What's the purpose of an estate tax? Is it a budget booster or social engineering mechanism? Why, in recent times, has the debate over the size or existence of this levy become more intense?
President George W. Bush and the Republican leadership in Congress, as well as anti-tax advocates such as influential lobbyist Grover Norquist, have turned the disparagement “death tax” into a rallying cry for outright repeal. At the same time some of the wealthiest individuals in the country are pressing to retain the estate tax. What will its fate be?
Some answers lie in the history of this tax.
The imposition of a levy at death is far from new. We are told that when the Emperor Augustus decided to establish a permanent military force to defend ancient Rome against its enemies, he found that customs duties collected from the importation of goods proved inadequate to fund the affairs of state and, at the same time, pay soldiers, reward veterans and defray the costs of war. (Sound familiar?) The shortfall was covered when the Roman Senate enacted a 5 percent tax on legacies and inheritances, with a limitation on the minimum value subject to tax and an exemption from the tax for the nearest of kin on the father's side.1
Fast forward 1,000 years to England in the Middle Ages. There, we find the feudal incident of relief — a charge that an heir had to pay to be able to succeed to the lands of his ancestor. The ability to inherit land after the payment of relief began with the king's tenants-in-chief, who generally held their estates through knight service.2 Only later did relief spread to other types of feudal tenancies.
Clearly, a levy at death was intended solely as a revenue raiser. There is nothing to indicate that the Romans or English had any notion of a redistribution of wealth when these payments were put into place. Indeed, here in the United States, the call for additional revenue in time of conflict served as the original impetus for the first estate taxes imposed by Congress in 1797. The law to impose a tax on transfers at death was part of a stamp tax act designed to raise funds necessary to cope with the undeclared naval war with France. (History buffs will recall the “XYZ Affair.”) The tax was progressive: 25 cents for any legacy or distribution in intestacy of more than $50 but less than $100; an additional 50 cents for the next $400; and an additional sum of $1 for every additional $500. An exemption was provided in the case of any legacy or intestate distribution left to, or divided among, the wife (might this be the precursor of the marital deduction?), children or grandchildren of the decedent. After hostilities with France subsided, this estate tax was repealed in 1802.
Armed conflict visited the young nation again in the War of 1812. Unlike the crisis between France and the United States, this war involved forays by American troops into Canada and attacks by the British against U.S. positions. In short, it was more urgent, being so close to home. Yet, there was no legislation to increase revenues to defray the cost of the war through the imposition of a stamp tax or similar levy on legacies and distributions. One was proposed, but there must have been enough revenue on hand: No action was taken after the cessation of hostilities and the signing of the Treaty of Ghent, which ended the war.
The Civil War sparked a new need for the federal government to obtain additional funds. Thus, the United States' second estate tax was born. In 1862, Congress adopted a tax law that included a levy on legacies and distributive shares of personal property; there was no tax imposed on real property. Unlike the 1797 legislation in which the tax was based on the size of the decedent's estate, the 1862 tax was more of an inheritance tax, with the amount of the tax dependent upon the relationship of the legatee or distributee to the decedent. The lowest rate of 75 cents for each $100 of value was prescribed for interests passing to the lineal issue, lineal ancestors, and brothers and sisters of the decedent. The rate increased in four steps to $5 for each $100 of value where the legatee or distributee was related to the decedent more remotely than a great-uncle or great-aunt or a descendant of such a relative, was not a blood relative, or was a corporation or governmental body. No tax was imposed unless the total estate exceeded $1,000. Property passing to a surviving spouse was exempt from tax. The 1862 legislation marked the entry into the tax system of a form of estate-tax return, requiring the executor or administrator to file a verified statement or schedule of the assets and people receiving property interests, and to pay the tax due before any distribution of property from the estate. A penalty was assessed if the personal representative refused or neglected to file the necessary papers or pay the tax. The inheritance-type tax was not the only burden imposed; there was also a graduated stamp tax, with a rate that reached $20 for estates of $150,000, plus another $10 for each $50,000 or fraction thereof over that amount.
