Revised July 20, 1999

Eliminating The Estate Tax:
A Costly Benefit For The Wealthiest Americans

by Iris J. Lav

Advocates of proposals to repeal or sharply scale back the estate tax often say such proposals are necessary to address problems that families encounter when they inherit small businesses and farms but lack sufficient liquid assets to pay the tax. There are two problems with this argument. First, only a very small fraction of the estate tax is paid on small family businesses. The overwhelming bulk of the large tax-cut benefits that would result from sharply reducing or eliminating the estate tax would go to wealthy individuals who are not owners of small family businesses or farms.

Second, several provisions of the tax-cut legislation enacted in 1997 already are reducing estate taxes on small family businesses and farms. In addition to increasing the amount of any estate that is exempt from the estate tax to $1 million, the 1997 law increased exemptions and special-payment provisions for family-owned enterprises. To the extent that problems may remain in the taxation of small family-owned businesses and farms under the estate tax, those problems could be specifically identified and addressed at a modest cost to the Treasury.

By contrast, elimination of the estate tax — a proposal that Rep. Bill Archer, the Chairman of the House Ways and Means Committee, has said will be part of his forthcoming tax proposal — would provide huge windfalls to a small number of the nation's wealthiest residents at a large cost to the Treasury. An analysis by the Institute for Taxation and Economic Policy finds that 91 percent of the benefits of eliminating the estate tax would go to the highest-income one percent of taxpayers, a group with incomes exceeding $300,000 a year.

And the cost of eliminating the entire estate tax would be large. Over the next 10 years, the estate tax is expected to raise approximately $330 billion. Although the Archer proposal likely will call for a gradual phase-out of the estate tax rather than its immediate elimination, the ultimate revenue loss would be on the order of $330 billion over 10 years.

It also should be noted that estate taxes play an important role in the U.S. tax system. Because they are paid only on the estates left by the less-than-two percent of decedents with the greatest wealth, these taxes add progressivity to federal and state tax systems. In addition, the estate tax compensates in part for a major gap in the taxation of capital gains income. The gain in the value of assets held until death is not subject to the capital gains tax; the only way the income from such gains are subject to tax at all is through the estate tax.


Most Estate Taxes Are Paid by Large Estates

Most estate taxes are paid by large estates rather than by small family-owned farms and businesses.


Smaller Estates Subject to Tax Generally Have Resources to Pay Obligations


Smaller, Family-Owned Business Already Eligible for Favorable Treatment

Family-owned businesses and farms already are eligible for special treatment under current law.


Estate Taxes Improve Progressivity; Offset Capital Gains Loophole

In the U.S. tax system, capital gains income — the income from the appreciation of assets such as stocks, bonds, and real estate — is not taxed until the income is "realized" — that is, until the assets are sold. If an asset is held until the owner dies, the gain in the value of the asset is never subject to capital gains taxation. The heirs inherit the assets valued at the market price at the time of death and are not required to pay tax on any appreciation that took place during the life of the decedent.

The federal revenue loss in fiscal year 1999 from not taxing these capital gains at death is estimated by the Treasury Department to be $26 billion and by the Joint Committee on Taxation to be $19 billion.(3) The estate tax provides a way of recouping a portion of the loss of revenue that results from forgiving capital gains at death. The estate tax also provides a means to redress the loss of tax equity that results from the fact that most of the untaxed capital income is held by the highest-income Americans.

End Notes:

1. Joint Committee on Taxation, Present Law and Background on Federal Tax Provisions Relating to Retirement Savings Incentives, Health and Long-Term Care, and Estate and Gift Taxes (JCX-29-99), June 15, 1999.

2. Internal Revenue Service, SOI Bulletin, Winter 1996-97.

3. There is very little information collected on which to base an estimate of the revenue loss resulting from exempting capital gains income from taxation when the asset is held until death. While the amount of assets included in estates large enough to file estate tax returns is known, data are not collected on the original price of those assets. Moreover, no information need be filed on assets held by decedents with estates below the $650,000 estate-tax filing threshold. The lack of underlying data may account for the wide variation in estimates of revenue loss.

4. In addition, revenue collections likely would be somewhat lower. Estimates of the 1999 revenue loss from the failure to tax capital gains at death range from $19 billion to $26 billion, while the estate tax is expected to raise $28 billion.