South Australia opted for succession duties with rates and exemptions
° Ibid.
”On the early history of death duties in the Australian colonies, see Julie P. Smith, Taxing Popularity: The
Story of Taxation in Australia, (Canberra: Federalism Research Centre, 1993) at 16-18. For a history of the
estate tax in New Zealand, see L. McKay, “Historical Aspects of the Estate Tax” (1978), 8 N.Z. U.L. Rev. 1.
In Australia, New South Wales enacted the first death duty in 1851. Tasmania followed in 1865, Victoria in
1870, South Australia in 1876, Queensland in 1886, and Western Australia in 1895. In New Zealand, a tax
on estates was first introduced in 1866.
" J. Harvey Perry, Taxes, Tariffs, & Subsidies: A History of Canadian Fiscal Development, (Toronto:
University of Toronto Press, 1955), Vol. 1 at 110-11 1. See also George E. Carter, “Federal Abandonment
of the Estate Tax: The Intergovernmental Fiscal Dimension” (1973) 21 Can. Tax J. 232 at 233. Ontario was
the first Canadian province to introduce a succession duty, which was modeled closely after similar
legislation enacted a few years earlier in the states of New York and Pennsylvania. R.A. Bayly, Succession
Duty in Canada, (Toronto: The Carsweil Company, Limited, 1902) at 10. Later that year, succession duties
were also introduced in Quebec, New Brunswick, and Nova Scotia. Manitoba enacted a succession duty in
17
118
applied to amounts received by beneficiaries,” and New Zealand's tax depended both on
the size of the estate and the degree of consanguinity between the beneficiary and the
deceased.” In Canada, the constitutional restriction on provincial taxing powers to
” meant that provinces limited their death duties to
“Direct Taxation within the Province
property situated within the province upon the death of the owner, and to property
situated outside the province only if the deceased was domiciled in the province and the
beneficiary was resident or domiciled in the province.” Rates were determined both by
the value of the estate and by the relationship between the deceased and the beneficiary.”
In each of these jurisdictions, wealth transfer taxes were the first major direct
taxes to be imposed, marking a major departure from an earlier era in which governments
were financed almost entirely from customs duties and excise taxes.” Although the
introduction of these taxes reflected an important political shift from regressive indirect
1893, and British Columbia and Prince Edward Island followed the next year. Alberta and Saskatchewan.
introduced similar fevies in 1903 under the Northwest Territories Ordinance.
* Peter Saunders, “An Australian Perspective on Wealth Taxation,” in John G. Head, ed., Taxation Issues
of the 1980s, (Sydney: Australian Tax Research Foundation, 1983) 397 at 398. In South Australia,
legislators favoured the latter approach on the grounds that “a man should leave his property to several
persons instead of one only”. Parliamentary Debates, 1893, I, 342, cited in Stephen Mills, Taxation in
Australia, (London: McMillan & Co., 1925) at 140.
” McKay, supra note 70 at 1. In 1881, the legislature abandoned the succession duty basis of the tax,
adopting a pure estate-type tax with an exemption and progressive rates based on the size of the estate. In
1909, however, a succession duty was reintroduced to operate in tandem with the estate tax. Ibid. at 3–4.
"Constitution Act, 1867, s. 92(2). -
* Carter, supra note 71 at 233. For a summary of the leading constitutional cases that shaped the evolution
of provincial succession duties in Canada, see G.V. LaForest, The Allocation of Taxing Power Under the
Canadian Constitution, Canadian Tax Paper No. 65 (Toronto: Canadian Tax Foundation, 1981) at 106-09,
For a more detailed analysis of the impact of Canadian constitutional law on the design of these succession
duties, see Wolfe D. Goodman, “Provincial Wealth Taxes,” In Report of the Proceedings of the Twenty-
Third Tax Conference, 1971 Conference Report, (Toronto: Canadian Tax Foundation, 1972) at 29
(contending that provincial succession duties could have applied to all amounts received by beneficiaries
resident or domiciled in the province without violating the constitutional provision limiting provincial
taxing powers). That provincial succession duties could also apply to amounts received by resident
beneficiaries regardless of the domicile or residence of the deceased, was subsequently established in
Attorney-General of British Columbia v. Ellett Estate [1980] CTC 338 (SCC).
*Carter, supra note 71 at 233. -
" Smith, supra note 70 at 16; Philipps, supra note 9 at 91.
119
taxes to progressive direct taxes,” their primary rationale appears to have been to raise
revenue.” In Australia, revenues from estate duties exceeded 30 percent of total State tax
revenues in 1909/10,” and continued to account for a significant share of State tax
revenues until the late 1960s.” In Canada, provincial succession duties accounted for
almost 40 percent of provincial tax revenues in 1913,” and remained substantial
contributors to provincial finances until 1946, when most provinces ceded occupancy of
this field to the federal govemment” In New Zealand, the estate tax accounted for 13.5
percent of government revenues in 1915, but declined thereafter.”
Revenue considerations were also central to the decision of the Commonwealth
government in Australia to enact a national estate duty in 1914, and the decision of the
federal government in Canada to enact a succession duty in 1941. In Australia, estate
” Smith, supra note 70 at 16; Philipps, supra note 9 at 93-94 (contending that political agitation for direct
taxation was much more muted in Canada than in the United States).
” Smith, supra note 70 at 17 (referring to Australia); McKay, supra note 70 at I (referring to New
Zealand); and Perry, supra note 71 at 109 (referring to Canada).
* Calculated from figures in R.L. Mathews and W.R.C. Jay, Federal Finance: Intergovernmental
Financial Relations in Australia since Federation, (Melbourne: Thomas Nelson Australia Ltd., 1972) at 83
(Table 11).
* Although the contribution of estate duties to State tax revenues decreased to 15.1 percent in 1918/19,
12.0 percent in 1928/29 and 7.6 percent in 1938/39, this share increased to 24.1 percent in 1948/49 (after
the states abandoned their income taxes to the Commonwealth government during the Second World War),
and exceeded 18 percent in 1958/59 and 16 percent in 1968/69. Calculated from figures in ibid. at 100, 166,
194, 230, and 247 (Tables 14, 21, 24, 34, and 38). For a breakdown among different States in the years
after the Second World War, see Saunders, supra note 72 at 398-99.
*Calculated from figures in Perry, supra note 71 at 123 (Table VII).
* The contribution of succession duties to provincial tax revenues was almost 30 percent in 1937 and over
20 percent in 1946, but declined thereafter to 6.9 percent in 1949, 4.8 percent in 1959, and 2.0 percent in
1969. Calculated from figures in Statistics Canada, Historical Statistics of Canada, H92-112. Provincial
governments, net general revenue by major source, selected years, 1933 to 1969, available on the web at
http://www.statean.ca/english/freepub/11-516-XIE/sectionh.htm#Fed%20Gov%20Fin. While succession
duties obviously accounted for a larger share of tax revenues in those provinces that collected their own
taxes (Ontario and Quebec until 1963 and British Columbia thereafter), the relative role of these taxes also
declined in the postwar period, falling to 9.2 percent in Ontario and 6.1 percent in Quebec in 1958/59 and
3.2 percent in British Columbia, 2.7 percent in Ontario, and 2.4 percent in Quebec in 1968/69. Calculated
from figures in Provincial Finances 1969, (Toronto: Canadian Tax Foundation, 1969) at 207,211, and 224
(Tables 53, 55, and 63).
* As a percentage of total government revenue, the estate tax declined to 9.1 percent in 1925, 8.8 percent in
1935, 4.6 percent in 1945, 4.0 percent in 1955, 2.5 percent in 1965, and 1.4 percent in 1975. McKay, supra
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duty and income tax were enacted in order to help finance participation in the First World
War, after revenues from customs and excise duties collapsed due to the disruption of
trade.” In Canada, where a federal income tax was enacted primarily for revenue reasons
during the First World War,” the main justification by Minister of Finance J.L. Ilsley for
the introduction of a federal succession duty was “the compelling need for revenue” to
fight the Second World War.” At the same time, he emphasized, since the provinces had
“not fully occupied” the field, there was “room for an additional and independent
dominion tax” as a permanent source of federal revenue.” As a percentage of total tax
revenues, however, federal wealth transfer taxes in Australia and Canada were never very
large, accounting for only 2 to 4 percent of federal tax revenues in Australia from 1914 to
1940 and no more than 1.4 percent of federal tax revenues in the post-war period,” and
contributing no more than 1.7 percent of federal tax revenues in Canada.”
In Australia, the introduction of the national estate duty led to a lengthy period in
which the Commonwealth and State governments jointly occupied the wealth transfer tax
note 70 at 21 (Table I). By 1985, the share of tax revenues represented by the estate tax fell to 0.2 percent.
OECD, supra note 3.
* Mathews and Jay, supra note 80; and Smith, supra note 70 at 45. Although the estate duty included gifts
made within a year of death, a separate gift tax was not enacted until 1942. -
* On the origins of the federal income tax in Canada, see Richard Krever, “The Origin of Federal Income
Taxation in Canada” (1981), 3 Canadian Taxation 170.
* Hon. J.L. Isley, Minister of Finance, Budget Speech, 29 April 1941, (Ottawa: King's Printer, 1941) at 16
(adding that “[d]eath duties, in general, are a very good type of tax, second only to income tax in their
essential fairness and the possibilities of adjusting them progressively to ability to pay”). The succession
duty was based partly on the share of the estate received by each beneficiary, partly on the size of the
estate, and partly on the relationship between the beneficiary and the deceased. In 1958, this tax was
replaced by an estate tax with progressive rates based solely on the aggregate value of the estate. A gift tax
hº been introduced in 1935, primarily to discourage income-splitting under the federal income tax.
Ibid.
*Saunders, supra note 72 at 398-99. - -
* Figures calculated from Statistic Canada, Historical Statistics of Canada, H75-91. Federal government,
net general revenue by major source, selected years, 1933 to 1969, available on the web at
http://www.statean.ca/english/freepub/11-516-XIElsectionh/sectionh.htm#AH%20Gov.
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field. Despite recurring proposals to allocate this revenue source solely to the States,” or
solely to the Commonwealth government,” joint occupancy continued until the taxes
were repealed at both levels of government in the 1970s and early 1980s. As a result,
although the Commonwealth and State governments cooperated to some extent in the
administration of these taxes,” Australia’s “double or duplicative” wealth transfer tax
system was a source of considerable complexity and high compliance and administration
costs.”
In Canada, complete joint occupancy lasted only from 1942 to 1946, when all
provinces but Ontario and Quebec agreed to withdraw from the collection of succession
duties as well as personal and corporate income taxation in return for unconditional
grants from the federal government.” In order to relieve the estates of decedents in
Ontario and Quebec from the combined burden of federal and provincial taxes, the
federal succession duty was amended to provide a credit for provincial succession duties
* At the Premiers Conference in 1926, for example, the Commonwealth proposed to vacate the estate duty
and other revenue sources to the States in exchange for the abolition of per capita grants. The States
rejected the proposal for a number of reasons, including the absence of any guarantee that a subsequent
Commonwealth Government would not re-enter the field. Mathews and Jay, supra note 81 at 120. Likewise
in 1974, the Senate Standing Committee on Finance and Government Operations recommended that the
Commonwealth government vacate the field of estate and gift duty, subject to the States agreeing on
uniform legislation and rates of duty. Senate Standing Committee on Finance and Government Operations,
Report on Death Duties, (Canberra: Australian Government Publishing Service, 1974).
* In 1975, for example, the Taxation Review Committee (Asprey Committee) recommended a single
national estate and gift duty administered by the Commonwealth government, with a portion of revenues
shared with the States based on “the domicile of deceased persons and donors domiciled within the State
and property within the State of deceased persons and donors domiciled outside Australia.” Taxation
Review Committee, Full Report, (Canberra: Australian Government Publishing Service, 1975) at 24.74.,
available on the web at http://setis.library.usyd.edu.au/oztexts/parsons.html.
* Saunders, supra note 72 at 400.
* Willard H. Pedrick, “Oh, to Die Down Under! Abolition of Death and Gift Duties in Australia” (1981),
35 Tax Lawyer 113 at 119. See also Peter Groenewegen, “Options for the Taxation of Wealth” (1985), 2
Australian. Tax Forum 305 at 315 (attributing the unpopularity of death duties in Australia in part to “their
high compliance costs for taxpayers, the size of which was strongly influenced by the fact that death duties
were a major area of Federal-State duplication”); and Taxation Review Committee, supra note 92 at 24.71
(acknowledging criticism of the death duties then in force “on grounds of the complexity of separate
Commonwealth and State taxes and the considerable costs in administration and compliance that result”).
* Carter, supra note 71 at 235,
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up to 50 percent of the federal tax otherwise payable.” In 1957, the unconditional grant
system was replaced by a series of agreements under which most provinces continued to
relinquish succession duties to the federal government in exchange for “rental payments”
equal to 50 percent of federal collections of succession duties in each province.” In
Ontario and Quebec, which refused to “rent" their succession duties to the federal
government, the federal tax was reduced in the form of a 50 percent abatement that
replaced the former tax credit.” In 1964, British Columbia withdrew from this “tax rental
agreement” and began to collect its own succession duty, receiving the same abatement
as was available in Ontario and Quebec.” The next year, federal rental payments for this
revenue source were increased to 75 percent, with a corresponding increase in the
abatement allowed under the federal tax.” While British Columbia increased its
succession duty to take full advantage of this abatement, Ontario and Quebec left their
succession duties unchanged, opting to receive rental payments equal to 25 percent of
"As a result, while federal-provincial agreements
federal collections in their provinces.
simplified the collection of wealth transfer taxes in seven often Canadian provinces, the
combination of federal and provincial taxes in the remaining three was as complicated
and “duplicative” as the system in Auna. More importantly, perhaps, the federal
government’s agreement to return 75 percent of federal wealth transfer tax revenues to
the province where the tax was collected (or to abate the federal tax by up to 75 percent
* Ibid. at 235-37 (explaining that the credit did not always relieve the combined burden of both taxes).
” Ibid. at 236 (adding that these revenues were supplemented by an equalization component designed to
raise the per capita yields in each participating province up to the per capita yield in the two provinces
having the highest per capita yields).
*Ibid. (emphasizing that the substitution of the abatement for the tax credit “amounted to a change merely
in form, not in substance”). r
° Ibid.
* Ibid.
* Ibid.
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where a province collected its own tax) might be expected to significantly weaken its
commitment to the tax. As the following sections demonstrate, however, complexity and
revenue yield are only two of many reasons why wealth transfer taxes were abolished in
Canada, Australia and New Zealand.
A. The Abolition of Wealth Transfer Taxes in Canada
The specific events leading to the abolition of wealth transfer taxes in Canada
began somewhat innocuously with the appointment of a Royal Commission on Taxation
(the Carter Commission) in 1962, unfolded at the federal level between 1967 and 1971 as
the federal government responded to the Report of the Carter Commission, and continued
at the provincial level over the following fourteen years. This section examines each of
these phases.
1. The Carter Commission: 1962-1967
Promised by Progressive-Conservative Prime Minister John Diefenbaker in the
opening speech of his 1962 election campaign,” an independent commission had long
been favoured by tax professionals and business leaders as a vehicle to reduce
progressive rates, simplify administration and enforcement, and address technical
* When the Progressive-Conservative Party formed a
anomalies in the income tax.
minority government after the election, Diefenbaker announced the appointment of a
Royal Commission comprising mainly professionals and businesspersons and chaired by
* “The Vital Pledge”, The Globe and Mail (7 May 1962) at 6. .
* See Les MacDonald, “Why the Carter Commission Had To Be Stopped,” in Brooks, supra note 24, 351
at 351-53. The main technical issues involved the characterization of isolated transactions as taxable
business income or non-taxable capital gains, and “surplus stripping” transactions designed to convert
taxable dividends into non-taxable capital gains.
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Toronto accountant Kenneth Carter.” The Carter Commission's terms of reference were
extremely broad, involving a review of all aspects of federal taxation including “income,
sales and excise taxes and estate duties”.”
Given its origins and its membership, there was every reason to expect that the
Commission would affirm the prevailing “tax orthodoxy” of business and professional
commentators that taxes were too high, that indirect sales or value-added taxes should be
considered as alternatives to high income taxes, and that wealth transfer taxes were
causing Canadian family businesses to be sold to foreigners.” Indeed, submissions to the
Commission, most of which were from the same business and professional interests
which had pushed for its establishment,” tended to repeat these views in more technical
form.” According to the Shoe Manufacturers’ Association of Canada, for example,
“[t]he unreasonably high level of succession duties has been the largest single factor both
in encouraging the sellout of Canadian enterprises to foreign interests and in eliminating
from the economic scene continuing independent family businesses.” The Canadian
Bar Association decried the “excessive amount of property” that was tied up for ºns
periods of time in trusts to avoid wealth transfer taxes, concluding that these
“Of the six members of the Commission, three were “acknowledged authorities in tax circles, with
impeccable professional and business connections”, one was a lawyer and General Manager of the Nova
Scotia Trust Company, another was Treasurer of the National Council of Women and had previously
managed the western Canadian branch of an insurance firm, and the last was Manager of the British
Columbia Federation of Agriculture and an Executive Director of the Canadian Federation of Agriculture.
Ibid. at 353.
* Order in Council, P.C. 1962-1334 (25 September 1962), reproduced in Royal Commission on Taxation
(Carter Commission), Report, (Ottawa: Queen’s Printer, 1966), Vol. 1, at v.
*MacDonald, supra note 103 at 354.
" According to one commentator, over half of the submissions to the Commission came from business
organizations while less than 5 percent were from labour and employee organizations. Robert Gardner,
“Tax Reform and Class Interests: The Fate of Progressive Reform, 1967-72” (1981), 3 Canadian Taxation
245 at 246, n. 9. For a list of submissions received by the Commission, see Royal Commission on Taxation,
supra note 105, Vol. 1, Appendix A, at 121-30.
*MacDonald, supra note 103 at 354.
”Reported in “Nation's Business: The dead hand of death duties,” Financial Post (1 February 1964), p. 1.
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arrangements “frequently restrict the company’s proper development and expansion and
may add to production costs.” On the basis of these and other submissions, Canada's
leading financial newspaper concluded that “the economic damage” caused by these
taxes was “staggering.”"
As well as accepting submissions, the Commission embarked on an ambitious
research programme, lasting four years and costing approximately $4 million.” Among
27 research studies, one found no evidence that the estate tax was a major factor in the
113
sale of small businesses.” Others challenged the non-taxation of capital gains, which
were traditionally excluded from the source concept of income that Canada had borrowed
"Another study examined the incidence of taxation Canada,
from the United Kingdom.
concluding that the tax system as a whole was regressive for at east the poorest third of
Canadian families and possibly more.” After much delay, and two intervening elections
resulting in Liberal minority governments, the Commission’s six-volume Report was
finally released in February 1967.
Of the Commission’s many recommendations, the most central was its conclusion
that “taxes should be allocated according to the changes in the economic power of
individuals and families.” Emphasizing that “[t]he first and most essential purpose of
* Ibid.
* Ibid.
* John G. Head, “Evolution of the Canadian Tax Reform” (1973), 1 Dalhousie L.J. 51.
* John G. Smith, D.B. Fields, and E.J. Mockler, Death Taxes, Studies of the Royal Commission on
Taxation, Number 11 (December 1964) at 18-20.
"Geoffrey R. Conway and John G. Smith, The Taxation of Capital Gains and the Law Concerning
Capital Gains, Studies of the Royal Commission on Taxation, Number 19 (1966); and Douglas J.
Sherbaniuk, The Concept of income – The Receipts Side, Studies of the Royal Commission on Taxation,
Number 20 (February 1967).
* W. Irwin Gillespie, The Incidence of Taxes and Public Expenditures in the Canadian Economy, Studies
of the Royal Commission on Taxation, Number 2 (1966).
