April 21, 1997

Estate Tax Cuts Would Benefit Wealthiest Americans;
Targeted Family Businesses and Farms Changes Could Help

by Iris J. Lav


Advocates of proposals to repeal or sharply scale back the estate tax often cite the problems families encounter when they inherit small businesses and farms but lack sufficient liquid assets to pay the tax. To the extent these problems exist, they account for an extremely small portion of all estates subject to estate taxes. The problems of small, family-owned businesses and farms can be addressed at a modest cost to the Treasury.

By contrast, the estate tax provisions in the Senate Republican Leadership tax plan would reduce the estate tax for large estates and for large family-owned business. The proposals go well beyond the measures needed to preserve small family businesses and farms. The revenue loss would also be large, rising to $12 billion a year by 2007.

Estate taxes play an important role in the U.S. tax system. Because they are paid only on 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 such gains are subject to tax at all is through the estate tax. If estate taxes are reduced in large-scale ways that extend beyond providing targeted relief to small family-owned businesses and farms, that would provide a windfall to the wealthiest taxpayers in the country.

A particularly stark contrast is drawn by including a costly estate tax reduction that benefits large estates in an agreement to reduce the deficit and balance the budget. The cost of the estate tax reduction would have to be paid for by increasing the amount by which the budget is cut. Thus a large estate tax cut benefiting the wealthiest Americans is likely to be paid for through sharp reductions in programs that benefit low- and middle-income households who will never amass estates large enough to be subject to taxation.


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.


Modest Changes Could Target Additional Relief to Small Businesses and Farms

Additional estate tax relief could be targeted to small, family-owned businesses and farms.


Senate Leadership Proposal Very Costly;
Benefits Accrue Primarily to Very Large Estates

By contrast, the estate tax proposal included in the Senate Republican Leadership tax plan (S. 2), introduced by Senator Trent Lott and others, would be very costly and would provide substantial benefits to the largest family-owned companies in the country.


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 lifetime of the decedent.

The federal revenue loss in fiscal year 1997 from not taxing these capital gains is variously estimated by the Treasury Department to be $31 billion and by the Joint Committee on Taxation to be $17 billion.1 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 resulting from the fact that most of the untaxed capital income is held by the highest-income Americans.


States would lose revenues at time of increased responsibilities

All states levy their own estate tax by computing a percentage of the federal estate tax liability. Under special federal rules, estates may subtract the state taxes paid, dollar for dollar, from federal estate taxes that otherwise would be due, up to a specified maximum percentage of the federal taxes. In other words, the heirs have the same amount of overall tax liability whether or not their state levies an estate tax; the state tax does not change the total amount of estate taxes collected but rather allows the state to share in a portion of the federal revenue. Every state uses this type of state estate tax, which is commonly known as the "pick-up" tax.

End Notes

1. 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 is not collected on the original price of those assets. Moreover, no information need be filed on assets held by decedents with estates below the $600,000 estate tax filing threshold. The lack of underlying data may account for the wide variation in estimates of revenue loss.