THE GIFT TAX IS BORN
Two years later, still more revenue was required to support Union forces in the battle against the Confederacy. This need led to an increase in the rates of tax — the lowest rate was set at $1 for every $100 of value, the highest at $6 for every $100 of value. Perhaps of greater importance than the rate increase was the imposition of a tax on real property at the same rates as those placed on personal property. The applicable rate again depended on the beneficiary's relationship to the decedent. Moreover, any transfer of real property for less than a valuable or adequate consideration during the life of the owner also was subject to tax — marking the nation's first gift tax. Real property received by a surviving spouse was not exempt from the tax in the original enactment, although this oversight was cured by a retroactive amendment passed the following year. The yield of the tax was not great. Only $543,000 was raised in 1865, at a time when a similar tax in Great Britain produced $11 million.3 By 1869, the year's revenue from the tax exceeded $3 million. The tax on both real and personal property was repealed one year later when war funds were no longer needed.
Almost a quarter of a century passed before there was any legislation that placed a tax on inherited property. Only this time, the Act of 1894 treated the receipt of property from a decedent as an item of income subject to a tax of 2 percent on yearly gains greater than $4,000 “or from any source whatever” — the catchall phrase still found in modified form in Section 61(a) of the Internal Revenue Code. This wording meant that the levy was imposed upon the beneficiary, not the decedent's estate. The statute fell the following year, as a result of the landmark decision in Pollock v. Farmers' Loan & Trust Co.,4 invalidating the tax as imposed on rents from real property.
Three years later, the Spanish-American War prompted a return to a tax at death for legacies and inheritances of personal property. No tax was imposed if the decedent died with less than $10,000 of personal property, or if the property passed to a surviving spouse or to charity. Congress did not reinvent the wheel when determining the tax rates. It used the same relationship scheme that appeared in the 1862 and 1864 revenue acts — and even used the same rates for the first $15,000 of property to which the tax applied. For estates containing more than $25,000 of personal property, the tax was increased in four stages by multiples of the rates applicable to the first $15,000. The tax was repealed in 1902.
The concept of an estate or inheritance tax as a means of wealth redistribution began to take hold in the latter part of the 19th century. Joseph Pulitzer, publisher of the daily newspaper New York World, called for help for the “downtrodden man” through taxation of luxuries, inheritances, large incomes and monopolies.5 Andrew Carnegie, the wealthy industrialist and benefactor (and, some say, robber baron), spoke in favor of a confiscatory inheritance tax, with a reasonable allowance for dependents, to force the wealthy to use their resources for beneficial causes during their lives.6 He cast aside claims that such a tax would impede the incentive to amass wealth. Rather, he said, the ambition to accumulate great wealth would be replaced by a nobler ambition to have large sums paid over to the government in the form of the tax.7
Passage of the revenue acts to bankroll the naval conflict with France and the Civil War did not evoke much in the way of comment from politicians. This silence was broken during the debate over the bill to finance the Spanish-American War. Populists saw an inheritance tax as a levy on the wealthy who did not pay their fair share of the burden of government.8 Conservative senators Henry Cabot Lodge of Massachu-setts and Steven Elkins of West Virginia led an attack on the measure, claiming the tax would destroy businesses by requiring the liquidation of assets and kill the incentive to accumulate wealth.9 Are today's “death tax” critics taking their arguments straight out of the history books? Or is it simply that nothing is new under the sun?
In 1906, Theodore Roosevelt — a Republican president turned populist, at least with respect to taxation — suggested adopting a graduated inheritance tax and graduated income tax, both to promote a more equitable distribution of the burden of supporting the government.10 Nothing came of his proposition.
Then a new need for additional revenue arose in 1914. Skirmishes along the Mexican border increased military expenditures. The Germans were waging submarine warfare that included the sinking of the Lusitania in 1915. World War I was underway, although American entry into the conflict was still two years in the future. Appropriations for the Army and Navy jumped dramatically. Ratification of the 16th Amendment led to the enactment of the modern income tax. The next logical step was a new levy at death.
Passage of the Revenue Act of 1916 introduced the nation to the modern federal estate tax, one based on the value of the net estate without regard to the relationship of the beneficiaries to the decedent. Inheritance taxation based on the shares passing to beneficiaries and distributees was left to the states. The rates of tax ranged from one percent for estates of less than $50,000 to 10 percent for estates of more than $5 million. These rates were increased in each of the next two years, as the United States became more deeply involved in the “Great War.”