" Royal Commission on Taxation, supra note 105, Vol. 1, at 9. See also ibid., Vol. 3, at 39 (suggesting
that taxes should be based on “the sum of the market value of goods and services consumed or given away
in the taxation year by the tax unit, plus the annual change in the market value of the assets held by the
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taxation is to share the burden of the state fairly among all individuals and families”,” a
majority of the Commissioners rejected any distinction among different sources of
changes to a taxpayer’s economic power,” proposing a “comprehensive tax base”
according to which the “all the net gains ... of each tax unit” should be subject to tax “on
an annual basis”.” Among the implications of this approach, gifts and inheritances
would be included in the comprehensive tax base for the year in which they were
received,” and capital gains and losses would be fully recognized on an accrual basis
' For administrative reasons, however, the Commission
irrespective of any sale.”
retreated from accrual treatment for capital gains and losses, recommending instead that
these gains and losses should be recognized on a realization basis, as well as when
property is transferred by way of gift or on death.” Since gifts and inheritances would be
included in the recipient’s income, the Commission also recommended that separate
d 123
wealth transfer taxes should be repeale Other key recommendations included the
124
introduction of a family tax unit (including dependent children),” a reduction in the top
unit”). In adopting this approach, the Commission was obviously inspired by the broad definitions of
income formulated by U.S. economists Robert Haig and Henry Simons. See R.M. Haig, “The Concept of
Income – Economic and Legal Aspects,” in R.M. Haig, ed., The Federal Income Tax, (New York:
Columbia University Press, 1920) 27 at 59 (defining income as “the money value of the net accretion to
one’s economic power between two points of time”); and Simons, supra note 14 at 50 (defining personal
income as “the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change
in the value of the store of property rights between the beginning and end of the period in question”).
” Royal Commission on Taxation, supra note to 5, Vol. 1, at 4.
* Ibid. at 9 (emphasizing that if a person “obtains increased command over goods and services for his
personal satisfaction we do not believe it matters, from the point of view of taxation, whether he earned it
through working, gained it through operating a business, received it because he held property, made it by
selling property or was given it by a relative”).
”Ibid., Vol. 3, at 39. Two Commissioners (Beauvais and Grant) dissented from this recommendation. See
ibid., Vol. 1, at 51-1}l.
* Ibid., Vol. 3, at 41.
* Ibid.
* Ibid. at 368-80.
*Ibid. at 473 and 513
* Ibid., chapter 10.
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marginal rate from 80 percent to 50 percent, * the complete integration of corporate and
personal income taxes,” and a dramatic reduction in tax concessions for income from
mineral and petroleum extraction.”
2. Federal Reform: 1967-1971
While the Commission’s Report was hailed by leading tax academics as “a
landmark in the annals of taxation”,” affluent individuals and the business and
professional interests that pushed for the Commission’s formation were overwhelmingly
negative.” Although a reduction in the top marginal rate and repeal of wealth transfer
taxes would provide some benefit for affluent individuals, this would be more than offset
by the full taxation of capital gains and the inclusion of gifts and inheritances in income.
While the Report estimated that 64 percent of Canadian taxpayers would pay lower taxes
under its proposals, these reductions averaged only about 5 percent of taxes otherwise
payable and were generally limited to taxpayers with incomes of less than $35,000 in
1964.” In contrast, 27,000 taxpayers with incomes over $35,000 could have expected to
pay an additional $1,000 on average, while an estimated 633 individuals with incomes
over $300,000 could have expected to pay an average of more than $67,000 in additional
taxes.” The mining industry stood to lose the most, as the Report's proposed withdrawal
of net depletion allowance and a three-year tax holiday were expected to increase its
taxes by more than 100 percent – most of which would have been paid by the 15 largest
* Ibid., chapter 11.
* Ibid., Vol. 4, chapter 19.
”Ibid., chapter 23.
* Arnold C. Harberger, “A Landmark in the Annals of Taxation” (1968), Can. J. Econ, Supplement No.
1, 183-94. See also Head, supra note 112 at 52.
* See, e.g., the detailed review in Gardner, supra note 107. See also Meyer Bucovetsky and Richard M.
Bird, “Tax Reform in Canada: A Progress Report” (1972), 25 Nat. Tax J. 15 at 17-18; and Head, supra note
| 12 at 58-59.
* Royal Commission on Taxation, supra note 105, Vol. 6 at 62, Table 36-7.
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companies.” Not surprisingly, therefore, mining companies led organized opposition to
the Report, threatening the cessation of Canadian investments, and enlisting the support
of premiers from Western provinces where the extraction industries predominated.”
At the end of April 1967, then Finance Minister Mitchell Sharp announced a
timetable to deal with the Report, inviting comments on the major recommendations by
September of that year, and promising a White Paper incorporating the government’s
proposals thereafter and draft legislation to be enacted by the end of 1968.” Within two
weeks, however, Sharp responded to pressure from the mining industry by guaranteeing
that the three year tax exemption for new mines would remain until the end of 1973,
whatever decisions were made on the basis of the Report of the Royal Commission.” By
autumn 1967, Sharp had received over a thousand responses, including 150 substantial
submissions, mostly from corporations and business and professional organizations, and
mostly critical.” While many of these submissions opposed the withdrawal of special
tax preferences,” considerable criticism was also directed at the Commission's emphasis
on fairness as “the first and most essential purpose of taxation” and at the comprehensive
tax base in particular. Imperial Oil, for example, opposed the “sacrifice of economic
* MacDonald, supra note 103 at 360.
* Royal Commission on Taxation, supra note 105, Vol. 6 at 96 and 121.
* See, e.g., Bucovetsky and Bird, supra note 129 at 17-18; and Gardner, supra note 107 at 249.
* Hon. Mitchell Sharp, “Tax Reform – The Fiscal Context,” Address at Banquet of the Nineteenth Tax
Conference, 24–26 April 1967, in Report of Proceedings of the Nineteenth Tax Conference, (Toronto:
Canadian Tax Foundation, 1967) 471 at 473.
* House of Commons Debates (11 May 1967) at 111 (Hon. Mitchell Sharp) (assuring that “should the
government decide to propose the removal of this incentive, it would not do so in a manner that would
remove the exemption with respect to income earned before January 1, 1974, nor would it in any essential
manner change the method of application of that exemption before that date”).
* Gardner, supra note 107 at 248,
” According to Graham Hodgson, “More than 100 oil industry briefs oppose recommendations of Carter
tax report” Globe and Mail (26 September 1967) p. B1, for example, over 100 protesting submissions were
made by the oil industry alone.
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growth to the commission's concept of equity.” The Trust Companies Association
warned that the inclusion of gifts and inheritances in the income tax base “would remove
a major incentive for Canadians to work and produce for the benefit of their families”
resulting in a “very large annual disappearance of private capital”.”
The Government’s first official response to the Report came on November 30,
1967, when the Minister of Finance tabled the federal budget. Identifying as common
concerns in the submissions that he had received both the uncertain impact of such far-
reaching reforms and the need to attract foreign capital, Sharp announced that whatever
proposals the Government would “place before parliament and the public in the form of a
White Paper and ultimately in draft legislation” would “undoubtedly be influenced” by
the Report of the Commission, but “will be more in the nature of reforms to the existing
tax structure rather than the adoption of a radically different approach.” In other words,
the Government would adopt a more piecemeal approach to tax reform, rather than the
comprehensive framework adopted by the Commission. Before any more specific
proposals could be formulated, however, the Government was thrown into turmoil when
then Prime Minister Lester Pearson announced his intention to resign in December 1967
and a leadership race and federal election intervened."
* Imperial Oil Limited, “Submission to the Minister of Finance Regarding The Recommendations of the
Royal Commission on Taxation,” (September 1967), p. A-10, cited in Gardner, supra note 107 at 248.
”Trust Companies Association of Canada, “To: The Honourable Mitchell Sharp Minister of Finance. Re:
Report o the Royal Commission on Taxation” (September 1967), p. 2, cited in Gardner, supra note 107 at
250.
* House of Commons Debates (30 November 1967) at 4906 (Mr. Mitchell Sharp).
“As a contender in the race for leadership of the Liberal Party, Sharp insisted that he was in no position to
take a public stance on tax reform. Hartle, supra note 24 at 412. Before the leadership campaign came to an
end, however, Sharp withdrew in favour of Pierre Trudeau, who became Liberal leader and Prime Minister
on April 6, 1968. Under Trudeau, the Liberals called a federal election for June 25, 1968, which they won
handily and formed a majority government.
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With a new Liberal Government under Prime Minister Pierre Trudeau, the
promised White Paper was predictably delayed. In April 1968, the new Finance Minister
Edgar Benson announced a change in the government’s tax reform schedule, explaining
that major reforms would not be presented until some time in 1969.” In the interim,
however, the Government signalled its rejection of the Commission’s comprehensive tax
base by introducing major revisions to the federal gift and estate taxes in the October
1968 federal budget: exempting inter-spousal transfers, integrating these taxes in the form
of a cumulative progressive tax, and increasing rates on estates valued at less than $5
million.” Defending the continued existence of a separate gift and estate tax, the
Finance Minister explained that he respected “the intellectual coherence and elegance” of
the Commission’s recommendation, but that “the overwhelming weight of Canadian
opinion is against it now, and many Canadian practices and institutions would be
seriously disrupted if we embraced this proposal.”
Not surprisingly, given the increased impact on small and medium-sized estates,
the amendments to the gift and estate tax generated considerable political opposition,
particularly from owners of small businesses and family farms who had played a
relatively minor role in opposition to the Royal Commission Report.” In Western
Canada, where farming interests were particularly strong, the provincial governments of
Alberta and Saskatchewan acceded to this sector by refunding the provincial share of the
* Head, supra note 112 at 61.
”An Act to amend the Income Tax Act and the Estate Tax Act, R.S. 1968-1969, c. 33. See, e.g., Michael
B. Jameson, “Proposed Estate Tax Changes,” in Report of the Proceedings of the Twenty-First Tax
Conference, 1968 (Toronto: Canadian Tax Foundation, 1969) 72.
"House of Commons Debates (22 October 1967), at 1685 (Mr. Edgar Benson).
* Gardner, supra note 107 at 251. See also Richard M. Bird, “Canada's Vanishing Death Taxes” (1978),
16 Osgoode Hall L.J. 133 at 137 (observing that the amendments to the federal gift and estate taxes “gave
rise to considerable public outcry, to the point where it appears the whole experience may have made the
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federal estate tax to estates from which it had been collected.” In these two provinces,
therefore, estate taxes were effectively reduced by 75 percent.
In this context, the long-awaited White Paper was finally released on November
7, 1969." Although explicitly rejecting the Commission's comprehensive tax base,” as
well as several other proposals such as family taxation” and the elimination of all
resource tax incentives,” the White Paper agreed with the Commission Report that, as a
general rule, capital gains should be fully taxable at ordinary rates.” In order to prevent
the concurrent application of capital gains tax and estate tax “at a most inconvenient
time”, however, the White Paper rejected the Commission’s proposal that capital gains
should be recognized when property is transferred at death, recommending instead that
“the person who inherits the assets be treated as if he had purchased them at their cost to
the deceased” plus “part of the death taxes paid on the assets in question — the part that
relates to the capital gain.” In the case of gifts, though, the White Paper recommended
that capital gains be taxable in the year of the gift and that the person receiving the
government particularly cautious in this area when designing its major tax reform over the next few
years”).
* Provincial Finances 1969, (Toronto: Canadian Tax Foundation, 1969) at 58. In Alberta, this legislation
came into effect on April 1, 1967. In Saskatchewan, refunds commenced on April 1, 1969. In its 1969
budget, the Government of Manitoba announced that it would also introduce legislation to refund the
provincial share of the federal estate tax unless the federal government resolved the “competition for
economic advantage” satisfactorily. Millie Goodman, “Checklist” (1969), 17 Can. Tax J. 155 at 161-62.
The legislation, however, died on the Order Paper when a provincial election was called, and was not
reintroduced by the social democratic New Democratic Party that came to power.
* Hon E.J. Benson, Proposals for Tax Reform, (Ottawa, 1969). For useful summaries of the White Paper's
proposals, see Bucovetsky and Bird, supra note 129 at 18-20; and Head, supra note 112 at 61-67.
“Benson, supra note 147, para. 3.3, at 36 (stating that the government “rejects the proposition that every
increase in economic power, no matter what its source, should be treated the same for tax purposes”).
” Ibid., para. 2.5, at 15 (noting that the Commission's proposed family unit would create a “tax on
marriage”).
”Ibid., para. 5.24, at 64 (concluding that “special rules are still needed for the mineral industry”).
* Ibid., paras. 3.13–3.18, at 38 (proposing as well special rules to exempt gains on the sale of principal
residences and to tax only half the gains of widely-held Canadian companies). In order to prevent
retroactive application of the tax, the White Paper also proposed that tax should only apply to gains
accruing after a stipulated “valuation day”. Ibid., para. 3.16, at 38.
* Ibid., para. 3.42, at 42.
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property be treated “as if he had purchased the asset for its fair market value.” Finally,
and unexpectedly, the White Paper recommended that shareholders in widely-held
Canadian corporations should be required to recognize accrued gains and losses every
five years – though only half of these gains and losses would be recognized for tax
purposes.”
In the White Paper itself, the Minister of Finance welcomed “public discussion of
the proposals... before Parliament is asked to approve a bill to implement tax reform.”
For this purpose, the Government's preferred vehicle was the parliamentary hearings on
the White Paper conducted by the House of Commons Standing Committee on Finance,
Trade and Economic Affairs and the Standing Senate Committee on Banking, Trade and
Commerce. Unlike Congressional Committees in the United States, these committees had
limited staff and minimal technical knowledge, and were completely unprepared for the
difficult task of reviewing and commenting upon detailed tax proposals.” The Commons
committee alone received 524 briefs and 1,093 letters, and heard 21 1 oral presentations
from 820 individuals.”
The vast majority of these submissions were from corporations and business
associations,” most of which were highly critical of the proposals to tax capital gains at
ordinary rates and to tax accrued gains on widely-held shares every five years.” Many
organizations also objected to the taxation of capital gains as well as gifts and estates,
”Ibid., para. 3.41, at 42.
”Ibid., para. 3.33, at 40-41. This approach had been considered in the Commission's Report, but was not
specifically recommended, Royal Commission on Taxation, supra note 105, Vol. 3, at 344 and 378-80.
”Ibid., paras. 1.1 and 1.4, at 5.
* Bucovetsky and Bird, supra note 129 at 21.
‘’Standing Committee on Finance, Trade and Economic Affairs, Eighteenth Report Respecting the White
Paper on Tax Reform, (Ottawa; Queen's Printer, 1970) at 5.
* Gardner, supra note 107 at 252.
”Bucovetsky and Bird, supra note 129 at 21; and Head, supra note 112 at 67-70.
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notwithstanding the White Paper’s proposal to defer the recognition of gains on bequests
until the property is ultimately sold.” The Ontario Govement released a serofcounter.
proposals in June 1970, recommending significantly lower capital gains tax rates,
taxation of accrued gains at death, and a simultaneous and substantial reduction in wealth
transfer taxes.”
Small business owners organized a broader campaign of public
advertisements, letters, speaking tours, and rallies under the banner of the Canadian
Council for Fair Taxation, established in December 1969.” According to the group's
founder and President, John Bulloch, the combination of capital gains tax and the estate
tax amounted to “an attack on the middle-class values of hard work, thrift and initiative”
and a “confiscation of the money and resources of the huge middle segment of the
population”.” At the height of the campaign, the Government was reported to be
receiving protest letters at a rate of 7,000 each day.”
When the parliamentary committees reported in the fall of 1970, it was not
surprising that they would “reflect in varying degrees the overwhelmingly hostile
reaction of representatives of the business and professional organisations from whom the
bulk of the brief and other submissions were received.” According to the Commons
committee, the one-half inclusion rate for shares of widely-held corporations should be
* R.M. Bird and M.W. Bucovetsky, Canadian Tax Reform and Private Philanthropy, Canadian Tax Paper
No. 58, (Toronto: Canadian Tax Foundation, 1976) at 34. See also the summary of various submissions in
Hartle, supra note 22 at 66-72.
* Hon Charles MacNaughton, Ontario Proposals for Tax Reform in Canada, (Toronto: Department of
Treasury and Economics, 1970).
*See Gardner, supra note 107 at 252; and Philipps, supra note 9 at 133-34.
* Ronald Anderson, “Benson meets hostile response at public meetings on proposals” Globe and Mail (11
February 1970) p. 1,
* Ronald Anderson, “Tax reform fight found producing hysteria” Globe and Mail (21 February 1970) p.
Bi.
* Head, supra note 112 at 70. See also Bucovetsky and Bird, supra note 129 at 21 (concluding that their
limited staff and minimal technical knowledge “meant that the two Committees were unlikely to serve as
anything else than a sounding board for those segments of public opinion that were most vocal”).
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134
extended to all capital assets,” the five-year realization rule for these shares should be
abandoned," and the proposal to tax accrued gains at death should be restored in order
to prevent indefinite deferral.” Since the last of these recommendations would, the
committee noted, “magnify the problem, brought to the committee’s attention
innumerable times, of the concurrent impact of the two taxes at the same time, at death,”
a further recommendation proposed a reduction of the federal estate tax “across the
” The Senate
board, either by reducing the rates or by expanding the brackets.
committee went further, recommending a distinction between short-term and long-term
gains and a rate of tax on the latter limited to the lesser of 25 percent or half the marginal
income tax rate of the taxpayer," and the postponement of tax on transfers of property
by gift as well as at death, with a carryover of the donor’s cost to the recipient." In
addition, the committee suggested, the government “might well consider abandoning the
estate tax field to the provinces.”
The Government, which had given itself room to manoeuvre by presenting its
response to the Commission Report in the form of a White Paper rather than a budget,”
substantially revised its proposals in light of the parliamentary committee reports and the
organized opposition, releasing its final tax reform package in the form of draft
legislation accompanying the federal budget on June 18, 1971." Following the
º Standing Committee on Finance, Trade and Economic Affairs, supra note 157 at 26.
Hbid.
* Ibid. at 33.
* Ibid. at 33 and 34.
"Standing Senate Committee on Banking, Trade and Commerce, Report on the White Paper Proposals
for Tax Reform Presented to the Senate of Canada, (Ottawa, September 1970) at 59-60.
”Ibid. at 61.
* Ibid. at 45.
"Bucovetsky and Bird, supra note 129 at 21 (explaining that the defeat of a budget constitutes a “want of
confidence” requiring the government’s resignation, while a White Paper constitutes “an expression of the
thrust of government thinking that nonetheless provides freedom for alteration or strategic retreat”).
"Hon. E.J. Benson, Summary of 1971 Tax Reform Legislation, (Ottawa: Queen's Printer, 1971).
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135
recommendations of the Commons committee, the draft legislation adopted a one-half
inclusion rate for all capital gains and losses accruing after a designated valuation day,”
dropped the White Paper proposal to tax accrued gains on widely-traded shares every five
years,” and accepted the Carter Commission's original proposal to tax accrued gains
when property is transferred on death as well as by gift.” Following the
recommendation of the Senate committee, the Government decided to abandon the estate
and gift tax field to the provinces.”
The reasons for the Government’s decision were expressed in four short
paragraphs in its Summary of 1971 Tax Reform Legislation. First, it explained, the
combination of capital gains tax and estate tax at death “could in some instances result in
substantial tax impact arising on the death of a taxpayer.” Second, it continued, “[a]
reduction in federal estate taxes to the extent suggested by the Commons committee
would result in a revenue loss of about half the $55 million now received by the federal
government from this source” after payment of the provincial share to provincial
governments.”
Third, it concluded, “[t]wo provinces now return their entire share of
estate taxes to estates and it is no longer possible to establish a uniform national system
of death duties through federal legislation.” As a result, it concluded, “[i]n these
circumstances, it has been decided that the federal government will vacate the estate and
gift tax field on December 31, 1971.” Thus, it would seem, the introduction of capital
gains tax at death, the low revenue yield for the federal government, and the disparate
” Ibid. at 30 and 32-33.
* Ibid. at 30.
"Ibid.
*Ibid. at 33.
”Ibid.
* Ibid.
* Ibid.
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effects of federal and provincial joint occupancy of the field led to the repeal of the
federal gift and estate tax. Unstated, of course, was the organized opposition to capital
gains and wealth transfer taxes reflected in public campaigns and submissions to the
parliamentary committees.
By sacrificing the federal gift and estate tax, the Government finally obtained the
acquiescence of organized interest groups to the introduction of capital gains tax and the
recognition of accrued gains at death. In a letter to the editor of the Toronto Daily Star,
Canadian Council for Fair Taxation President John Bulloch praised the “highly
nationalistic” tax legislation for abolishing wealth transfer taxes “that would, in
combination with capital gains taxes, have forced the sale of family businesses,
frequently to foreign interests.” The construction industry and the Canadian Real
Estate Association welcomed the repeal of the federal gift and estate tax because “the
small builder is still the backbone of the residential construction industry.” The
business press was generally favourable, characterizing the tax reform legislation as “a
far superior tax plan” to the White Paper.” Aside from a critical editorial in the Toronto
187
Daily Star,” and unfavourable commentary from a few Canadian tax academics,” the
predominant public response to the repeal of the federal gift and estate tax was silence.”
* Ibid. -
* John F. Bulloch, Letter to the Editor, Toronto Daily Star (22 June 1971), p. 7.
* Kenneth B. Smith, “Budget, Tax Reaction” Globe and Mail (19 June 1971), p. B13.
* I.H. Asper, “Benson Iceberg Becomes Benson Compromise and a Political Timebomb is Defused,”
Globe and Mail, (19 June 1971), p. B3.
* “Santa to the rich,” Editorial, Toronto Daily Star (30 June 1971), p. 6 (arguing that the abolition of
federal wealth transfer taxes “clearly violates a principle to which society should give some deference:
equality of opportunity. And it overlooks without justification a perfectly good source of government
revenue”). The editorial proceeded to describe the repeal of the federal gift and estate tax as “but one
example of Mr. Benson's depressingly long march from Carter's central concern with tax equity”, adding
that: “The people who would have directly benefited from its implementation were not heard in Ottawa:
their small voices ignorant, and poor, were submerged in the flood of glossy briefs that poured into the
capital from all the vested interests.”
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137
In Parliament, where the Liberal Party held a comfortable majority, enactment of
the draft legislation was never in doubt. While the Progressive-Conservative Leader of
the Opposition criticized the Government for the inconsistency of amending the gift and
estate tax in 1968 and repealing it three years later,” he and the members of his
parliamentary caucus generally supported the decision to repeal the federal gift and estate
tax. In fact, several complained that since provincial governments might continue to levy
succession duties, the taxation of capital gains at death could create “extreme hardship” –
particularly for family farms.” Only members of the social democratic New Democratic
Party opposed abolition of the tax, criticizing the Government for abandoning the Prime
”See, e.g., Gordon Bale, Letter to the Editor, Globe and Mail (25 June 1971), p. 7 (describing repeal of
the federal gift and estate tax as “tax regression rather than tax reform”). See also Richard M. Bird, “The
Case for Taxing Personal Wealth” in Report of the Proceedings of the Twenty-Third Tax Conference, 1971
(Toronto: Canadian Tax Foundation, 1972) 17 at 24 (defending wealth transfer taxes on “moral, social and
economic grounds” and emphasizing the need for “a reaffirmation of the national interest in taxing wealth);
and John Bossons, “Economic Overview of the Tax Reform Legislation” in ibid., 45 at 54 (concluding that
the repeal of the federal estate tax “would provide a substantial windfall for a relatively small number of
present wealth holders” equivalent to “a lump-sum transfer of approximately $4.5 billion to individuals
who currently own wealth that would be taxed in future years under the estate tax”).
* Bird, supra note 145 at 133. .
”See, e.g., House of Commons Debates (23 June 1971) at 7307 (Mr. Stanfield) (arguing that “the minister
put the country through a lot of turmoil and trouble by an increase in estate taxes in an attempt to reduce the
tax on very small estates. Now, with great fanfare the minister announces its abolition, also for the very
best of reasons”); and ibid. (17 December 1971) at 10572 (Hon. Robert Stanfield) (contending that after the
reform of the estate tax in 1968, the minister of finance was “doing away with all of what he put before the
House two years previously and all that he had fought for in the House”).
”Ibid. (8 November 1971) at 9447 (Mr. Gordon Ritchie) (suggesting that the federal capital gains tax in
combination with provincial estate taxes “will create extreme hardship in agriculture and in the farm units
as we know them today”). See also ibid. (22 June 1971) at 7226 (Hon. Marcel J.A. Lambert) (arguing that
with the introduction of a federal capital gains tax, “[t]he people for whom this means another tax on top of
other taxes are the farmers and ranchers, particularly those who live in provinces where the removal of the
estate tax is meaningless”); ibid. (8 November 1971) at 9416 (Mr. Cliff Downey) (suggesting that despite
the abolition of the federal estate tax, “really there will be no respite for many people in this country in
respect of estate taxes, simply because there has not been sufficient consultation with the provinces”); ibid.
(9 November 1971) at 9483 (Mr. A.P. Gleave) (arguing that “I really do not see how you can have an estate
tax as well as a capital gains tax applied to the farming industry. You can have one or the other, but I doubt
that you can have both. If you have both the result will be a tax jungle because a number of provinces have
indicated they are going to retain and even increase estate taxes”); ibid. (15 November 1971) at 9568 (Mr.
Wallace Bickford Nesbitt) (suggesting that following the repeal of the federal estate tax, “[u]ndoubtedly
some of the provinces will move into the estate tax field, as a result of which Canadians in certain parts of
Canada will, in effect, be taxed doubly as compared with Canadians in other places”); and ibid. (15
November 1971) at 9589 (Hon. Marcel J.A. Lambert) (suggesting that federal and provincial estate taxes
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138
Minister’s campaign promise of a “Just Society” by ignoring equality of opportunity and
#9;
tax progressivity.” After minor technical amendments, the draft legislation was passed
on December 17, 1971, and came into effect on January 1, 1972.
3. Provincial Aftermath: 1971–1985
At the provincial level, the federal government's decision to repeal the federal gift
and estate tax was generally opposed.” Although the Province of Quebec had long
3.
favoured exclusive provincial jurisdiction of these taxes” and welcomed federal
4
d.”
abandonment of the fiel most other provinces objected to the loss of revenue from
federal rental payments and worried about the prospect of tax competition among
195
provinces opting to collect their own succession duties.” Smaller provinces in particular
complained about the lack of prior consultation and the absence of adequate notice to
have contributed to foreign ownership of Canadian businesses, and are “the reason family businesses have
been sold to strangers, whether they are from the United States or elsewhere”).
”See, e.g., ibid. (14 September 1971) at 7803 (Mr. J. Edward Broadbent) (arguing that the abolition of the
estate tax is detrimental to the principle of equality of opportunity, and that the Liberal party “which
governs this country is the one which talks about equality of opportunity. This is the same party that is
abolishing estate taxes. So much for justice in that area”); ibid. (15 September 1971) at 7840-41 (Mr. David
Orlikow) (describing gift and estate taxes as “one of the basic features of every progressive tax system”);
ibid. (17 September 1971) at 7955 (Mr. John Gilbert) (suggesting that the abolition of federal wealth
transfer taxes “will further stratify the Canadian people into an economic caste system”); and ibid. (10
December 1971) at 10369 (Mr. John Burton) (arguing that “it is absolutely essential, if we are to have any
sort of just society at all, to tax inherited wealth”).
*Carter, supra note 71 at 239.
* See, e.g., Report of the Proceedings of the Federal-Provincial Conference, 1963 (Ottawa: Queen's
Printer, 1964) at 47; and Prime Minister Pierre Trudeau, The Taxing Powers and the Constitution of
Canada, Government of Canada Working Paper on the Constitution, (Ottawa: Queen’s Printer, 1969) at 34.
” Michel Bélanger, Secretary of the Treasury Board, Province of Quebec, addressing the Canadian Tax
Foundation’s Twenty-Third Tax Conference, in Proceedings of the Twenty-Third Tax Conference, 1971,
supra note 190 at 267 (stating that “[t]here is some benefit in having at least one more field of taxation
where there will no longer be joint occupancy”).
* See, e.g., H. Ian Macdonald, Deputy Treasurer and Deputy Minister of Economics, Province of Ontario,
addressing Canadian Tax Foundation’s Twenty-Third Tax Conference, in ibid. at 260 (criticizing the
federal government’s decision as “a withdrawal from fiscal leadership, an invitation to tax avoidance, and
an undermining of the equity considerations which loom so large in the federal tax reform program”).
Although provincial governments would gain some revenue over time from the taxation of accrued gains at
death, revenue estimates suggested that these were unlikely to exceed revenue losses from the abolition of
the federal estate tax. Bossons, supra note 187 at 56 (projecting annual losses for all provincial
governments of $160 million in 1972, growing to $451 million in 2002). For a similar conclusion, see Bird
and Bucovetsky, supra note 160 at 54-55.
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establish their own gift and succession duties, as well as the administration and collection .
COStS that this would entail,” requesting the federal government to maintain the existing
system of estate and gift taxation for at least a year from January 1, 1972, to give them
time to address the implications of the federal proposal.” Although it refused to accede
to this request, the federal government nonetheless offered to administer and collect
provincially-imposed succession duties and gift taxes for a period of three years,
provided that: (1) the agreements were entered into by at least four provinces; (2) that
each participating province would agree to a model Act under which the base of the tax
would be the same for all provinces; (3) that “some degree of uniformity of rates would
be provided under the model Acts having regard to the rates now in effect in those
provinces imposing their own succession duties;” and (4) that “it would be clear that the
federal government’s role is purely administrative and that the presentation to the public
would make it clear that it is a provincial, not a federal tax.”
In Alberta, where the provincial share of the federal estate tax had been refunded
since 1967, the provincial government made it clear that it had no intention to enter into
any such agreement and would not introduce its own wealth transfer tax.” In Manitoba
and Saskatchewan, however, where the social-democratic New Democratic Party
* Carter, supra note 71 at 241.
” The National Finances, 1971-72, (Toronto: Canadian Tax Foundation, 1972) at 49.
* Hon. Patrick M. Mahoney, Parliamentary Secretary to the Minister of Finance, House of Commons
Debates, (19 October 1971), p. 8851. See also Douglas H. Clark, Department of Finance, Ottawa,
addressing Canadian Tax Foundation’s Twenty-Third Tax Conference, in Proceedings of the Twenty-Third
Tax Conference, 1971, supra note 187 at 275-76. The offer to collect provincial succession duties was
extended only to the seven provinces (other than British Columbia, Ontario and Quebec) that did not collect
their own succession duty at the time. The offer to collect provincial gift tax was extended to the nine
provinces (other than Quebec) that had entered into federal-provincial tax collection agreements in the field
of personal income taxation.
” Hon. Gordon Miniely, Provincial Treasurer, Alberta, 1972 Budget Address, (Edmonton: Treasury
Department, 1972) at 6 (stating that the provincial government “will not ... enter into an agreement for the
collection on our behalf of succession duties, and estate and gift taxes, as we have no intention of imposing
these taxes on citizens of Alberta”).
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(N.D.P.) had won provincial elections in 1969 and 1971, as well as the four Atlantic
Provinces, provincial governments accepted the federal government’s offer and
introduced largely uniform succession duties and gift taxes.” In order to protect their
succession duties, British Columbia and Ontario entered into agreements with the federal
government for the collection of gift tax, and Quebec enacted its own gift tax which it
collected as of January 1, 1972.” At the beginning of 1972, therefore, the federal
government was weams the uniform succession duty for six provinces and gift tax for
eight provinces, the governments of British Columbia, Ontario and Quebec were
collecting their own succession duties, Quebec was collecting its own gift tax, and
Alberta levied no wealth transfer taxes. Not surprisingly, this situation did not last very
long.
Of the six provinces accepting the federal government’s offer to administer and
collect provincial succession duties, Prince Edward Island was the first to repeal its
d.” Estimating
succession duty legislation, which it did before any tax was even collecte
that total collections from the new tax over three years would amount to only
$240,000.” the provincial government apparently concluded that the anticipated revenue
was simply not worth the effort. In his Budget Speech in 1973, however, the Province’s
Minister of Finance proudly declared that “Alberta and Prince Edward Island are
* Provincial and Municipal Finances 1975, (Toronto: Canadian Tax Foundation, 1975) at 87. According
to one commentator at the time, “revenue considerations were of primary concern to these six provinces;
they concluded that they simply could not afford to give up this source of revenue.” Wolfe D. Goodman,
The New Provincial Succession Duty System: An Examination of the Succession Duty Acts of the Atlantic
Provinces, Manitoba and Saskatchewan, Canadian Tax Paper No. 56, (Toronto: Canadian Tax Foundation,
1972) at 1. -
* Provincial and Municipal Finances 1975, supra note 200 at 87.
* Bird and Bucovetsky, supra note 160 at 40. -
* Ibid., n. 122.
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presently the only two provinces without some form of death duties.” Fearing the loss
of investment to this “tax haven”, the government of Nova Scotia announced on February
23, 1973 that it’s succession duty and gift tax would expire by March 31, 1974.” A
month later, New Brunswick’s Minister of Finance blamed “tax policies in other
provinces” when he announced the repeal of his province's succession duty and gift tax
effective December 31, 1973* Newfoundland concluded the abolition of wealth transfer
taxes in Atlantic Canada by repealing its succession duty and gift tax effective April 9,
1974,207
In Western Canada, where Alberta became Canada’s first “death tax haven” when
2,” provincial wealth transfer taxes
it refused to enact a succession duty or gift tax in 197
lasted only a few more years. Although the Premier of British Columbia promised in June
1972 to repeal his province’s succession duty and gift tax by 1 April 1973, 209 the election
of a N.D.P. Government the next month put this policy on hold.” When the collection
agreements with the federal government expired at the end of 1974, British Columbia
assumed the administration of its own gift tax, and N.D.P. Governments in Manitoba and
* Hon T.E. Hickey, Minister of Finance, Prince Edward Island, Budget Speech (Charlottetown:
Department of Provincial Treasury, 1973) at 5.
* Nova Scotia, Budget Address, (23 February 1973). For references to the “tax haven” problem, see the
exchange between the Nova Scotia Minister of Finance and an opposition member in Nova Scotia, House
of Assembly, Debates and Proceedings, (23 February 1973), p. 936.
* Hon. Jean-Maurice Simard, Minister of Finance, New Brunswick, Budget Speech, 20 March 1973,
(Fredericton: Finance Department, 1973) at 23. For family farms and fishing businesses, provincial
succession duty ceased to apply from March 31, 1973.
* Provincial and Municipal Finances 1975, supra note 200 at 87.
* Hartle, supra note 22 at 75.
* “B.C. to cancel death duties and gift tax” Globe and Mail, (2 June 1972) p. B2.
* See British Columbia, Debates of the Legislative Assembly (24 October 1972) at 235-6 (Hon. D.
Barrett), where Premier David Barrett defended the continuance of the provincial succession duty as
follows: “If one rich man leaves because of this law or because of succession duty then I say let him go.
And good riddance! We'd be far better off without him rather than having someone living around here
who's trying to escape their social and financial responsibility to the people of British Columbia ... We say
the rich are welcome, the capital we want it to stay, but it must pay its fair share."
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Saskatchewan began collecting their own succession duties and gift taxes.” The election
of the conservative Social Credit Party in British Columbia at the end of 1975, however,
marked the beginning of the end of wealth transfer taxes in Western Canada. In his 1977
Budget Speech, British Columbia’s Minister of Finance announced that the provincial
succession duty and gift tax would be abolished in order to prevent the “forced” sale of
family farms and businesses to “outsiders” and “to encourage the retention and
accumulation of capital by residents of British Columbia.” Later that year, the N.D.P.
Government in Saskatchewan announced that it would repeal the provincial succession
duty and gift tax, wºunding the Government’s conviction that “a tax on wealth is a
fair tax” – attributing this decision to the abolition of these taxes in other provinces and
“a widespread opinion that the successors of the average citizen will be subject to the
- tax” even though it applied to less than 3 percent of estates in Saskatchewan.” Although
the N.D.P. Government in Manitoba maintained its commitment to provincial wealth
214
transfer taxes in its 1977 budget,” a Conservative Government was elected later that
year, and repealed these taxes in early 1978.”
By 1978, therefore, Ontario and Quebec were the only Canadian jurisdictions that
continued to collect succession duties and gift taxes.” In each of these provinces,
however, provincial governments had adopted a policy of gradually reducing these taxes
* Provincial and Municipal Finances 1975, supra note 200 at 87.
*Hon. Evan M. Wolfe, Minister of Finance, British Columbia Budget, (Victoria: Department of Finance,
1977) at 23.
* Hon. Walter E. Smishek, Minister of Finance, Saskatchewan, Budget Speech, (Regina: Treasury
Department, 1977) at 30. -
*Hon. Saul A. Miller, Minister of Finance, 1977 Manitoba Budget Address, (Winnipeg. Department of
Treasury, 1977) at 16. According to the Minister: “We believe the federal government belongs in the estate
tax field, and we are prepared to vacate it, if and when Ottawa recognizes its responsibility. In the interim,
we believe the provincial Succession Duty Act should be maintained.”
* Bird, supra note 145 at 140. -
* Like British Columbia, Ontario began collecting its own gift tax in 1975 after the collection agreement
with the federal government expired.
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over time as revenues from the taxation of post-1971 capital gains increased — regarding
these taxes as temporary measures to maintain revenues until “the capital gains tax
3×217
matures.” In Ontario, where succession duty rates were originally increased in 1972 in
order to compensate for the loss of federal rental payments,” basic exemptions were
increased from $100,000 to $150,000 in 1974,” $250,000 in 1975,” and $300,000 in
1977.” Making the perceived connection between succession duty and capital gains tax
explicit, the 1977 Budget also made capital gains tax payable at death creditable against
222
succession duties.” Two years later, the provincial Government repealed Ontario’s
succession duty and gift tax, declaring that “the continuation of this tax is hurting our
economic performance and costing us jobs” and that “the present combination of other
taxes provided government with an adequate return as wealth is accumulated.”
* Hon. W. Darcy McKeough, Treasurer of Ontario, 1972 Ontario Budget (Toronto: Ministry of Treasury,
Economics and Intergovernmental Affairs, Taxation and Fiscal Policy Branch, 1972) at 37. See also
Ontario, 1973 Budget, (Toronto, 1973) at 29 (emphasizing the “undesirable impact on small businesses,
family farms and Canadian ownership” and noting that other provinces were vacating the field); and Mr.
Raymond Garneau, Minister of Finance, Quebec, Budget Speech (18 April 1972) at 18 (promising “the
gradual abolition of succession duties” with reductions “made in light of possible action on the part of the
other provinces and the impact of the capital gains tax”).
* Hon W. Darcy McKeough, Introduction to Supplementary Estimates and Tax Legislation (Toronto:
Ontario Department of Treasury and Economics, Taxation and Fiscal Policy Branch, 1971) at 27.
* Hon. John White, Treasurer of Ontario, 1974 Ontario Budget (Toronto: Ministry of Treasury,
Economics and Intergovernmental Affairs, Fiscal Policy Division, 1974) at 12.
*Hon. W. Darcy McKeough, Treasurer of Ontario, 1975 Ontario Budget (Toronto: Ministry of Treasury,
Economics and Intergovernmental Affairs, Taxation and Fiscal Policy Branch, 1975) at 27.
* Hon. W. Darcy McKeough, Treasurer of Ontario, Ontario Budget 1977 (Toronto: Ministry of Treasury,
Economics and Intergovernmental Affairs, Fiscal Policy Division, 1977) at 18.