Even with the estate tax, taxpayers who planned carefully could avoid the full impact of the levy by making lifetime gifts. There was no gift tax until 1924, and that one only lasted two years. Although a permanent tax on transfers during life was reintroduced in 1932, the stated rates were less than the estate tax rates until 1976 when the unified transfer tax structure was enacted.
While the rates have changed over the years, reaching a high of 77 percent for estates over $10 million for a time before 1976, the basic concept of the tax as one levied on the net estate of the decedent has not. There have been structural changes, the most important (prior to 2001) being the marital deduction enacted to align the taxation of the estates of those living in common law property jurisdictions with individuals residing in community property states.
The Bush administration came to power in 2001. A Republican-controlled Congress, eager to help a Republican president make good on his campaign promise to abolish the “death tax,” voted to decrease the rates and increase the exemption amount from 2002 through 2009, then abolish the tax. For reasons that were procedurally and politically based, the legislature was prevented from enacting a permanent repeal of the estate tax; the tax leaves the scene for one year in 2010 and then is resurrected in its pre-2002 format in 2011.
The tax's contribution to the federal treasury is minimal, today accounting for roughly 1 percent of the total tax collected from all sources in a given year. The number of people affected by the tax is relatively small; the number of taxable estate tax returns filed during the last 20 years amounts to less than two percent of the number of deaths. Leona Helmsley told us that “only little people pay taxes,”11 but that is not true with the federal estate tax. When translated into an exclusion amount, the unified credit eliminates the tax for most people.12
So why does the estate tax engender such resentment, even by the “little people?”13 One commentator suggests that some people hold onto the hope that they might strike it rich — perhaps by guessing the correct numbers in the lottery — and do not want the government to claim a large slice of their winnings; others, through ignorance, may not realize how few decedents pay a substantial estate tax.14 Treasury Department figures for 1999 show that only the top 2 percent of estates paid any tax at all, that 25 percent of total federal estate tax revenue came from just 467 estates valued at more than $20 million each, while more than one-half of the federal estate tax revenue was paid by 3,300 estates (0.16 percent of the total), with a minimum value of $5 million and an average value of $17 million.15
Some politicians in favor of repeal (read, Republicans in general) allege that they are motivated to help the middle class — those owners of small businesses and family farms who claim that the estate tax makes it costly or impossible to pass on the business or farms to their descendants.16 But the evidence suggests that, at least with respect to the family business or family farm, no one has been forced to sell to raise the money to pay the tax.17 Nevertheless, the Republican leadership continues to push repeal of the tax to retain the American heritage of families working, creating wealth and building businesses.18
If the supposed rationale for repeal does not ring true, then there must be some other reason for the urge to repeal. How about those good old standbys — fairness and morality — two grounds suggested by Republicans as the basis for repeal?19 In 2003, Representative Earl Pomeroy, Democrat of North Dakota, introduced a bill that would have raised the value of exempted assets to $3 million for an individual and $6 million for a married couple beginning in 2004. Pomeroy said his bill would eliminate the tax on 99.65 percent of all estates, including all but 400 farms.20 This proposal would seem to be the epitome of fairness and even morality. Only the super-rich would be subject to the tax. The incentive to work hard and accumulate wealth would remain for most individuals — the middle class business owners, farmers and the “little people.” Nonetheless, the bill was defeated on the House floor.
The average person's estate consists of property originally purchased with earnings from employment. There is a certain ring to the protest about being “taxed twice.” But for many, wealth does not come from taxable compensation. For still others, the increase in their estates is the result of capital appreciation that may never be subject to income tax, because of the rules prescribing a step-up in basis for property held at death. Why do some of these people, such as Bill Gates, Sr., Warren Buffet and George Soros, all of whom clearly would benefit from estate tax repeal, speak out against it?
The answer has to be social conscience, an awareness of the ever-widening gap between rich and poor in this country and a desire to level the playing field economically. But there may be something more.