* Ibid. (explaining that “this credit mechanism will result in ever-increasing reductions in succession duty
over time, as the value of capital assets increases and the Succession Duty Act is amended periodically to
recognize the effect of inflation”). This approach had been recommended by a provincial advisory
committee in 1973 in order to address the perceived “double tax burden” from succession duty and capital
gains tax at death. Ontario Advisory Committee on Succession Duties, Report (23 February 1973) at v and
10-14,
*Hon. Frank S. Miller, Treasurer of Ontario, Ontario Budget 1979, (Toronto: Ministry of Treasury and
Economics, Fiscal Policy Division, 1979) at 5 and 6.
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In Quebec, succession duties were reduced by 20 percent in each year from 1974
to 1977, resulting in a total reduction in tax otherwise payable of 80 percent by 1977°
With the election of the sovereigntist and social democratic Parti Québecois (P.Q.) in
November 1976, however, the final 20 percent reduction tha had been scheduled for
1978 was cancelled in the new Government's first budget.” The next year, the P.Q.
Government announced that the provincial succession duty would be retained but
substantially amended, with rates based solely on amounts received by each beneficiary,
the total exemption of bequests between spouses, and further exemptions for transfers to
children and other dependents.” The legislation, which was introduced in Quebec’s
National Assembly in June 1978, was enacted on 22 December 1978, and came into
effect immediately.” Over the next several years, the tax raised up to about $45 million
per year,” but the Government faced continuing pressure to abolish provincial wealth
* Mr. Raymond Garneau, Minister of Finance, Quebec, Budget Speech, (28 March 1974) at 19, Mr.
Raymond Garneau, Minister of Finance, Quebec, Budget Speech, (17 April 1975) at 19, and Mr. Raymond
Garneau, Minister of Finance, Quebec, Budget Speech, (11 May 1976) at 35.
* Mr. Jacques Parizeau, Minister of Finance, Minister of Revenue, and Chairman of the Treasury Board,
1977-78 Budget Speech, (12 April 1977) at 52 (noting that the Carter Commission had recommended the
abolition of succession duties on the basis that inheritances should “be taxed as if they were income for
those receiving them” and adding that “governments have not adopted this theory, but have used the partial
taxation of capital gains as a reason for removing succession duties”).
* Mr. Jacques Parizeau, Minister of Finance, ministre des Finances, ministre du Revenue, and président du
Conseil du trésor, 1978-79 Budget, (18 April 1978) at 50-51.
” Succession Duty Act, L.Q. 1978, c. 37. For a detailed review of the revised legislation, see Robert Raich,
“An Overview of the New Quebec Succession Duty Act” in Report of the Proceedings of the Thirtieth Tax
Conference, 1978, (Toronto: Canadian Tax Foundation, 1980) 725. Among the many revisions to the
provincial succession duty, one of the most important was replacement of a “transmissions basis” whereby
the tax applied to property situated outside the province only if the deceased was domiciled in the province
and the beneficiary was resident or domiciled in the province with an “accessions basis” according to
which the tax would apply to all property situated outside the province received by a person resident or
domiciled in Quebec on the death of another person. Although the constitutionality of this approach was
called into question by the British Columbia Court of Appeal in A-G of British Columbia and the Canada
Trust Company v. Ellett Estate, [1979] C.T.C. 134 (B.C.C.A.) (ruling on a provision of the British
Columbia succession duty enacted in 1972), it was accepted on appeal to the Supreme Court of Canada in
A-G of B.C. v. Ellett Estate, [1980] C.T.C. 338 (S.C.C.).
* See the revenue figures reported in Mr. Gérard D. Levesque, Minister of Finance, Québec, 1986-1987
Budget, (1 May, 1986) at 20.
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transfer taxes “because such duties do not exist elsewhere in Canada”,” With a new
Minister of Finance, and a provincial election on the horizon (which it lost), the P.Q.
Government repealed Quebec’s succession duty and gift tax on 23 April 1985.”
B. The Abolition of Wealth Transfer Taxes in Australia
Unlike Canada, where the events leading to the repeal of federal and provincial
wealth transfer taxes began with the appointment of a Royal Commission, the abolition of
wealth transfer taxes in Australia originated in a popular protest movement initiated by a
skilled carpenter and building contractor from Western Australia named Sydney
Negus.” In 1970, after learning that estate duty could have a substantial impact on
relatively modest amounts left to his wife, Negus launched a successful petition
campaign calling for the abolition of estate duties, ran for public office, and was elected
to the Federal Senate.” As Willard Pedrick observes, “the election of an Independent,
whose only campaign issue had been abolition of death duties, was not lost on
professional party leaders.” Little more than a decade later, Australian wealth transfer
taxes had completely disappeared.
Three factors appear to have contributed to the strength of Australia’s estate duty
abolition movement in the early 1970s, particularly among farmers and small business
owners.” First and foremost, exemptions had not been increased to account for inflation,
* Mr. Jacques Parizeau, ministre des Finances, Québec, 1983-84 Budget, (10 May 1983) at 24.
* Mr. Yves L. Duhaime, ministre des Finances, Québec, 1985-86 Budget, (23 April 1985) at 17 (stating
erroneously that “Québec has ... been the only province to collect succession duties” since capital gains
became partially taxable in 1972).
* See Pedrick, supra note 94 at 114.
*Ibid.
* Ibid.
* Smith, supra note 70 at 79-80.
45
causing Commonwealth and State taxes to apply to relatively modest estates.” At the
federal level, for example, the Commonwealth estate duty at the time contained an
exemption of only AU$10,000 for estates passing to a spouse, child or grandchild, and
AU$5,000 for all other estates.” As a result, as the Taxation Review Committee (Asprey
Committee) reported, over 55 percent of taxable estates in 1972-73 were valued at less
than AU$40,000 and almost 83 percent were valued at less than AU$80,000.” At the
State level, exemptions were generally lower, resulting in a larger number of taxable
estates.” Farming interests consistently complained that farms had to be sold to pay the
duties, though evidence to this effect was “sparse and mostly anecdotal.” Not
surprisingly, therefore, it was political leaders with a rural political base who pushed the
abolition agenda.”
In addition to the failure to adjust estate duties for inflation, a second factor
contributing to the unpopularity of these taxes was the failure to integrate the
Commonwealth and State duties.”
While the existence of this “double or duplicative”
system of wealth transfer taxes increased compliance costs for all taxable estates,” the
relative burden was likely higher for small and medium-sized estates.” In addition, a
study for the Asprey Committee concluded that the costs to comply with the
Commonwealth and State taxes were larger for estates with small businesses than for
* Ibid. at 79. See also Pedrick, supra note 94 at 119-20; and Groenewegen, supra note 94 at 315.
* These figures resulted from the Statute Law Revision (Decimal Currency) Act 1966 (No. 93), which
converted amounts in pounds to dollars by simply doubling the nominal amounts. Prior to 1966, the
exemptions were £5,000 for estates passing to a spouse, child or grandchild, and £2,500 for all other
estates. Estate Duty Act 1941 (No. 51) (Australia).
*Taxation Review Committee, supra note 92 at para. 24.1 (Table 24.B).
* Pedrick, supra note 94 at 119-20.
* Ibid. at 121.
240 Groenewegen, supra note 94 at 311-12.
* Smith, supra note 70 at 80.
* Pedrick, supra note 94 at 119.
* Groenewegen, supra note 94 at 315.
46
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most other estates.” Despite several recommendations to allocate this revenue source
either solely to the states or solely to the Commonwealth government, however, joint
occupancy remained until the taxes were finally repealed.”
A final explanation for the strength of Australia’s estate duty abolition movement
relates to the relative ease with which these taxes could be avoided.” Discretionary
trusts, for example, could be used to transfer wealth from generation to generation
247
without any tax.” At the federal level, gift tax was not integrated with estate duty, and
gifts themselves were aggregated only over an eighteen month period.” Because of
249
these and other deficiencies,” the tax was generally considered to be easily avoided by
the most affluent and sophisticated taxpayers,” shifting the primary burden to small and
25]
medium-sized estates.” As a result, as one commentator explains, “[t]he extent of tax
avoidance ... created public cynicism about the taxes.”
At the same time as the unpopularity of these taxes increased, their importance to
Commonwealth and State revenues declined. In 1973, the Commonwealth government
collected roughly AU$75 million from its gift and estate duties, representing only 0.7
* B.L. Johns, W.C.D. Dunlop, and W.J. Sheehan, Taxation and the Small Firm in Australia, Taxation
Review Committee Commissioned Studies (Canberra: Australian Government Publishing Service, 1975),
chapter 8.
*See supra notes 91-94 and accompanying text.
* Smith, supra note 70 at 79.
* Hill, Death and Gift Duties, Taxation Review Committee Commissioned Studies (Canberra: Australian
Government Publishing Service, 1975) at 75-76, cited in Pedrick, supra note 94 at 122.
* Hill, supra note 248 at 92 and 105-06, cited in Pedrick, supra note 94 at 122-232.
* For a detailed description, see Pedrick, supra note 94 at 122-24.
* See, e.g., Taxation Review Committee, supra note 92 at 115 (concluding that the Commonwealth estate
duty “is certainly at present a tax which can be avoided by well-advised persons with ease, and which
might almost be said to be paid principally from the estates of those who died unexpectedly or who had
failed to attend to their affairs with proper skill”).
* Smith, supra note 70 at 79-80.
* Ibid. at 79.
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148
percent of total tax revenues – a lower percentage than at any time in their history.”
While the States collected approximately $185 million from their wealth transfer taxes in
* this percentage had
1973,” accounting for almost 9 percent of total tax revenues,
declined substantially from only a few years earlier due to the transfer of the payroll tax
1,” and was lower than at
field from the Commonwealth to the State governments in 197
257
any time since the end of the Second World War.” As inflation caused more and more
small estates to become taxable, moreover, net revenues suffered because administrative
costs were incurred to obtain relatively amounts of revenue from these estates.” In
1972-73, for example, the smallest 55.7 percent of estates subject to Commonwealth
estate duty accounted for only 3.9 percent of revenue collected.” Joint occupancy by the
Commonwealth and State governments also contributed to high administrative costs as
both levels of government as well as all State governments were required to maintain the
organizational apparatus to enforce and collect the taxes.
The abolition movement's first legislative victory was in Queensland, a “hotbed
of agrarian resentment against death duties”, where the Brisbane Courier Mail had run a
series of articles highlighting the hardships caused by death duties and the growing
campaign for abolition.” After exempting inter-spousal transfers from estate and gift
duties in 1975,” the conservative Liberal-Country Party coalition government embraced
* Saunders, supra note 72 at 399 (Table 1). Income taxes, on the other hand, accounted for almost 70
percent of total tax revenues in 1973. Calculated from figures in O.E.C.D, supra note 2.
*Calculated from figures in Saunders, supra note 72 at 399 (Table 1).
*Calculated from figures in O.E.C.D., supra note 3.
* For an explanation of the events leading up to the transfer of this revenue source, see Mathews and Jay,
supra note 81 at 248–54. In 1968/69, wealth transfer taxes had accounted for 16.6 percent of State tax
revenues. Calculated from figures in ibid. at 247 (Table 38).
” Saunders, supra note 72 at 399 (Table 1). -
*Ibid. at 400.
*Taxation Review Committee, supra note 92 at para. 24.1 (Table 24.B).
* Pedrick, supra note 94 at 114.
* Gift Duty Act Amendment Act 1975 (No. 63). See also Pedrick, supra note 94 at 114-15.
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complete abolition in 1976 and repealed the taxes effective January 1, 1977.* Although
the coalition’s Liberal Party Treasurer Sir Gordon Chalk expressed misgivings about the
budgetary implications of abolition, which would reduce State revenues by $25 to $30
million dollars per year.” Country Party Premier Joh Bjelke-Peterson apparently
concluded that the loss in revenues would be more than offset by internal migrants
attracted by the combination of a warm climate and tax-free bequests.” Indeed, before
the repeal had even come into effect, the Gold Coast Visitor's Bureau prepared a
pamphlet entitled “Legal Information on the Abolition of Death Duties in Queensland”
reporting the duty payable in other States on an estate of $100,000 and detailing the ways
in which death duties could be avoided by investment or domicile in Queensland.”
Not surprisingly, other States responded to this interstate tax competition by
amending and then abolishing their own gift and estate duties. In 1976, inter-spousal
transfers were exempted in New South Wales and South Australia,” and the State of
Victoria enacted legislation exempting estates passing to spouses, children and
grandchildren from duty in stages between 1976 and 1981.” Over the next three years,
Tasmania introduced exemptions first for inter-spousal transfers and then all transfers.”
In Western Australia, inter-spousal transfers were made exempt in 1977 and gift and
*Succession and Gift Duties Abolition Act 1976 (No. 93) (Qld). See also Pedrick, supra, note 94 at 115.
* Brisbane Courier Mail (3 December 1976). For the fiscal year 1975-76, Queensland collected almost
$27 million from succession and probate duty. Pedrick, supra note 94 at 115, n. 6.
* Ibid. at 115. Since 1980, in fact, over half a million Australians from other states have moved to
Queensland, though the abolition of wealth transfer taxes in these other states suggests that climate was
destined to play a bigger role than taxation!
* Ibid. at 115, n. 10. - - -
*Stamp Duties (Amendment) Act 1977 (No. 13) (NSW); Succession Duties Amendment Act 1976 (No. 72)
(SA).
*' Probate Duty Act 1976 (No. 8936) (Vic), Probate Duty Act 1977 (No. 9056) (Vic), Probate Duty Act
1979 (No. 9334) (Vic), Probate Duty Act 1980 (No. 9441) (Vic), Probate Duty Act 1981 (No. 9618) (Vic).
See also Saunders, supra note 72 at 398. - -
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estate duties were abolished in 1980.” Finally, South Australia abolished its gift and
estate duties in 1980 and New South Wales in 1981.” As a result, as one commentator
has written, “by the early 1980s, the momentum against any death taxation in Queensland
carried all other state death duties to the grave.”
At the Commonwealth level, interstate competition was obviously not an issue.
Nonetheless, the political momentum of the estate duty abolition movement rve
overwhelming After Mr. Negus was elected, and before Queensland abolished its gift
and estate duties, a Senate Committee examined the subject of wealth transfer taxes,
recommending that the Commonwealth vacate the field, leaving the States to negotiate a
**,
uniform base and rates.” Of the eight Senators on the Committee, however, three filed a
dissenting report recommending that the Commonwealth repeal its gift and estate duties
and that the States be encouraged to reduce their taxes with a view to their eventual
abolition.”
Although the Asprey Committee affirmed an important role for wealth
transfer taxation when it delivered its Report in January 1975.” recommending a
national integrated gift and estate duty designed to reduce administration and compliance
* Deceased Persons' Estates Duties Act (No.2) 1978 (No. 49) (Tas), Deceased Persons' Estates Duties
Amendment Act 1982 (No. 49) (Tas). See also Pedrick, supra note 94 at i 15-16; and Saunders, supra note
72 at 398.
* Death Duty Act Amendment Act 1977 (No. 3) (WA), Death Duty Act Amendment Act 1978 (No. 61)
(WA). See also Pedrick, supra note 94 at 115-16.
* Succession Duties Act Amendment Act 1979 (No. 67) (SA); Stamp Duties (Further Amendment) Act
1980 (No. 161) (NSW). See also Saunders, supra note 72 at 398.
*" Smith, supra note 72 at 79.
* Senate Standing Committee on Finance and Government Operations, supra note 93. Senator Negus was
invited to chair the Committee for the purpose of this inquiry, but “declined on the ground that his
commitment to death tax relief would disable him from performing as an impartial chairman.” Pedrick,
supra note 94 at 114, n. 2.
*Saunders, supra note 72 at 401,
*Taxation Review Committee, supra note 93 at para. 244 (emphasizing that these taxes “support the
progressivity of the tax structure by the indirect means of a progressive levy on wealth once a generation”
and “limit ... the growth of large inherited fortunes, a trend that most people would agree to have
undesirable social consequences”).
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costs and to minimize opportunities for avoidance.”
the effort to modernize these taxes
appears to have been too late.” In the election that followed the Anim constitutional
crisis later that year.” former Labor Prime Minister Gough Whitlam promised to abolish
Commonwealth estate and gift duties in an unsuccessful effort to return to power.”
During the 1977 election campaign, the incumbent Liberal Prime Minister Malcolm
Fraser announced the immediate exemption of all transfers to a spouse or a child, and
promised to abolish Commonwealth estate and gift duties altogether if re-elected.” After -
the Liberal-Country Coalition won a majority on 10 December 1977, the Government
introduced legislation to repeal these taxes effective 1 July 1979.” Although the Labor
Party moved to withdraw the legislation “until such time as an alternative form of tax on
capital is introduced,” the motion was defeated along party lines and the legislation
was enacted in 1978.”
C. The Abolition of Wealth Transfer Taxes in New Zealand
Though separated from the Australian mainland by more than a thousand miles of
water, New Zealand was not immune from the effects of estate and gift duty abolition in
* Ibid. at paras. 24.7-24.76.
* Smith, supra note 71 at 79-80 (attributing the abolition of these taxes to “tax policy inertia, which
allowed popular support for these taxes to dwindle”).
*” On 11 November 11 1975, Australia's Governor-General Sir John Kerr dismissed the Labor Prime
Minister Gough Whitlam after the Senate, in which the opposition Liberal-Country coalition had a
majority, blocked a bill that appropriated funds for the payment of government expenditure, Kerr appointed
the Opposition Leader Malcolm Fraser, who obtained passage of the bill and immediately requested the
Governor-General to dissolve Parliament and call a general election. For a useful explanation of the 1975
constitutional crisis, see http://www.nationmaster.com/encyclopedia/Australian-constitutional-crisis-of-
1975.
*Pedrick, supra note 94 at 116.
* “Fraser: reject Labor’s ‘recipe for disaster” Sydney Morning Herald (22 November 1977) at 8 (quoting
Fraser's statement that “[e]state duty has caused distress and hardship to thousands of Australian families,
to smail business, to farmers”). -
* Estate Duty Amendment Act 1978 (No. 23) (Australia), Gift Duty Amendment Act 1978 (No. 25)
(Australia). See also Pedrick, supra note 94 at 116-17.
* Australia did not tax capital gains at the time.
* Pedrick, supra note 94 at 116-17.
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Australia. Under pressure from farming interests, who complained that increased land
values resulted in a larger estate tax burden.”
the New Zealand Government amended
the estate and gift duties in 1979 by significantly increasing the basic exemption in stages
from $25,000 to $250,000 in 1982.” Little more than a decade later, the estate tax was
effectively abolished by reducing to zero the rate of tax on persons dying on or after 17
December 1992.” In 1999, further legislation formally repealed New Zealand's estate
tax, though its gift tax remains in place.”
Although less than one percent of decedents were subject to the tax in 1992.”
abolition of estate duty was welcomed by New Zealand’s leading agricultural
organization, Federated Farmers of New Zealand, which praised the legislation as a
“victor[y] for rural business and communities.” From the government’s perspective,
while the tax raised approximately NZ$80 million in 1992, this accounted for less than
0.3 percent of total tax revenues.” Finally, as Cedric Sandford has suggested, New
Zealand’s estate duty “may also owe its demise, at least in part, to whº happened in
Australia, because of the free movement of nationals between New Zealand and
Australia".” As an estate-type tax based on the estates of persons dying while domiciled
* See R.A. Green and Lindsay McKay, “The Estate and Gift Duties Amendment Act 1979: The Demise of
Wealth Transfer Taxation” (1980), 10 Vict. U. Wellington L. Rev. 227 at 240-42.
* Financial Statement to the House of Representatives, (Wellington, 21 June 1979) 33. For a critical
assessment of this amendment, see Green and McKay, supra note 283.
* Estate Duty Abolition Act 1993 (No. 13) (New Zealand). See the brief discussion of this amendment in
Asa Gunnarson, “Ability to Pay in New Zealand’s Tax System” (1997), 27 Vict, U. Wellington L. Rev. 697
at 711.
* Estate Duty Repeal Act 1999 (New Zealand).
* According to a story in the Daily News (3 December 1998), of 55,000 persons who died while domiciled
in New Zealand in 1992, only 453 estates were subject to estate duty. -
*“Stamp Duty Cut Applauded,” Christchurch Press (27 May 1999).
* O.E.C.D., supra note 3.
* Cedric Sandford, Why Tax Systems Differ: A Comparative Study of the Political Economy of Taxation,
(Fersfield: Fiscal Publications, 2000) at 100.
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in New Zealand, New Zealand's tax, like that of the Australian States, was particularly
vulnerable to tax-motivated emigration by affluent retirees.
D. Public chore Theory and the Abolition of Wealth Transfer Taxes
Writing in 1978, Canadian economist Richard Bird characterized the
disappearance of Canada's wealth transfer taxes as “strange”.” wins in 1983,
Australian economist John Head described the abolition of Australia’s federal eme and
gift duty as “totally incomprehensible”.” More recently, Cedric Sandford argued that the
abolition of wealth transfer taxes in both countries “had an accidental element about
it”.” While there is certainly a large element of contingency to the events amming in
the abolition of these taxes in Canada, Australia and New Zealand, public choice theory
Suggests that the outcome in each of these cases is neither “strange”, nor
“incomprehensible”, nor entirely “accidental”. On the contrary, the abolition of wealth
transfer taxes in these countries was in many respects a predictable response to the
shifting political costs of these and other taxes.
In Canada, the Carter Commission’s proposals to tax gifts and inheime 3S
income and capital gains at death significantly increased the wia costs of the federal
gift and estate tax as well as provincial succession duties – taxes for which the political
costs were already high given their application to a relatively narrow group of people.
While the 1968 amendments to the federal gift and estate tax might have lowered
political costs by rejecting the Carter Commission’s proposal to tax gifts and inheritances
as income and exempting inter-spousal transfers, political costs were clearly increased by
* Bird, supra note 145 at 133.
* Head, supra note 72 at 14.
* Sandford, supra note 290 at 105.
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integrating the gift and estate taxes and increasing federal rates on estates valued at less
than $5 million. Not surprisingly, these amendments galvanized farming and small
business interests, increasing further the political costs of Canadian wealth transfer taxes
and federal tax reform more generally.
Although the White Paper attempted to contain these political costs by rejecting
the taxation of accrued gains at death, the proposals to tax capital gains at ordinary rates
and widely-held shares every five years were politically very costly, since these measures
would “impose obvious and substantial new burdens on a relatively small but affluent,
articulate and well organised section of the community which could hardly be expected to
stand idly by", resulting in benefits that “would be widely dispersed over the relatively
unorganised mass of taxpayers at the bottom of the income scale.” Clearly expecting
opposition from organized interest groups, the Government attempted to manage the tax
reform process by referring its proposals to parliamentary committees. These committees,
however, were completely unprepared for this task and served mostly as “sounding
board[s] for those segments of public opinion that were most vocal” – namely, the
organized interest groups that had opposed the Carter Commission's proposals from the
outset. Predictably, the parliamentary committee reports “reflect[ed] in varying degrees
the overwhelmingly hostile reaction of representatives of the business and professional
organizations from whom the bulk of the briefs and other submissions were received.”
Finally, confronting the prospect of substantial revenues from the introduction of capital
gains tax versus minimal revenues from the gift and estate tax (75 percent of which was
transferred to provincial governments or abated in the case of provinces collecting their
2.94 Head, supra note 112 at 69 and 70.
* Bucovetsky and Bird, supra note 129 at 21.
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own succession duties), the federal government opted to withdraw from the wealth
transfer tax field, enacting a capital gains tax on half the amount of the gain with accrued
gains taxable at death.
At the provincial level, several governments endeavoured to maintain wealth
transfer taxes, though the eventual abolition of these taxes was probably inevitable when
Alberta refused to enact a provincial succession duty and gift tax in 1972. With low
revenues, high administrative costs, and the risk of inter-provincial migration, wealth
transfer taxes were abolished in Atlantic Canada by 1974, Western Canada by 1978, and
Ontario in 1979. While Quebec held out, substantially amending its succession duty in
1978, even it succumbed to the pressures of horizontal tax competition, repealing its
succession duty and gift tax in 1985.
In Australia, the political costs of estate and gift duties collected by
Commonwealth and State governments increased significantly in the late 1960s and early
1970s as inflation eroded the real value of exemptions, increasing the number of taxable
estates. Even before then, the political costs of these taxes were probably high, given
their relatively narrow application and the high administrative and compliance COSłS
resulting from joint occupancy by both levels of government. Not surprisingly, those who
were subject to the tax established an organized movement pressing for abolition of the
taxes. As the political costs of these taxes increased and government reliance on estate
and gift duties as a source of revenue decreased, these governments looked at other less
politically coal, sources of revenue as alternatives to these taxes. When Queensland
abolished its estate and gift duties effective January 1977, horizontal tax competition
quickly led to the abolition of these taxes in all other States. At the federal level,
* Head, supra note 112 at 70.
156
Committees made recommendations for major reform, but the political momentum of the
abolition movement carried the day and Commonwealth gift and estate duties were
repealed effective 1 July 1979. New Zealand held out for a little more than a decade, but
the combination of political opposition, low revenues and horizontal tax competition
proved fatal there as well as the estate tax was repealed effective 17 December 1992.
IV. Conclusion
Opponents of wealth transfer taxes are apt to take comfort both from their
abolition in Canada. Australia and New Zealand and from public choice explanations for
these events, and proponents may despair. As an advocate of these taxes myself” this is
obviously not what I intend. Although wealth transfer taxes were abolished in Canada,
Australia, and New Zealand, are under pressure in the United Kingdom, and are
scheduled to be phased out in the United States, they appear to have retained their vitality
in several other countries,” a few of which rely on these taxes more today than they did
in the early 1970s.” While political costs and benefits may influence the choices that
governments make among different revenue sources, these are clearly not the only factors
” Duff, supra note 5.
* In Norway, for example, wealth transfer taxes accounted for 0.21 percent of tax revenue and 0.08
percent of GDP in 1971 and 0.2 percent of tax revenue and 0.09 percent of GDP in 2001, Similarly in
Japan, wealth transfer taxes accounted for 1.27 percent of tax revenue and 0.26 percent of GDP in 1971 and
1.22 percent of tax revenue and 0.35 percent of GDP in 2001. OECD, supra note 3.
” In France and Germany, for example, wealth transfer taxes accounted for larger percentages of tax
revenues and GDP in 2001 than they did in 1971: increasing in France from 0.52 percent of tax revenue
and 0.18 percent of GDP in 1971 to 1.23 percent of tax revenue and 0.6 percent of GDP in 2001, and
increasing in Germany from 0.2 percent of tax revenues and 0.06 percent of GDP in 1971 to 0.4 percent of
tax revenues and 0.15 percent of GDP in 2001. Ibid. -
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as political values and ideologies as well as the structure of state institutions can also play
an important role.”
Nonetheless, it is important to be realistic about the considerable political
challenges that are apt to make the retention or reintroduction of wealth transfer taxes
especially difficult. As experience in Canada, Australia and New Zealand suggests, the
political costs of these taxes tend to be much higher than those of broad-based income,
consumption, or payroll taxes, and can increase significantly if tax reforms (Canada) or
tax pois inertia (Australia) increase the burden on small and medium-sized estates.” In
federal systems, moreover, the political costs of wealth transfer taxes are greatly
increased by joint occupancy by both levels of government (vertical tax competition) and
mobility among sub-national jurisdictions (horizontal tax competition). Although the
costs of horizontal tax competition in this field can be reduced by applying the tax to
inheritances received by beneficiaries who are resident or domiciled in the taxing
jurisdiction, since these persons are likely to be less mobile than affluent retirees, the
example of Quebec (where this “accessions basis” was adopted in 1978 but provincial
succession duty and gift tax were repealed in 1985), suggests that wealth transfer taxes in
a federal jurisdiction should be collected by the federal government.
For those who wish to preserve and restore the taxation of wealth transfers, then,
what lessons can be drawn from the abolition of these taxes in Canada, Australia and
New Zealand? Reflecting on public choice accounts of tax policy and the historical
experience in these countries, three conclusions seem evident. First, if wealth transfer
* See, e.g., Banting, supra note 9 at 352-55 (considering literature on the politics of redistribution as well
as public choice theory, and concluding that these approaches should be understood as complementary, not
contradictory).
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taxes are to be maintained or reintroduced, the political costs of these taxes cannot be
allowed to increase beyond a level that is necessary to their essential purposes. Basic
exemptions, for example, must exclude small and medium-sized estates, and special rules
must minimize the burden on family-owned enterprises and principal residences – ideally
by deferring the collection of tax until these assets are sold rather than exempting these
transfers from tax altogether. Capital gains taxes must be adjusted to lessen the combined
impact of two taxes when property is transferred by gift or on death, for example by
permitting the donor's cost to carryover to the recipient. Administrative and complime
costs must be minimized by integrating federal and sub-national taxes or abolishing the
latter, by eliminating complex rate structures based on the size of an estate and the shares
received by different classes of beneficiaries, and by statutory rules designed to minimize
opportunities for avoidance. Horizontal tax competition must be discouraged by ensuring
that wealth transfer taxes are collected by federal governments in federal systems and by
applying these taxes to gifts and inheritances received by beneficiaries who are resident
or domiciled in the taxing jurisdiction in addition to property situated in the taxing
jurisdiction and transfers of property by persons domiciled in the taxing jurisdiction.
Second, if governments are to enact the legislative measures necessary to preserve
or re-establish wealth transfer taxes, methods must be devised in order to protect public
decision-making processes from the influence of organized interest groups who can be
expected to oppose these measures. In Canada, for example, the Carter Commission was
able to produce a Report that was hailed as “a landmark in the annals of taxation”
because it had both the institutional mandate and the financial resources to engage in a
"This appears to have been a factor in the U.S. as well, where inflation and increased real estate values
eroded the effectiveness of the integrated gift and estate tax credit in the 1990s.
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thorough and non-partisan analysis of tax policy. In contrast, the parliamentary
committees that considered the federal government’s White Paper proposals in 1970 were
thrust into a highly political exercise without the knowledge or resources to withstand the
pressure exerted by organized interest groups that dominated the process. Although this
was only one of many factors that led to the eventual abolition of wealth transfer taxes in
Canada, its impact at the time may have been decisive.
Finally, if these taxes are to retain and attract public support, efforts must also be
made to increase their perceived benefits. One strategy for this purpose might be to
earmark the revenues from these taxes to a particular expenditure program, especially a
program that complements the relatitute objectives of the tax such as early childhood
education for children from low-income families. More generally, a greater “tax
preference” for wealth transfer taxes might result from less amous on the revenues
raised from these taxes, which are bound to be less than taxes on income, consumption or
payrolls, and more explicit acknowledgement of their symbolic and social function to
lessen inequalities and unequal opportunities.” Public support for these taxes might also
be improved by applying these taxes to amounts received by living beneficiaries rather
than the aggregate amount of a decedent’s estate, demonstrating that the tax is intended
not to punish those who have succeeded in life or to compound the misery of death, but to
regulate the distribution of wealth and opportunities among beneficiaries for whom a gift
* In this respect, see Ontario Committee on Taxation, Report, (Toronto: Ontario Printer, 1967), Vol. HI at
136 (emphasizing the social purpose of wealth transfer taxes “to control the growth in this country of an
economically powerful minority whose influence is based upon inherited wealth”); and Taxation Review
Committee, supra note 92 at para. 24.4 (recognizing role of wealth transfer taxes to “limit ... the growth of
large inherited fortunes, a trend that most people would agree to have undesirable social consequences”).
See also McKay, supra note 70 (noting the rare emphasis on the social purposes of wealth transfer taxes in
New Zealand); and Bird, supra note 145 at 138 (suggesting that public support for the wealth transfer taxes
in Canada was weak because “revenue was clearly the main purpose of [these] taxes so far as most
Canadians and Canadian governments were concerned”).
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or inheritance is largely undeserved.” In fact is interesting to note that the decline in
wealth transfer taxes in O.E.C.D. countries has been much greater among countries with
estate-type taxes that fall on the estates of persons dying domiciled in the jurisdiction
than countries with inheritance-type taxes that apply to amounts received by beneficiaries
living in a particular jurisdiction. m addition to any lessons from the history of abolition
in Canada, Australia and New Zealand, wealth transfer tax advocates might also look to
the experience of these countries where wealth transfer taxes appear to have been more
resilient.
* See, e.g., Graetz and Shapiro, supra note 2 at 233-36 and 256.
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Statement by U.S. Representative Tim Mahoney
“Alternatives to the Current Federal Estate Tax System”
United States Senate Committee on Finance
March 12, 2008 -
Thank you, Chairman Baucus and Ranking Member Grassley, for holding this hearing on
estate tax reform, and for allowing me to submit my testimony to the Committee. I
appreciate your leadership on this issue, which is important to family farmers and small
business owners in my district.
In high growth states or in expanding metropolitan areas, such as Florida, land values
appreciate due to the value of the land for commercial or home development.
Unfortunately, this creates a situation where a family may be forced to sell the family
farm to pay the estate tax, as agricultural income is insufficient to cover the liability.
The sale of property for development reduces America’s capacity to be an independent
producer of a safe food supply. The Centers for Disease Control and Prevention (CDC)
estimates that each year in the United States, 76 million people get sick, 325,000 are
hospitalized, and 5,000 die from food-related illnesses. While these illnesses are the
result of a variety of factors, increased attention has been paid to the safety of imported
foods.
Following revelations that pet food imported from China sickened or killed an unknown
number of dogs and cats, Congress focused on the more than $4 billion worth of food we
import from China. While the U.S. food supply, including imported food, is among the
safest in the world, a challenge is emerging—how do we keep our food supply safe in the
face of rapidly rising imports.
Finally, the sale of agricultural property reduces the green space we have and
development puts greater pressure on our environment.
As you may know, last year, I joined Representatives John Salazar and Baron Hill in
introducing H.R. 1929, the Save the Family Farm and Ranch Act of 2007. This bill will
defer the payment of the estate tax on family farms and ranches as long as the land is
used for agricultural or conservation purposes. Specifically, the legislation would apply
to those who receive more than 50 percent of their gross income from farm or ranch
operations. As long as their heirs keep the estate in accordance with the Internal Revenue
Services’ definition of farmland, the estate tax is deferred until the family decides to sell
it or at such time as the family income drops below 50 percent. At that time the sale of
the estate would be subject to the estate tax currently in law on the full value of the estate.
The Save the Family Farm and Ranch Act of 2007 protects family farms, maintains farm
production, lessens urban development in rural areas, and conserves or environment.
This legislation is similar to S. 1994, which was introduced by Senator Ken Salazar.
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As the Senate Finance Committee continues to examine alternatives to the current federal
estate tax system, I would urge you to consider the provisions contained in the Save the
Family Farm and Ranch Act.
Again, thank you Chairman Baucus, Ranking Member Grassley, and Members of the
Committee for your work on estate tax reform, and for providing me with the opportunity
to testify before you today.
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Senate Finance Committee
Statement for the Record
Senator Pat Roberts
Alternatives to the Current Federal Estate Tax System
March 12, 2008
Thank you, Mr. Chairman, for scheduling this hearing. : -
This is the second estate tax hearing we’ve had in recent months, and I hope that this
reflects a commitment by the committee to move toward reform, or repeal, of the estate
tax. We all know that we have one year, in 2010, when the estate tax is permanently
repealed and then the tax returns with full force to its pre-2001 levels, with a tax rate of at
least 55 percent and an exemption level reduced down to one million dollars,
One of the repeated concerns that Kansas small businesses, family farmers, and
ranchers share with me is that the burden of the estate tax limits their ability to pass on
their business, farm or ranch to their children or grandchildren.
In Kansas, as in many states, small businesses are the leaders in job creation and the
drivers of local economies. And, yes, there are family farms in Kansas where the children
hope to take over the farm from their parents. However, when the estate tax hits, these
younger generations are too often placed in the difficult position of having to sell the
business or the farm just to pay their tax bill to Uncle Sam. It is an unfortunate reality that
this frequently results in the kids packing up and leaving their rural community to earn a
living elsewhere. -
Absent Congressional action, in 2011 and beyond, more and more family farms and
small businesses will be impacted and generations-old farms and family businesses will
cease to exist.
Several years ago, the Senate came close to reaching a compromise on a reform of the
estate tax. As the witnesses here today have pointed out, there are a number of options to
reform the estate tax. Whatever approach we ultimately take, we need to act sooner rather
than wait until 2010, so that taxpayers who are subject to the estate tax can have certainty
with respect to how they plan for the future of their small businesses or the family farm.
COMMUNICATIONS
Dick Patten
President
American Family Business Institute
1920 L Street NW, Suite 200
Washington, DC 20036
Testimony to:
The U.S. Senate Finance Committee
Hearing on “Alternatives to the Current Federal Estate Tax System”
March 12, 2008
Chairman Baucus, Ranking Member Grassley, and Members of the Committee: I am
honored to present testimony on behalf of the American Family Business Institute and the
family-businesses and farms we represent. I want to explain why the inheritance tax is no
“alternative” to the existing federal estate (or rather, death) tax.
This hearing, though thought-provoking, may miss the point. Any alternative to the
existing system should reduce the overall burden placed on family businesses and farms.
The inheritance tax, as I will explain, would increase the overall burden. Moreover, the
arguments for this proposal are predicated on the same wrong notions about earned
wealth as those of the arguments for maintaining our existing death tax. Family-
businesses and farms create economic opportunity for all and should not be punished as
though their success came at the expense of other Americans. Abolishing the death tax is
the policy most in the interest of America’s family-business owners, farmers and the
economy as a whole.
I. Problems with the Inheritance Tax
There are three specific problems with the inheritance tax in her proposal as proposed by
panelist Lily Batchelder, who made the clearest case in support of such a tax. Taken
together, these problems make the inheritance tax an unacceptable “alternative” for the
existing estate tax.
First, the effective rate of the inheritance tax would be somewhere between 65% and
69.6%, much higher than the current rate of 45%' and even the scheduled 2011 rate of
55%. Ms. Batchelder recommends using the income tax to establish the base level of
taxation, the highest rate of which is currently 35% (but slated to increase to 39.6% in
2011 when the 2001 tax relief expires). Next she would add a “surtax” of 15%',
'Tax Law Changes for Gifts and Estates and Trusts, Internal Revenue Service, December 1, 2007,
http://www.irs.gov/formspubs/article/0,,id=112782,00.html.
*Brian G. Raub, Recent changes in the Estate Tax Exemption level and Filing Population, Internal
Revenue Service, http://www.irs.gov/pub/irs-soi/05estate.pdf.
(165)
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bringing the current total to 50% and the 2011 total to 54.6%. Finally, she implies that
stepped-up basis for capital gains should be eliminated, resulting in yet another 15%.
When today, farms and family-businesses are already facing financial ruin due to a rate
of 45%, what sense does it make to increase it by 50%?
Second, the Batchelder inheritance tax would encourage the disintegration of family-
farms and businesses through fragmented ownership. The inheritance tax provides an
exemption on the basis of inheritances received, meaning the only way around the
onerous rate is to bequest to enough owners as to take advantage of the full exemption
amount (Ms. Batchelder recommended an exemption of $2 million'). For many family-
business and farmers, this would mean making bequests to non-children and even non-
relatives, who may or may not have an interest in the business's long-term viability.
For instance, if the owner of a farm valued at $10 million dies and has no cash to pay the
inheritance tax, he would be encouraged to make 5 bequests (each at the $2 million
exemption rate). However, if he does not have 5 children or other suitable heirs, then he
would have to bequest a fifth of the ownership (or more) of his farm to an outside heir.
This person may very well have more interest in immediate cash rather than preserving
the farm's character and viability. Giving this person ownership of the farm would place
the rest of the family in conflict, rather than ensuring the long-term sustainability of the
farm.
Proponents of the inheritance tax claim that it would make tax-planning less complex, but
the incentive for disintegration of family-enterprises will make tax-planning only more
difficult.