Andrew Carnegie's confiscatory tax plan was premised on the notion that each generation should start anew and that inheritance promoted laziness. Carnegie did not reach this conclusion on the basis of any empirical evidence; it was merely his conjecture. Yet, his notion has been borne out by hard evidence. A 1993 study shows that families with one or two earners who received inheritances in excess of $150,000 were about three times more likely to stop participating in the labor force than families with inheritances of less than $25,000.21 Put differently, Warren Buffet portrayed repeal of the estate tax as the economic equivalent of “choosing the 2020 Olympic team by picking the eldest sons of the gold medal winners in the 2000 Olympics.”22
Clearly, public opinion favors repeal, but is it rationally based or the product of propaganda? All of the facts lead to the conclusion that the tax has no impact on most Americans and that its absence may lead to a loss of productivity. Maybe the urge to repeal has nothing to do with the estate tax itself, but rather is part of a notion held by many that Americans pay too much in the way of taxes in general.
But talk of fairness is probably moot right now. The United States is facing mounting deficits — including the cost of maintaining troops in Afghanistan, fighting a guerrilla war in Iraq and rooting out terrorists around the world. History has shown that whenever our country needed additional revenue Congress looked to the estate tax to do its part, however small. The rational approach would be to retain the estate tax. But rhetoric and politics may so overwhelm reason that the push to repeal could very well prevail.
Note: The author thanks Jeremy Alexander, Syracuse University College of Law, Class of 2004, for his invaluable research assistance in the preparation of this article.
- Edward Gibbon, The Decline and Fall of the Roman Empire, pp. 141-142. The Romans were not the first to impose a tax on property transfers at death. Records indicate that such a tax existed in Egypt as early as 117 B.C. William J. Shultz, The Taxation of Inheritance, p. 3 (1926).
- Theodore F. P. Plucknett, A Concise History of the Common Law, pp. 523-524 (5th ed. 1956).
- Randolph E. Paul, Taxation in the United States, p. 17 (1954).
- 157 U.S. 429 (1895).
- Randolph E. Paul, note 3, at 30.
- Andrew Carnegie, The Gospel of Wealth, p. 11.
- Ibid, p. 12.
- Barry W. Johnson and Martha Britton Eller's essay, “Federal Taxation of Inheritance and Wealth Transfers,” in Inheritance and Wealth in America, p. 69, Robert K. Miller, Jr. and Stephen J. McNamee, eds. (1998).
- Randolph E. Paul, note 3, pp. 66-67.
- Randolph E. Paul, note 3, p. 89.
- Jeffrey A. Yablon, “As Certain as Death — Quotations About Taxes,” 86 Tax Notes 231, 266 (2000).
- Presently, the exclusion amount is set at $1.5 million for 2004 and 2005, $2 million for 2006, 2007 and 2008, and $3.5 million for 2009. Internal Revenue Code Section 2010(c).
- A Gallup poll in June 2002 revealed that 60 percent of respondents supported repeal. Steven Greenhouse, “Soaking the Rich Isn't What it Used to Be,” The New York Times (July 16, 2000), Section 4, p. 5.
- Eric Ratkowski, “Transferring Wealth Liberally,” 51 Tax L. Rev. 419, 424-425 (1996). A survey sponsored by the Kaiser Foundation found that half of the respondents thought that most families are subject to the estate tax. Alan B. Krueger, “Cloudy Thinking on Tax Cuts,” The New York Times (Oct.16, 2003), p. C2.
- Paul Krugman, “For Richer,” The New York Times (Oct. 20, 2002) Section 6, p. 62.
- Richard W. Stevenson, “House Approves a Bill to Repeal the Estate Tax,” The New York Times (June 10, 2002), Section A, p. 1.
- Paul Krugman, endnote 15.
- David Firestone, “House Votes to End Federal Estate Tax as Senate Battle Looms,” The New York Times (June 19, 2003), Section A, p. 18.
- Richard W. Stevenson, note 16.
- David Firestone, endnote 18.
- Douglas Holtz-Eakin, David Joulfaian and Harvey S. Rosen, “The Carnegie Conjecture: Some Empirical Evidence,” 108 Quarterly Journal of Econ. 413, 432 (1993).
- Elizabeth Allen, “Saving the homestead; Reviled estate tax actually has some supporters,” San Antonio Express-News (Sept. 3, 2003), p. 1E.