Third, the inheritance tax as proposed by Batchelder would provide a “deferred” payment
plan" for family-businesses and farms, which in reality, would only shackle them with
burdensome debt. Under this plan, heirs who receive illiquid assets such as a business or
farm and lack cash, could defer the tax indefinitely until the asset is sold. On face value,
it almost sounds like a plausible solution to the problem faced by family businesses and
farms.
However, there are two very important problems posed by this “solution” which make it
untenable. First, annual interest would accrue on the amount of the tax owed by the heir."
*Effective Tax Rates Under Current Law: 2001-2014, Congressional Budget Office, August 2004,
http://www.cbo.gov/ftpdoc.cfm?index=5746&type=0&sequence=1.
"Lily Batchelder, “Reform Options for the Estate Tax System: Targeting Unearned Income,” Testimony
Before the United States Senate Committee on Finance, March 12, 2008, page 10.
* Batchelder, page 2.
“Ibid., 15.
"Ibid., 16.
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This means that within a number of years, a family inheriting a business or farm could
theoretically owe 100% of the value of their enterprise to the government in taxes.
Moreover – as with any federal debt – until the tax is paid, the business would become a
“borrower” of the federal government, making the IRS a silent partner in the business’s
operations, secured by an IRS lien. As any executive is aware, the complications of
nonproductive loans can wreak havoc with a business’s ability to borrow money for
growth. This “deferment” plan does not work on paper and it would ruin family-
businesses in real life.
I know of many business-owners and farmers who are strained by the burdens of the 10-
year loan plan offered for the current death tax. Congress would not accomplish much
for them by simply offering infinite debt and the consequent financial strains. Business-
owners and farmers who have worked hard do not deserve an IRS loan-shark as the
“compromise” to immediate confiscation.
II. Ideological misconceptions common to both the death tax and the
inheritance tax
The reasons for an inheritance tax, based on its proponents own words, are very similar to
those used in support of the current death, or estate tax. This belies the notion that the
proponents of the inheritance tax are actually interested in dealing with the problems
created by the current death tax. The reality, as explained below, is that these individuals
are looking for a more aggressive way to accomplish their goal: the redistribution of
wealth in America.
The primary misconception is the notion that income inequality in America is an
undeniable crisis of moral proportions, Certainly, no just society can tolerate the
subjugation of any class. However, there is nothing wrong with discrepancy in economic
net-worth, insofar as that discrepancy is not static. And the evidence from a recent
Treasury Department study finds that income in America is incredibly dynamic.”
This study found that over the last 10 years, income mobility has not been static, but
instead incredibly dynamic. In fact, more than half of the lowest income earners have
moved into a higher income bracket in the 10-year span and nearly a quarter of the lowest
income earners have moved into middle or upper-middle income brackets. The only
income bracket to see a drop in real income over the last ten years was the top 1%.
Not only is wealth dynamic, but it is particularly so among those in the lowest wealth
brackets. A study in 2003 found that within five years, one-third of households in the
bottom wealth quintile move up to a higher quintile.”
* “Income Mobility in the U.S. from 1996 to 2005,” Department of the Treasury, November 13, 2007,
http://useuusmission.gov/Dossiers'Economic Relations/Nov1307 Income Mobility Study.pdf -
"Ana Castaneda, Javier Diaz-Gimenez and Jose-Victorrios-Rull, “Accounting for the U.S. Earnings and
Wealth Inequality” Journal of Political Economy 1 11, no. 4 (August 2003): 848.
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Moreover, the notion that wealth between generations in a family is static stands in stark
comparison to the evidence. A paper published in the Journal of Political Economy
found that two thirds of children of parents in the poorest wealth quintile ended up in
higher quintile than their parents. And the children of parents in the wealthiest quintile?
They had a 64% chance of being in a different (lower) wealth quintile than their
parents,
Only those who are ideologically committed to Marxist egalitarianism can find fault with
these trends. Real humanitarians are interested in improving the lot of all Americans, and
have no problem with a “wealth divide” so long as there is nothing preventing anyone
from moving up, And leading economists have found that inheritances have little impact
on such inequality,
Alan Blinder, a former member of President Bill Clinton’s Council of Economic
Advisers, stated that only 2 percent of inequality is due to the unequal distribution of
inherited wealth." Joseph Stiglitz, chairman of President Clinton’s CEA, stated
inheritances might actually reduce income inequality. 12
Supporters of death tax repeal know that inheritances do not hold anyone back. In fact,
they allow everyone to move forward faster than they would otherwise. Beyond helping
the heirs move into higher income brackets, inheritances enable economic growth which
brings better jobs for everyone, particularly in the case of family businesses. A death tax
hampers this growth and slows the economy, holding everyone back.
III. The Truth about the Family Farm
Ms. Batchelder repeated the oft-cited but patently false claim that the death tax has not
resulted in the sale (or destruction) of any family-farms. This common lie holds
continued weight only due to the shallow analysis with which most policy-experts and
academics approach it. You see, it is unlikely that any farms have been sold the day after
the death tax levy, or any time close to it. However, there are plenty of instances of
farms which have been sold in advance of the tax, as the aging owners realized that their
children would be burdened with a major tax liability and subsequent fire-sale if it was
not addressed sooner. Selling the farm provides liquidity to pay for the tax, and leaves
some inheritance for the children, though hardly in the form that the family intended.
"Kerwin Kofi Charles and Erik Hurst, “The Correlation of Wealth across Generations,” Journal of
Political Economy 111, no 6 (December 2003): 1155-1182.
"Alan S. Blinder, Toward an Economic Theory of Income Distribution (Cambridge, MA: MIT Press,
1974).
*Joseph E. Stiglitz, “Equality, Taxation and Inheritance,” in Personal Income Distribution: Proceedings
of a Conference Held by the International Economic Association, Noordwijk aan Zee, Netherlands, April
18–23, 1977, eds. Wilhelm Krelle and Anthony F. Shorrocks, 283 (New York, NY): North-Holland
Publishing Company, 1978).
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In other cases, family farms are forced to take on burdensome loans in order to pay for
the tax. In these cases, it often is just a matter of time before the debt loan becomes an
unmanageable loss, and the farm is sold. Allow me to share with you a few examples of
both scenarios. -
For instance, consider the story of Lex McCorvey a resident of Santa Rosa, CA.”
In the late 1800's my Swiss born grandfather Antonio Ghisletta immigrated to the United States in
search of new opportunities. It was the classical story of him arriving with no money in a new
land where hope and hard work would somehow fulfill a life’s dream
My grandfather Antonio was a dairyman, as his family before him was in the old country.
Through his hard work and determination he saved and borrowed money to purchase a dairy farm
in the Chileno Valley of Petaluma, California. My mother Lorraine was born on the ranch in 1914
and milked cows by hand before and after school, harvested hay, potatoes and grains and did other
routine chores, Antonio even donated land on the ranch to create Laguna School, a new rural one
room elementary schoolhouse so the three children could be closer to the farm.
With over 70 years of a farming legacy in the community, Antonio passed away in the mid 1960's.
His children and their families faced the daunting task of dealing with his estate. What took a
lifetime for my grandfather Antonio to build disappeared as his children were forced to sell both
farms to simply pay the inheritance taxes. The family farm was no more. Even more damaging
was that the properties had to be sold quickly to meet the inheritance tax obligations. As a result,
both farms brought less than the market value adding insult to injury for the heirs as they saw
there family farming legacy swept away in a few short months. - .
To this day, those farms would still be in the family had it not been for an injustice that is served
by unfair inheritance laws in this country. It is difficult enough for generations of new or aspiring
farmers to buy or even rent land for agriculture. I hope that Congress will act soon to repeal the
death tax before more farm families suffer the same fate. - -
Another sad case is that of Tim Koopman, whose family has operated a ranching
operation in two locations since 1889." Tim had long planned to be the fourth
generation of his family to run the farm. However, with this grandfather’s unexpected
and unprepared death at the age of 80, his plans quickly changed:
As a simple hardworking man, he had prepared just a simple Last Will and Testament. After
several years of meetings with accountants, appraisers, IRS officials and attorneys, the IRS
prevailed in establishing a non-agricultural appraised value on the Sunol ranch [one of two ranches
owned by the Koopmann family]. The result was an inheritance tax liability of over $125,000...
...In 1973, in order to generate sufficient cash to settle the death tax liability, the family had to sell
the Turlock ranch. The family ranching operation was reduced in scale to adapt to the loss of the
Turlock ranch, additionally, at that time 150 acres of the leased share crop farm ground was lost
due to residential development. As a result of the death tax liability and the costs associated with
attorneys and appraisers, cash reserves were reduced to nothing. The reduced scale of operations,
in conjunction with increasing expenses, provided for meager income flow. To compound an
* Lex McCorvey, “Letter to Members of Congress,” Living Through the Death tax: Personal Stories from
Farm and Ranch Families in California, California Farm Bureau Federation, September 9, 2005.
"Tim Koopmann, “Koopmann Ranch,” Living Through the Death tax: Personal Stories from Farm and
Ranch Families in California, California Farm Bureau Federation, July 13, 2005.
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already dismal economic condition, came the weather conditions of 1975 through 1977. The lack
of rainfall for these two years was classified as the most severe drought in over 100 years in
northern California....
...As my college agricultural education tenure neared its end, my hopes of entering into a family
agricultural partnership were dashed....I thus became the first Koopmann family member from
four generations of California agriculturalists to be “off the land”...
Though unable to make a living as a full-time rancher, Tim continued to be an active
participant in the family agricultural operation, and looked for ways to keep the
remaining land from being sold. Unfortunately, this ultimately proved to be a futile
effort:
In April of 1991, we accomplished a small goal by establishing a family trust for the ranch. It was
a beginning to estate planning that we all hoped could be further enhanced. Unexpectedly, my
father died of a massive heart attack on July 1, 1991. The family trust that had been established to
re-structure ownership proved to be of some benefit. My mother’s health had been poor prior to
my fathers’ death and further deterioration occurred. In November 1994, after months of
suffering, my mother was hospitalized. After emergency lifesaving surgery due to a cancerous
colon rupture, she remained in the hospital until February. On Easter Sunday she passed away.
Following the death’s of my parents I completely utilized all available cash reserves and liquidated
assets in order to meet the alleged obligation imposed upon my family by the IRS and state of
California for their death taxes. Appraisals, attorney fees, and accounting costs have amounted to
thousands upon thousands of dollars. Initially we paid $76,000+ to the state of California for
death taxes that the state claims technically not to have. The IRS received $49,000+ as a down
payment on our “obligation” of over $300,000.
Following our final estate tax return submission, that we assumed would finalize our term
payment plan, we received notice of the IRS intent to audit, Additional legal and accounting fees
were needed in order to prepare documentation and respond to the IRS audit. As a result of the
audit, it was determined that the ranch had been appraised at below market value at the time of my
fathers’ death. The IRS demanded an additional $1 1,700+ up front (not to be added to the term
obligation) and the state of California required an additional $8,000+...,
...At the time, I was left with absolutely no alternative than to engage in a sale of real estate. The
only buyers that presented themselves were developers and speculators who maintained no desire
for operating an agricultural business or maintaining the open space provided by this working
landscape. Each January, from 1996 to 2000, I made the required payment in the amount
$16,500+ to the IRS for the interest only installment on my “obligation”. In the year 2000, I was
invoiced for $36,000 as the amortized payment schedule began, Gross agricultural product sales
of $50,000 to $60,000 were not sufficient to service this debt, thus borrowing money was required,
pending real estate sales. The sale of two conservation easements on portions of the ranch were
finally completed in 2002 and 2005 which allowed the payoff of the loan and estate taxes,
however, there remains a capital gains obligation due in April of 2006 estimated at 220,000+.
Following the payment of this capital gains tax, there will be a total depletion of the sales proceeds
from the conservation easements.
Given this family narrative, how can the Federal Estate Tax be considered fair and equitable
treatment?
My grandfather purchased this ranch in 1918 and every payment due to purchase the ranch was
made as agreed. Every property tax bill ever presented was paid as agreed and every dime of
income tax due for ranch-generated income was paid as agreed. Multi-generational land
ownership, the American dream for generations of future farmers and ranchers is officially dead.
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Even when the farm isn’t sold, the death tax often results in drastic changes to its
composition. These changes are almost always deleterious for the local ecology. Hannah
Tangeman-Cheney's experience” is indicative:
Mrs. Tangeman-Cheney's ranch has been owned by her family since 1862, and run by women
since 1914. Hannah’s mother passed away in 1990. Immediately, Hannah found herself working
with the IRS, attorneys and appraisers, while her grieving got pushed aside. Her mother had a will
and a trust, but there was a still a significant tax burden placed on Hannah and her sister.
It took two years for Hannah and the IRS to come to an agreement on the appraised land value of
the ranch since their appraisers came up with different numbers. Mrs. Tangeman-Cheney entered
an agreement with the IRS to pay the taxes off over a ten-year period. As part of the agreement,
the IRS placed a lien on her ranch until the amount was paid off in full.
With the weight of the IRS lien on her shoulders, Hannah and her sister made a tough decision:
they harvested thousands of trees that they didn’t plan on harvesting. 13,157 trees were cut – far
more trees than they ever conceived of harvesting under any other circumstances. These trees
took over 100 years to grow, and the property had not been harvested since the 1950s. But the
burden on the ranch was too much, so they consulted with their local forester to create a timber
harvest plan that would have the least environmental impact on the local wildlife and habitat. .
Moreover, they had to pay capital gains tax on the trees, then turn the rest of the revenue over to
the IRS.
This was extremely frustrating for Hannah and her sister because they are environmentally
conscious; in fact, the ranch has since been certified as part of the “Green Building” program with
the Forest Stewardship Council. Now, Hannah and her sister have the IRS debt paid off, and they
have life insurance policies on each other to help with estate taxes in the future. However, if her
mother passed away today, Hannah argues they would never be able to pay off the tax burden due
to the increased land values, . -
These stories speak for themselves, and put to rest the lie that the death tax does not
affect family farms. - -
Today’s hearing to consider an inheritance tax is far removed from legislative reality. I
know as well as the members present that it is unlikely the Committee would mark up
legislation to actually replace the death tax with an inheritance tax. Instead of wasting
time on what is a foolish idea and a distraction, Congress return to the work of marking-
up legislation to actually repeal or substantially reduce the death tax. While this
committee delays, farmers and business owners across America wait in the balance.
*Hannah Tangeman-Cheney, “Involuntary Harvesting to Pay the Death Tax,” Living Through the Death
tax: Personal Stories from Farm and Ranch Families in California, California Farm Bureau Federation,
2005, -
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Lºft-
Statement of the
American Farm Bureau Federation
Submitted for the Hearing Record
Alternatives to the Current Federal Estate Tax System
United States Senate Committee on Finance
March 12, 2008
600 Maryland Ave. SW Suite 1000W Washington, DC 20024 p.202405.3600 | f 202406.3606 || www.fb.org

173
The American Farm Bureau Federation is a general farm organization with producer
members who grow every commodity commercially marketed in this country. They do
this on farm and ranch operations in 2,800 counties in all 50 states and Puerto Rico.
Federal estate taxes have long been a concern to American farmers and ranchers because
of the potential for the tax to force liquidation and hamper or prevent the
intergenerational transfer of farm operations after the death of an owner.
While other sectors of the economy have similar concerns, farmers and ranchers are
particularly sensitive to the estate tax issue for several reasons. First and foremost, farm
operations typically require substantially more in capital assets to generate $1 in income
than other sectors of the economy. Hence, a more modest-sized farm operation can pay
higher estate tax rates compared to non-farm businesses, even if the non-farm estate
generated comparable income while its owners were alive.
In addition to carrying a larger capital burden while operating and a high estate tax
burden in death, the typical farm estate has more capital tied up in fixed assets that are
difficult to liquidate. Hence, farm estates typically face greater difficulty making the
death tax payment.
This disparate estate tax burden has broadened over the last five years due to a
combination of rising inflation in asset values and increasing scale economies forcing
farmers to get bigger or get out of business. Appreciation in land values, increased costs
and more mechanization have worked to increase the size of the average farm
operation over time. Hence, farmers and ranchers typically bequeath larger businesses
subject to sharply graduated tax rates that translate into big enough tax bills to disrupt
larger-sized operations. In many cases, state estate taxes and the cost of complex estate
management add to this federal tax burden.
Replacing the estate tax with an inheritance tax or other tax due at the death of a business
owner will do little to resolve the issues that plague farmers and ranchers under the
current death tax regime. Taxes still will be owed by surviving sons and daughters who
want to continue to farm and many will be forced to sell off parts of their business to
settle the debt. The forced sell-off of assets can not only destroy the economic viability
of the business but can result in “fire sale” returns that further exacerbate a strained cash
flow situation.
Over time, Congress has included a number of provisions in the federal tax code to ease
the burden of estate taxes. These include provisions that are applicable to all estates as
well as provisions applicable only to farm estates. For example, a general unified credit is
built into the law, allowing for a sizeable exemption before any tax is collected. In 2007,
the exemption from the tax is set at $2 million. Special provisions applicable only to
farms and other small businesses include items such as pricing land at its use value rather
than its generally higher market value and paying estate taxes over 14 years rather than
over the nine months applicable to other estates. These special provisions have
historically cut the number of farm estates paying taxes and the taxes they paid by
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roughly half, but often at the cost of investing considerable time and money in farm estate
planning and administration.
Congress wisely moved in 1997 and 2001 to further ease and ultimately to eliminate the
estate tax. Estate taxes are being phased down through 2009 and eliminated completely
in 2010. Given their estate tax exposure, farmers and ranchers are a major beneficiary of
the 1997 and 2001 initiatives. However, the 2001 legislation included sunset language
that provides for the reinstatement of estate taxes (a reversion to the 2001 tax structure) in
2011. As a result of this lack of certainty in the law, the cost of estate planning has
multiplied while the confidence that farmers place in their plans’ ability to protect their
farm and ranch businesses has diminished. -
Replacing the estate tax with an inheritance tax or other tax due at the death of a business
owner will do little to reduce estate tax planning costs plus a transition to a different
system will add even more complexity and uncertainty to what is already an estate
planning nightmare. The cost of life insurance and attorneys fees is already out of reach
for some farm business owners and those that can afford to plan have no assurance that
the plan developed will save their farms and ranches from the ravages of taxes collected
at death.
For these reasons the American Farm Bureau Federation remains committed to the
permanent repeal of estate taxes. Until permanent repeal is achieved Farm Bureau
believes that the exemption should be increased to $10 million a person and be indexed to
inflation; full stepped-up basis must be maintained; the gift tax exemption should be
increased to $20,000 and indexed; and there should be no limits on the amount that
property values can be adjusted under IRS code section 2032A special use valuation.
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John Ed Anthony
Owner
Anthony Timberlands
1906 Highway 290
Hot Springs, AR 71913
Written Testimony prepared for the U.S. Senate Finance Committee
Hearing on “Alternatives to the Current Federal Estate Tax”
March 12, 2007
Chairman Baucus, Ranking Member Grassley, and members of the Committee: I am
making this contribution to the hearing record specifically in response to the claim of
panelist Lily Batchelder that “no family farms have been sold due to the death tax.” She
is wrong and as a tree-farmer in Arkansas, I know it.
At age 69 I serve as Chairman of Anthony Timberlands Inc., a Sub-S Corporation which
I own with my two sons and a daughter. My son Steven, now 47 with two sons of his
own now in college, is President.
Our company was formed in 1907 by my grandfather and operates manufacturing
facilities and owns timberland in South Arkansas in 7 communities employing over 1000
people in the plants and in support of our operations.
We paid the Death Tax when my father died in 1961 and again when my grandfather died
in 1980. It is hopeless for my heirs to pay the tax at my death and the company will have
to be sold to one of several corporate suitors either at my death or prior, which is more
likely, since the handwriting is on the wall unless the tax is repealed. We are one of the
last privately owned forest products company of significance remaining in the state and
one of only a few remaining in the South, all sold to pay the tax. Allow me to briefly
explain why.
Only a fool sits on the track waiting for the train the run over them. The reason it appears
to Ms. Batchelder that no family farms have been lost is that the owners of those farms,
in anticipation of the inevitable catastrophe of the Death Tax, have all sold the farm prior
to the train wreck.
In the process of a lifetime of accumulating assets, bought with after tax dollars, and
particularly with regard to farm, range and timberland, many efforts are made by
entrepreneurs to jump through countless hoops to deal with the Death Tax. These
include the purchase of insurance at enormous cost, legal fees for tax attorneys involving
often illogical business plans and formation of complicated trusts, gifts and spin-offs.
This almost always results in there coming a time when, at the end of the day, they see
that it was a hopeless effort. They then conclude that the only course of action is to
liquidate the asset, sell out to the corporate entity, and dissolve the family business.
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That's why there are no private companies of consequence, particularly in manufacturing,
remaining. It's also the reason no family farms have been sold on the courthouse steps.
Innovators and good managers are too prudent to allow their families to be bushwhacked
in their final days, so they salvage what they can by selling out, usually to corporate
interests, and most often to the detriment of the communities and regions which they
have helped develop and nurture. That's why rural America is slowing going away. All
the assets once held privately in the small towns of America have been acquired by the
multinational corporations, which are never exposed to the tax.
The case for death tax repeal has long been established. It is time for the committee to
support legislation which actually ends this unfair and pernicious tax.
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Warren I. Blum
7916 Melrose Avenue, #5
Los Angeles, California 90046
STATEMENT FOR THE RECORD
COMMITTEE ON FINANCE
WASHINGTON, DC 20510
February 6, 2008
Chairman Baucus, Ranking Member Grassley, and members of the Committee;
It is my honor to share my concerns about the death tax, and reasons for repeal:
In the late 1940’s, my mother and father traveled across the country from New
York on their honeymoon to visit Los Angeles. They loved it and decided to
stay. They rented a small storefront and opened a Television store in the front,
and lived in the back. I am told that I was conceived in that small living
quarter.
Eventually, the little store grew into a thriving business selling Televisions and
Stereo equipment. My parents were able to acquire two properties within a
few blocks of the store containing retail and residential space. Later they
bought a house, and then a larger one. In the early 1950’s property in Los
Angeles was much lower and affordable.
I was born, and a few years later, my sister was born. Those happy years for
our family came to an abrupt end when at age 47, my father died of a heart
attack.
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The TV and Stereo business was sold, and under new management closed
down soon thereafter due lack of success. what was left for our family were
the properties that my parents had acquired, which consisted of my parents’
residence, a three unit residential property, and the two commercial properties.
My mother lived in the residence, and the other properties provided her with a
modest income.
After I graduated college and law school, I worked in various business, but
eventually settled on helping my mother to manage the properties. Today we
manage the properties together. My office is in one of the buildings we own, a
block away from where my parents started and from where I was conceived. I
have spent most of my life in this neighborhood. I have seen people come and
go. I see a lot of familiar faces and longtime acquaintances. This
neighborhood is in my blood.
Now, property values have increased significantly to the point where, even
though there are only a few buildings, when my mother passes on, I may be
forced to sell the properties to pay the estate tax. The current exemption
amount will be insufficient to protectus. Not only will I will lose my dear
mother, and my management job, but I may have to move away from the
neighborhood I was born, raised, and worked in, and go somewhere where
property values are lower. This is not a happy prospect.
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I realize that the death tax is the law, but it is an unfair and immoral law. It
confiscates the fruits of a lifetime of hard work by someone like my mother to
pass something on the future generations of our family. It penalizes my mother
for keeping her capital invested, rather than depleting her estate by spending on
luxuries. It discourages sons and daughters from participating in a family
business. F or instance, since I don’t have an ownership interest in the business
yet, the fruits of my labor wn also be subject to the death tax. It also causes
interfamily conflict, as the overwhelming financial burden on the business
caused by the tax makes it difficult to provide a communion of livelihood for
all members of the next generation.
The death tax is now 45%, and in a few years, it is scheduled to go back up to
55%. Because of the cost of money to borrow such a large percentage of our
capital investment value, and the need to pay back principal, it appears that it
would be impossible to keep our family business intact.
I urge you to repeal the death tax immediately.
Thank you for this opportunity to provide a statement.
Warren I. Blum
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NATIONAL CATTLEMEN’s BEEF Associationſ
1301 Arnºogae, NW &ne ºx! - Wºng on DC 2000s 202347.0228. Razzºz.638-0307
March 12, 2008
The Honorable Max Baucus The Honorable Charles Grassley
Chairman Ranking Member
U.S. Senate Finance Committee U.S. Senate Finance Committee
219 Dirksen Senate Office Building 219 Dirksen Senate Office Building
Washington, DC 20510 Washington, DC 20510
Dear Chairman Baucus and Ranking Member Grassley:
The National Cattlemen’s Beef Association (NCBA) appreciates your continuing efforts to
address the immense logistical and financial burden placed upon farmers, ranchers and small
businesses by the current estate tax. We recognize the Finance Committee’s hearing entitled
“Alternatives to the Current Federal Estate Tax System” as a step towards meaningful action on
this important issue, and I appreciate this opportunity to offer our thoughts.
Producer-directed and consumer-focused, NCBA is the largest and oldest organization
representing America’s cattlemen and women, and it is dedicated to preserving and advancing
the beef industry. Tax policy is a key factor impacting American cattle producers, particularly in
today’s difficult business climate. Additionally, the long-term viability of our industry is
dependent upon the ability to pass on a farm or ranch to the next generation without exhausting
resources for arduous planning, or being forced to break apart economically viable operations.
The current tax structure for addressing the transfer of assets at the time of death fails in both of
these regards.
Under current law, farmers and ranchers have no choice but to direct monetary resources to
costly estate planning given that major components of the Death Tax shift from year to year.
Furthermore, the financial worth of farmers and ranchers is rarely derived from liquid assets such
as cash, but rather from the value of their land and equipment. Thus, they are faced with the very
real threat of being forced to break-up and sell-off portions of the operation in order to obtain the
funds necessary to meet liabilities imposed by the Death Tax. It is unacceptable that farming and
ranching families, who have succeeded in building a successful business and who have a sincere
interest in seeing it continue on with the next generation, are burdened in this manner.
It is absolutely essential that any legislative effort to eliminate or reform the Death Tax addresses
these fundamental issues. However, our assessment indicates that replacing the current law with
an inheritance tax will do nothing to remedy these problems. First, the inheritance tax merely
shifts the burden of the tax to the next generation. For families seeking to keep their farm, ranch
or business intact, this will do nothing to preserve or protect the value of the business.

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Secondly, dividing the operation into smaller offerings in order to accommodate the inheritance
structure may not be an option for every producer. If a farmer or rancher wants to pass their
operation along to the next generation and he/she has only one child, the concept of dividing up
the tax liability may not be possible because the value of the business is in the assets. Again, the
inheritance tax would fail to reduce or eliminate the burden relative to the current Death Tax.
In addition, replacing the current tax structure with an inheritance-based mechanism will do
nothing to address the inherent disparity between different sectors with regards to planning for
the tax. Wealthy individuals will continue to be able to pay teams of highly specialized
accountants and planners to help them navigate the new law and evade tax liability; that won't be
the case for small businesses. Instead, farmers and ranchers who have invested in prudent estate
planning will not only be left with a useless estate plan, but they will also be faced with the
challenge and significant cost of planning for a completely new tax,
Cattle producers understand and appreciate the role of taxes in maintaining and improving our
nation, but they also believe that the most effective tax code is a fair one. For this reason, NCBA
members fundamentally disagree with the taxing of assets that have already been taxed,
sometimes two and three times over. In the eyes of American farmers and ranchers, death should
not be a taxable event for either the estate or its heirs.
NCBA members have long been fervent supporters of full and permanent repeal of the Death
Tax. Our commitment to that outcome is unwavering, even though we understand it may not be
politically possible at this time. The reality is that regardless of all political beliefs and
budgetary constraints, the Death Tax continues to be a significant burden to farmers and
ranchers. Therefore, it is with a complete dedication to bringing about meaningful relief for these
families, that we stand ready to work with you to address this issue.
NCBA appreciates the Senate Finance Committee holding this hearing on the “Alternatives to
the Current Federal Estate Tax System.” Congress must take steps to address the challenge
facing cattle producers as they struggle to plan for the transfer of their livelihood from one
generation to the next. It is imperative, however, that as Congress contemplates legislative
action, careful attention be paid to the impacts of various ideas on planning costs and the ability
of farmers and ranchers to meet tax liabilities without dissolving their operations. In applying
these standards to the topic at hand, for the reasons outlined above, NCBA does not support
replacing the estate tax with an inheritance tax. U.S. cattle producers need your leadership to
bring about certainty and relief from the Death Tax, and I look forward to a continuing dialogue
on this important issue.
Sincerely,

(22.2%-4-
Andy Groseta -
President, National Cattlemen's Beef Association
Arizona Cattle Producer
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John R. Woloshen
Owner
RATA Associates, LLC
1916 Boothe Circle
Longwood, FL 32750
Written Statement for the U.S. Senate Finance Committee
Hearing on March 12, 2008
“Alternatives to the Current Federal Estate Tax System”
Chairman Baucus and Members of the Committee: I simply find it hard to believe how
short-sighted some policymakers and interest groups are. The inheritance tax presented
today as an “alternative” to the current death tax will affect no change in the tax burden
experienced by small-businesses such as my own. . -
Any form of death taxation will, without a doubt in my mind, eat up my entire estate
since I own a small but very successful business. Regardless of whether the tax is
applied to my children or to me, the burden of the tax will fall on the business and its 14
employees. When I die, my business will undoubtedly have a tax bill greater than all of
my other assets combined based on the money it generates, even though it is so
specialized that it has a very low, possibly ‘zero’ market value. My two grown children
who have been running it and making it grow for more than 10 years without my help
will not inherit anything and the business will go down the tubes, putting both of them
out of work along with 14 high-paid technical employees.
My business, RATA Associates was founded in 1989 to provide software support for
compliance with certain federal housing regulations. I believed in my ability to make this
business successful, and initially worked 70-80 hours a week to get it going. My effort
was rewarded, as the service turned out to be a profitable niche market and provided
substantial revenue, most of which was reinvested in software improvements. However,
the same boutique specialty that makes the business successful has also made it
effectively worthless as market value is concerned. My main “assets” are the minds of
the employees who understand the complexities of our software, the regulations of the
Home Mortgage Disclosure Act, Fair Lending, and Community Reinvestment Act, and
the proprietary services that we have developed to help banks and lending institutions
achieve compliance with these regulations. As a result, the IRS most likely will value the
business very high based on past and expected future profits, but there is not enough
tangible assets or property which could be sold to raise the cash needed.
An inheritance tax which taxes the individual bequests to my son and daughter, rather
than my estate, would still leave my children in a bind. After taking a small exemption,
perhaps $2 million a piece, they would still be forced to pay over half of the value of the
business in taxes. This could easily come to $10 to $20 million. The only way to pay
this would be to sell the business, or take out a loan that would make running the business
more of a chore than those two bright individuals deserve. In fact, it is likely that the
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highest loan I could take out would be $1 million, which would not be enough to cover
the likely death tax levy.
The federal government will possibly have a short term tax windfall by taking everything
I own and/or forcing the sale of houses and office building at ‘fire sale’ prices to make
them sell quickly. However, in about 5 years time or less, it will have taken in less than it
would have if the business were to keep running and growing, just from the income taxes
paid by my two children and the 14 (possibly more by the time I pass away) employees.
My employees are some of the most intelligent, hard-working and loyal individuals I
have ever known. Many of them have been with me from the start, and they have stuck
with the company through slow periods and rough patches. They do not deserve to have
their employment – and for that matter, retirement — security, thrown into a tail-spin due
to a tax which neither Inor my children will be able to afford.
Honorable Senators, I am very frustrated. I am also somewhat angry that this insidious
tax is still with us when simple ‘COMMON SENSE’ says it should have been repealed
long ago. The IRS has already taken 30-40% of my business’s earnings through the
income tax. Is it too much to ask that my children be allowed to keep running the
business, preserving my employees’ jobs and providing long-term income tax revenue?
I realize that some people think that all businesses possess the liquidity of Bill Gates or
Warren Buffett, and therefore face no serious burden with the death tax. Unfortunately,
this is not the case for me. I cannot set up foundations, hire a legal team specifically for
the purpose of rearranging my assets, or otherwise take advantage of the many benefits
open to individuals such as Gates and Buffett. When I die, absent a repeal or significant
reduction of the existing death tax, my children will definitely be forced to try to sell the
business.
Right now, it seems the prospects for positive legislation are low. I fear we will go into
2010 with a ‘recipe for murder' in place, and come out in 2011 with what we have now
or worse. Members of the Senate Finance Committee, I ask that you prevent this from
happening by supporting legislation to repeal the death tax or substantially reduce its rate.
This is the only appropriate “alternative” to an unfair and destructive tax.
I’m sure that my situation is not unique. There are tens of thousands of small businesses
who face the same problem. This tax is a nightmare for people like me who are trying to
live the American dream. Thank you for your time and for your efforts to deal with this
threat to my livelihood and that of my family. .
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Duane Shumaker
Owner
Schumaker Trucking and Excavating
3501 Havre Hwy
Great Falls, MT 59404
Testimony to the U.S. Senate Finance Committee
“Alternatives to the Current U.S. Estate Tax System”
March 12, 2008
Chairman Baucus, Ranking Member Grassley, and Members of the Committee: I am
honored to present testimony on today’s hearing, “Alternatives to the Current Federal
Estate Tax System”. As a family-business owner, I want to explain why Congress should
repeal, not replace, the federal estate tax, or death tax. Any “alternative” .
which leaves a large confiscatory tax in place will damage, if not destroy, Shumaker
Trucking and Excavating.
Shumaker Trucking and Excavating was born out of the cold war arms race, as the
military needed contractor support for missile silo installation. We were hired by the
military to transport site materials and provide labor for digging and constructing the
silos that would house the ballistic missiles. When we first started, our only assets were a
few dump-trucks and basic construction equipment. Over time, we have grown into a
moderate-sized full-service contractor. We now serve a variety of projects, most of
which are government related. -
Like many family-owned businesses, Shumaker Trucking and Excavating is asset rich but
cash poor. In order to maintain a competitive edge, we plow the majority of our profits
back into the business. We have no mythical slush fund of cash. This family’s American
dream requires constant reinvestment in order to stay afloat.
The result of this lack of cash is that the future obligation of paying the death tax-
currently at a rate of 45% but slated to return to a much higher rate of 55% - would entail
selling of considerable assets in order to raise sufficient cash. We cannot afford to sell
off 10% of our existing assets without the business becoming unsustainable and likely
folding — let alone 55%. Yet this is just what the law would require us to do.
Of course, the IRS in its generosity also extends the option of a 10-year deferred payment
plan. This may be workable for families with liquid assets, but few cash-strapped -
businesses are prepared for an unprofitable tax burden. 10-years of payout to Uncle Sam,
depending on my business’s valuation, could cost more than the business can reasonably
sustain. Even if the business is kept viable, such a loan would certainly hamstring future
growth and could result in payroll cuts to some of my 60-employees.
Like most family business owners, I have taken out life-insurance in order to provide
some liquidity when I die, but it will not be close to enough. The harsh reality is that my
family will face very harsh choices when I die. My wishes are to pass the operation on to
one of my two sons, both of which have shown interest in the business. Of course, they
are too young now to decide their future, but I think it is absolutely unjust that the death
tax could remove this opportunity from consideration.
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I understand that the Senate Finance Committee has heard a panel of witnesses propose
“alternatives” to the death tax, most prominently a proposed “inheritance tax”. Having
read through the panelists’ remarks, I have trouble understanding how this “inheritance
tax” would be any improvement over the current estate tax. -
As explained by panelist Lily Batchelder, the inheritance tax would be designed to fall
more on the heir rather than the deceased. Specifically, heirs would be able to inherit a
certain amount—perhaps $2 million-exempt from the tax. Above that, they would be
subject to the current rate of income tax (35%) plus a “surtax” of 15%. Currently, that
would come to 50%, slightly more than the 2008 death tax rate of 45%. And if Congress
does not make the 2001 tax relief permanent, then the income tax rate will rise to 39.6%,
making the total inheritance tax come to 54.6%, just below the 2011 death tax rate.
Finally, this assumes that stepped-up basis for capital gains is retained, which I’ve been
told Ms. Batchelder wants to eliminate. Without stepped-up basis, the full inheritance tax
burden could come to almost 70%.
The effect of this tax will be to place family-owned enterprises such as mine between a
rock and a hard place. Of course, one option is simply to bequest all of the company’s
ownership to one or both of my sons’ and let them deal with paying 50% of the
company’s value in tax. My prior remarks should make clear why this is not acceptable.
The other option would be to split up the family enterprise between enough heirs that
each receives no more than $2 million of total income. The problem with this is that I
have only 2 sons, and my company is valued well over $4 million. In order to take
advantage of the proposed exemption, I would have to bequest shares of my company to
individuals’ who lack long-term interest in maintaining the business’s viability.
I do understand that Ms. Batchelder has some understandings of how her proposal would
fall on family-owned businesses, and has suggested a sort of “deferral” plan. According
to her, this deferral would allow those who lack liquid assets to defer paying the tax until
they sold the business. Though this may seem benign at first blush, it comes with a host
of complications. First, Ms. Batchelder made it clear that until the tax is paid, interest
would accrue on the amount of deferred tax. This means that the total amount due will
climb even higher than the total rate. Second, it is assumed that the IRS would place a
lien on the property for amount of tax owed as long as it is deferred. I can tell you that it
would be very hard, if not impossible, for my company to continue to grow while
subjected to an IRS lien.
There is no way to “improve” on the death tax. Business owners such as myself will
continue to face harsh decisions about the future of their company as long as it exists.
Some proposals may shift the technical burden on paper, but the final effect will be the
same. Any redistributionist tax will punish those who have worked hard and invested
themselves and their profits in a viable company.
I recommend that the Senate Finance Committee get back to the work of crafting
legislation to permanently and substantially reduce, if not repeal, the existing death tax.
Thank you for hearing my remarks.
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Bill Simkins
Vice-President
Simkins-Hallin
326 North Broadway
Bozeman, MT 59715
Statement for the Record to the:
U.S. Senate Finance Committee
March 12, 2008 hearing
“Alternatives to the Current Federal Estate Tax System”
Chairman Baucus, Ranking Member Grassley, and members of the committee: I am
pleased to present testimony about “Alternatives to the Current Federal Estate Tax
System.” As the Vice-President of a family-owned business in the state of Montana, I
have a particularly strong interest in permanent repeal of the death tax.
Simkins-Hallin was originally started as a lumber yard by my father and grandfather in
1946. In the last 61 years, we have become very successful, employing over 170
individuals and providing considerable economic growth for the local community.
Though lumber remains the primary operation of the business, we also are very invested
in local development. In fact, our current project is development of real estate around the
Big Sky ski resort. A recent economic development study found that big sky is
responsible for $1 billion in Montana’s economy. Our development will help Big Sky
become a premiere vacation spot and will result in increased economic growth and tax
revenues for the state of Montana.
With that in mind, it is hard for me to understand why Congress refuses to repeal the
death tax, a tax that hampers my business’s growth and is going to make it very difficult
to pass it on to the next generation of the family. -
You see, the family business is very “cash poor.” Our capital is in the form of hard assets
such as property, machinery, lumber and payroll. Simkins-Hallin relies upon constant
reinvestment of profits. The management team takes very small salaries in order to plow
the majority of our resources into growing the business. This is common of many
businesses and stands in stark contrast to the fallacy that a $10 million business has $10
million in liquid assets. - -
This lack of cash means that when the principal owners of the company die, the heirs will
be forced to sell existing assets and likely take on expensive loans in order to pay the
55% death tax. It is very possible that we may have to sell the business entirely, rather
than passing it on to the next generation of the family. For Simkins-Hallin, the death tax
is a large and troubling unknown.
In fact, last December my family met to try to find a way to pay for the future death tax
levy. Our options are less than optimal. Unlike billionaires such as Warren Buffett, most
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small business owners do not have the time or money to make use of expensive tax-
planning measures.
We currently are paying for life-insurance, which is already a drain on the business and
will only become increasingly so as the owners become older. Other options include
deferring the tax and taking out large loans. However, we cannot sustain a high amount
of debt and still stay in business over the long term—particularly loans which will not
provide future profits. Honestly, it doesn’t make economic sense that we should have to
waste our precious resources in order to prepare for the death tax. My family left the
December meeting frustrated with lack of a solution to dealing with the death tax.
I am very bothered that Congress thinks replacing the death tax with an inheritance tax
counts as reform. Of course, I would rather that Congress simply repeal the tax. Short of
that, the rate should be substantially reduced. The inheritance tax “alternative” discussed
at the hearing will not effectively change the burden of the death tax for my family or
other family-business owners.
As I understand it, the inheritance tax rate would be equal to, if not larger than, the
current death tax when considered in full. Apparently the tax will allow for an
exemption, likely in the realm of $2 million, for each heir. Unfortunately, our business is
worth considerably more than we have suitable heirs to bequest it. In order to fully take
advantage of the exemption, we would be forced to bequest shares of the business to
relatives who have little interest supporting the long-term growth of the business. As a
result, the exemption would be of little use to us, leaving the family in the same place as
the current death tax.
As for the proposed “deferred payment plan” for family-businesses who lack cash, it is
important to keep in mind that any debt – whether due immediately or far in the future —
comes with immediate consideration, Even assuming we are never to sell the business,
which of course is our hope, a perpetually deferred debt would undoubtedly be secured
with an IRS lien. This would likely hamper the business’s ability to obtain further loans,
which it depends on for development projects such as Big Sky.
Moreover, I understand that interest would accrue on the amount of the tax as long as it is
deferred. Every year my family will face the reality of an even higher tax should they
choose to sell for lack of heirs to run it, or need the cash to deal with an emergency or
start a new business. With all due respect, whoever proposed this idea does not
understand that putting off a future obligation does not make it go away,
Congress should refocus efforts on actually dealing with the tax in a way that takes into
consideration the burdens it places on businesses like Simkins-Hallin. Though the Senate
certainly is within its rights to hear proposals for such concepts as the inheritance tax, it
has little import for family-business owners throughout the nation. We need a real
solution and we need it soon. I respectfully ask that the Senate Finance Committee
quickly draft legislation to repeal or substantially reduce the death tax.
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Comments Submitted to the United States Senate Committee on Finance
Hearing Oft
Alternatives to the Current Federal Estate Tax System
March 25, 2008
Prepared by Paula A. Calimafde Esq.
Chair of the Small Business Council of America
The Small Business Council of America (SBCA) appreciates the opportunity to submit our
comments to the Senate Finance Committee’s March 12, 2008, hearing titled “Alternatives to the
Current Federal Estate Tax System.”
The SBCA is a national nonprofit organization which represents the interests of privately-held
and family-owned businesses on federal tax, health care and employee benefit matters. The
SBCA, through its members, represents well over 20,000 enterprises in retail, manufacturing and
service industries, virtually all of which provide health insurance and retirement plans for their
employees. The SBCA is fortunate to have many of the leading small business advisors in the
country on its Advisory Boards, many of whom are the leading experts in the estate tax law and
how that law impacts small and family-owned businesses. -
Background
The 2001 Tax Act created a legal landscape that makes it impossible for small business owners
and other taxpayers to plan their estates with any predictability. Over the next four years, the
amount exempt from estate taxes will vary from $3.5 million to $1 million and in one year
(2010), the entire estate tax system is repealed! This unpredictability has undermined taxpayer
confidence in the estate tax system. -

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The estate tax system was developed to avoid the problems that occur when a very small elite of
the country is able to amass great wealth and pass this wealth down to the next generation; it was
not intended to cut in half the estates of working Americans who had built up a family business
or a small business based on their own hard work. - -
Estate Tax Certainty and Reform Needed Now for Small Business Owners
Small businesses need certainty in the estate tax area. In order to assist small businesses, the
estate tax exemption should be increased to the $3.5 million dollar level this year – not in 2009.
The SBCA is in favor of reforming the existing estate tax system and does not support repealing
the estate tax law in 2010 and beyond. We believe the following reforms are needed:
Q Increase the estate tax exemption amount immediately to $3.5 million and then
increase it gradually over a number of years until it reaches at least $5 million
and thereafter have it increase by COLA
Q Preserve the step-up in basis at death for simplicity
Ç Reunify the estate and gift tax exemptions, increasing the gift tax exemption to
immediately equal the estate tax exemption, for simplicity and flexibility
{} Exempt retirement plan assets from the estate tax in an amount up to an additional
$1 million if assets are going to a surviving spouse and up to an additional
$500,000 if the assets are going to other heirs
By implementing these steps, small business owners who have worked a lifetime to build their
companies will, in most cases, be exempt from the estate tax system.
The SBCA is opposed to the proposed repeal scheduled to take place in 2010. This is because
total repeal would be accompanied with a loss of the step-up in basis and a continuing $1 million
cap on the gift tax exemption. Unfortunately, many small businesses will actually end up paying
more taxes under the proposed repeal in 2010 than they would with the increased exemption
proposed to be in effect in 2009 because of the loss of the step-up in basis.
To understand the repeal proposal and our pro-Small business reform proposal, there are a few
basic concepts to our estate tax system that should be discussed.
Step-Up in Basis
Under our current estate tax system, any assets that a person receives from another person's
estate receive a “step-up" in basis - this means that the person receiving them gets them with a
tax basis increased to fair market value as of date of death. Thus, when a person decides to sell
the property, he would be taxed on the difference between the sales price and the date of death
fair market value (this gain would be subject to either income tax or capital gains tax depending
upon the asset).
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Upon the full repeal of the estate tax in 2010, the current rule providing for a fair market value
basis in property acquired from a decedent (i.e., the step-up in basis) is repealed. In lieu of this
rule, the recipient of property acquired from a decedent will have basis in such property equal to
the lesser of the decedent's adjusted basis in the property or the property's fair market value at
the time of the decedent's death. However, recipients of property from a decedent will be
entitled to an aggregate basis increase of $1.3 million (adjusted for inflation after 2010). In
addition, the decedent's surviving spouse will be entitled to an additional aggregate basis
increase of $3 million (adjusted for inflation after 2010). Accordingly, if a decedent is survived
by the decedent's spouse and the value of the decedent's estate is $4.3 million, the full amount of
the estate will pass to the spouse free of any estate tax and the surviving spouse will have a
stepped-up basis for the entire estate. If there is no surviving spouse, then only $1.3 million of
assets will receive the step-up in basis.
“Exemption Level" (formerly the "Unified Credit")
Any assets that a person owns up to the estate tax exemption level - $2 million this year, can be
given away at death, free of estate taxes. This is referred to as the estate tax exemption or
exclusion amount and it is scheduled to increase in 2009 to $3.5 million. This means
a couple could leave $7 million to their heirs without the imposition of estate tax and with a step-.
up in basis on the entire $7 million of assets, if they did some basic estate planning. If they did
not do any estate planning, then only $3.5 million would be exempt from estate taxes. Assets in
excess of $3.5 (or with proper estate planning done for a married couple, $7 million) in 2009
would be subject to the maximum estate tax rate of 45%.
In the 2001 Act, Congress was concerned that once the estate tax was repealed, taxpayers would
refocus their efforts on shifting assets to lower income tax bracket taxpayers (such as their
children or grandchildren). Accordingly, Congress capped the gift tax exemption (which had for
a long time been "unified" [or in lockstep] with the estate tax exemption) at $1 million. Thus,
although a person can pass up to $2 million estate tax free today (scheduled to increase to $3.5
million in 2009), only $1 million can be passed during lifetime.
Many estate planners have found that this artificial cap on giving has caused the senior
generation owners of small businesses to not be able to pass ownership of the family business to
the next generation.
Example — Why Making The Law in 2009 Permanent Rather Than Repeal Is
Advantageous for Small Businesses
Assume there is a small business owner who has $3.5 million of assets and no surviving spouse.
Under total repeal: $1.3 million of the assets receive a step-up in basis to the fair
- . - . . market value of those assets at date of death. The remaining $2.2
million of assets will have the basis that the decedent had in those
aSSetS. -
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As an aside, imagine if the decedent were an 85 year old man who
acquired many of these assets more than 40 years ago... how
anyone is even going to be able to figure out the carry over basis of
those assets is beyond us.
The burden is on the heirs to prove any basis, and many will fail to
have enough records, resulting in a zero basis. The step-up in basis
was repealed back in 1976 and was then reinstated in 1980, though
the carry-over rules never became applicable during that period,
because Congress learned from attorneys and accountants who
handled the probate process that the carry-over basis rules were
unworkable because it was almost impossible to determine the
carry-over basis for many assets.
Now when the heirs of this decedent sell this $2.2 million of
assets, they will be subject to income tax on the difference between
the then fair market value of the assets and any basis they can
prove the decedent had in those assets. For example, let's assume
that the heirs are able to prove that the carry-over basis in the
assets is $1 million - then the heirs will be taxed on $1.2 million
(assuming the fair market value of the assets was still $2.2
million).
With a $3.5 million exemption;
All $3.5 million of assets receive a step-up in basis to the $3.5
million level (this is the fair market value of his assets as of his
passing). Now when the heirs sell any of these assets (assuming
the fair market value of the assets was still $3.5 million), there
would be no income tax and no estate tax.
A single person with assets greater than $1.3 million up to $3.5 million is better off under the
estate law as it stands in 2009 and in most cases ends up in a worse tax position under repeal of
the estate tax. Similarly, a decedent who is married with assets greater than $4.3 million up to
$7 million does better under the law as it would stand in 2009 than he/she would under total
repeal. This covers a significant amount of taxpayers based on the data that illustrates how many
taxpayers drop off of the estate tax rolls as the exemption amount increases. Based on data set
forth in a March 16, 2005, issue paper from the Center on Budget and Policy Priorities':
C If the estate tax exemption were $1 million in 2011, then 53,800 estates would be
subject to the estate tax. Of the 53,800 estates that would be taxable, nearly half
' This paper is entitled, "Estate Tax Reform Could Raise Much-Needed Revenue: Some Reform Options
with Low Tax Rates Raise Very Little Revenue” by Joel Friedman and Ruth Carlitz.
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(46%) would have assets of less than $2 million and nearly three-fourths would
be valued at less than $3.5 million.
© If the exemption level in 2011 were $2 million instead of $1 million, then the
number of taxable estates would shrink to 21,000. This is a reduction of 61% in
the number of estates that would face the estate tax.
§ If the exemption amount in 2011 were $3.5 million instead of $2 million, then the
number of taxable estates would drop to 8,500 (84% of the estates would be
exempt compared to the number that would have been subject to estate tax if the
exemption amount were $1 million in 2011).
These numbers demonstrate how many small business owners would be worse off under total
repeal than if the law were frozen at 2009 (with the $3.5 million exemption and the step-up in
basis). Unfortunately, many small businesses owners do not understand the negative impact of
repeal because they do not understand the carry over basis and the ultimate imposition of income
tax on those assets which do not receive a step up in basis.
If the SBCA represented the interests of the wealthiest individuals in America, our suggestions
would be entirely different. We would not suggest increasing the exemption amount because
when one’s estate is a billion dollars it does not matter at all if the exemption amount if $1
million or $3.5 million – the impact is negligible. What does matter is the tax rate. Thus, a tax
rate of 45% is incredibly significant when a billion dollars is involved. Contrast this to the small
business owner whose entire estate is $3.8 million. If the exemption amount is a $1 million or
$3.5 will make a huge difference to the heirs and an estate tax rate of 45% on $300,000 does not
appear to be overwhelming. A recent CRS Report (“Estate and Gift Tax Revenues: Past and
Projected in 2008, March 19, 2008”), set forth the following query: “What explains the
persistence of revenues despite a dramatic drop in the number of taxable estates?” The answer
#S. -
While large in number, the smallest estates as a group contributed relatively
little in estate taxes. Although the two lowest gross estate size classes
accounted for 33,179 or 64% of the 51,736 taxable returns filed in 2001, they
contributed only $2.7 billion or 11% of the $23.5 billion in estate taxes paid.
The large decrease in the total number of taxable returns between 2001 and
2005 can be explained by the elimination from taxability of the large number
of estates in the two lowest gross estate size categories (under $1 million and
$1 million up to $1.5 million) after the prevailing exemption rose to $1
million in filing year 2003. There was a further large decrease in the number
of taxable returns in the $1 million to $1.5 million category and a smaller
decrease in the $1.5 million to $2 million category in filing year 2005, when
the prevailing exemption rose to $1.5 million.
Between 2004 and 2005, the $1.4 billion loss in estate taxes paid by these
two smallest size classes plus a $0.7 billion loss in the $2 million to $3.5
million gross estate size class, was more than offset by the $2.1 billion
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increase in taxes collected from the largest size class, with gross estates of
$20 million or more. (at p. 10)
For years the SBCA has tried to come up with an effective reduction in tax rates for small
business and we have not been successful. When one takes into accounts that among our
advisory boards and board of directors, we have many of the leading estate planning advisors in
the country for small business and we have been unable to come up with an effective exclusion,
our guess is that none exists that will a) work correctly and b) not be subject to abuse.
We know that such an exemption should not bear any resemblance to the Qualified Family
Owned Business Interest (QFOBI) exemption that came into law a few years back (and would
spring back into existence in 2011, if the law is not changed). This rule was not only absurdly
complicated, but suffered from the most severe planning defect - a business owner would not be
able to know if he qualified for the exemption until death occurred.
Promote Retirement Savings
The SBCA believes that giving an exemption for up to $1 million in retirement plan assets that
are left to a surviving spouse and up to $500,000 for retirement plan assets that are left to others
would go a long way towards promoting retirement plan savings by small business owners and
others. This estate tax exemption on retirement plan assets is also important because these assets
can be subject to estate tax and income tax when distributed to the deceased plan participant's
beneficiary. Currently, the incentive for contributing money to a retirement plan (and thereby
locking it up until retirement) is being diminished by the lower tax rates on capital gains and
dividends that do not apply to funds coming out of a retirement plan.
Example of the Small Business Nightmare under the Current Federal Estate Tax
Landscape
Imagine Mr. Entrepreneur is the sole proprietor of a small business, Innovative Inc., which,
together with his home, totals $3.5 million in assets. Mr. Entrepreneur’s wife has passed away
and his single heir is his daughter, who may or may not want to take over the business, once her
father passes away. Mr. Entrepreneur wants to provide the best that he can for his daughter, Ms.
Smart, upon his passing and he is currently seeking out the best plan. Unfortunately, in the
current federal estate tax landscape, the next 4 years are almost too volatile to do any planning
unless he was able to decide what year to die!
Let’s say that Mr. Entrepreneur’s assets will be valued the following way upon his death:

ASSet Decedent’s Basis Fair Market Value at Death
Innovative Inc. $100,000 $2,600,000
Residence $500,000 $900,000
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Without Congress Acting:
If Mr. Entrepreneur were to pass away in the next five years, the following will occur:
• In 2008, Ms. Smart would owe $675,000 in federal estate tax.
• In 2009, (when the exemption level is $3.5 million), Ms. Smart will owe no federal estate
tax.
• In 2010, the federal estate tax will have been repealed and the step-up in basis is
significantly changed. Ms. Smart will have the burden to find the documentation of her
father's basis in his property (which could have been purchased decades ago). In 2010,
the law provides that Ms. Smart will receive $1.3 million in assets with a stepped-up
basis to fair market value. The remaining $2.2 million in assets will have the same basis
that her father had in those assets. Assuming Ms. Smart were to allocate all of the step-
up basis to Innovative, Inc. and a capital gains tax of 15%, Ms. Smart would pay
$255,000 in capital gains tax, if she chose to sell the business and the house. That is
$195,000 for Innovative Corp (15% of $2.6 million minus the $1.3 million in step-up
basis and $60,000 for the residence (15% of $900,000 minus $500,000), Depending on
what documentation can be provided, Ms. Smart can pay as much as $330,000 (15% of
$2.2 million) or as low as $255,000. Note that these taxes will not be due until Ms.
Smart chooses to sell the house and the business. º
• In 2011, the federal estate tax will be $1,220,000, because the exemption reappears at $1
million, which, in effect, would be devastating for Ms. Smart since she could not even
cover the cost by selling the residence so she would be forced to sell all or a portion of
the business, even if she wanted to keep running it. It is possible that some portion of the
$1,220,000 will be paid to a state government depending upon the state's estate tax law.
How can Mr. Entrepreneur plan properly for an estate tax which in the next 4 years can
fluctuate between zero and over a million dollars on a relatively modest estate!
With Congress Acting:
If Congress enacts a $3.5 million exemption immediately, all of Mr. Entrepreneur’s assets would
receive a step-up in basis of $3.5 million, assuring that there would be no federal estate tax and
no income tax. If Congress reunited the estate and gift tax systems, Mr. Entrepreneur could gift
his business to his daughter during his lifetime, if that made business sense. Furthermore, if a
gradual increase to $5 million exemption were enacted, Mr. Entrepreneur would not be
disincentivized to grow his business which in turn would keep our economy growing. In effect,
Congress would have repealed the federal estate tax for Mr. Entrepreneur and most other small
business owners who were never intended to be punished for their hard work.
Recommendation
To protect small business owners, Congress should increase the exemption amount immediately
up to $3.5 million and then increasing the exemption amount over the next several years, retain
the step-up in basis and reunify the gift and estate tax exemptions. Retirement plan assets
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should be exempt from the estate tax in an amount up to an additional $1 million if assets are
going to a surviving spouse and up to an additional $500,000 if the assets are going to other heirs
By enactment of these reforms, most small businesses will be removed from the reach of the
eState tax.
Ms. Calimafde is the current Chair, past President and a member of the Board of Directors of the Small
Business Council of America, Inc., the only national non-profit organization which has represented the
interests of privately owned businesses exclusively in the Federal tax, retirement, health care and employee
benefits areas for the past twenty-five years. She received her B.A. from Swarthmore College and her J.D.
from Catholic University. - . - -
She is a partner in the Bethesda, Maryland law firm, Paley Rothman, where she chairs the firm's Retirement
Plans Practice Area and the Employee Benefits Practice Area. Ms. Calimafde has nearly 30 years of
experience advising small businesses and closely held businesses in tax areas and estate planning. Fornearly
30 years, she has been a legislative advocate for small and closely held businesses in the Federal tax, health
care and employee benefits arena. -
In 1986, Ms. Calimafde was elected at the Maryland State Conference to serve as a delegate to the White
House Conference on Small Business. She was subsequently appointed by the White House Conference to
serve as one of eleven National Commissioners of the 1986 White House Conference on Small Business. As
such, she chaired the Payroll Costs Session at the National Conference, which covered qualified retirement
plans, employee benefits and social security, among other issues. In 1995, Ms. Calimafde was appointed by
the White House to serve as a Presidential Delegate at the 1995 White House Conference on Small Business.
She is also a member of the Board of Directors of the Small Business Legislative Council (1992–), Past Chair
(1988-1990) and Vice Chair (1986-1988) of the Closely Held Committee of the ABA Tax Section, Advisory
Board of the Journal of S Corporation Taxation, 1989–1994, Employee Benefits Council, Chamber of
Commerce of the United States, 1986-1994, 1996-, and Small Business Council of the U. S. Chamber,
1995-1998 and the Washington, D.C. Estate Planning Council, 1994–. She is a fellow of the American
College of Tax Counsel, the American College of Trust and Estate Counsel and a charter fellow of the
American College of Employee Benefits Counsel.
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