Death and Taxes, Slightly Less Certain

The second chapter of SuperFreakonomics, which is primarily about catching terrorists and running an emergency room, includes a few passages about the timing quirks of births and deaths. The birth quirks include the “Ramadan effect” analyzed by Douglas Almond and Bhashkar Mazumder; one death quirk we note concerns the U.S. estate tax:

Holding off death by even a single day can sometimes be worth millions of dollars. Consider the estate tax, which is imposed on the taxable estate of a person upon his or her death. In the United States, the rate in recent years was 45 percent, with an exemption for the first $2 million. In 2009, however, the exemption jumped to $3.5 million — which meant that the heirs of a rich, dying parent had about 1.5 million reasons to console themselves if said parent died on the first day of 2009 rather than the last day of 2008. With this incentive, it’s not hard to imagine such heirs giving their parent the best medical care money could buy, at least through the end of the year. Indeed, two Australian scholars found that when their nation abolished its inheritance tax in 1979, a disproportionately high number of people died in the week after the abolition as compared with the week before.

For a time, it looked as if the U.S. estate tax would be temporarily abolished for one year, in 2010. (This was the product of a bipartisan hissy fit in Washington, which, as of this writing, appears to have been resolved.) If the tax had been suspended, a parent worth $100 million who died in 2010 could have passed along all $100 million to his or her heirs. But, with a scheduled resumption of the tax in 2011, such heirs would have surrendered more than $40 million if their parent had the temerity to die even one day too late. Perhaps the bickering politicians decided to smooth out the tax law when they realized how many assisted suicides they might have been responsible for during the waning weeks of 2010.

We may have to amend the second paragraph in future editions, for according to an article in today’s Times by Carl Hulse, that hissy fit hasn’t been resolved, at least not yet. As of today, it appears that 2010 may indeed be an untaxed year (just in time for the N.F.L.’s uncapped season?). Here’s how one politician puts it:

“If you are at the checkout counter, you might want to expedite things,” said Representative Richard E. Neal, the Massachusetts Democrat who heads the House subcommittee on taxation.

Others are less funny:

“If you are rich, celebrate,” said Senator Harry Reid, Democrat of Nevada and the majority leader. “If you are not, you should be afraid.”

As Hulse writes, it is very unlikely that Congress will make an estate-tax deal by the year-end deadline; but he also makes clear that, as with most Washington deadlines, the deadline isn’t quite real:

Democrats hope to make the situation moot by restoring the current tax and making it retroactive to Jan. 1. Republicans would like to negotiate a new tax structure, perhaps taxing eligible estates at the 15 percent capital gains rate.

The estate tax this year brought in an estimated $25 billion. It is hard to imagine that Congressional Democrats won’t find a way to recapture at least that much revenue for 2010. But with the docket already crowded with health care and maybe even carbon-emissions legislation, might the estate tax temporarily slip into oblivion?


Brad

A meritocracy demands an estate tax! (Or, like the non-genetic lottery, it should at least be included as taxable income for the heir)

frankenduf

im gonna bookmark this and get back to it when my estate exceeds 3.5 million

Mike D

I think this is the most under-reported story of the moment - 12 months from now, when the estate tax is scheduled to go back to 45% on 1/1/11, just think how little care some on deathbeds might get.

Kai

If I understand this correctly, isn't an estate tax "double-dipping" by the government?

If you've earned money all your life, paying taxes on this money, and built up an estate, then when you die the government takes almost half of what's left? How does that make sense?

mfw13

I think the bigger question is why the estate tax exists at all.

I've yet to hear a really good argument for why the state should be entitled to a portion of someone's estate when they die.

a

It isn't double dipping in a lot of cases. For example
Bill Gates founds a company and has stock worth 50 billion dollars. Zero taxes have been payed on that money since it hasn't be realized as income. Or your parents bought a house for 50k that is now worth 1.2million. Again zero capital gains taxes have been payed. Besides everything is taxed 3 or 4+ times anyway (On ordinary income I pay state, federal, social security, medicare, state disability, and sales tax before I can turn a dollar I make into a dollar used to purchase a good and I might be missing some) and we seem to be ok with that.

Probably the "fairest" would be to charge capital gains on the untaxed portion but that could be an accounting nightmare for heirs. In the computer age, it should be trivial for the financial companies to do it. And it doesn't help valuating things like business (Once your up to 3.5 million, I am not sure how "small" you are), art work, property and so on.

The problem with the current system is the rate is way to high which encourages people to go to extremes to avoid paying it.

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David

You said it Kai! All the money in someones estate has for the most part been taxed already. Remember that they tax you on the total value of the estate and that includes property; real-estate, autos, etc. That is why estate planning is so important, you can beat the tax man at his own game if you do it right.

Eric

My family lost a fortune because of the timing of my grandparents' deaths, through a loophole in a superannuation plan.

Then again, we inherited from them the right to live in one of the best countries in world, so we can still count ourselves lucky. (so many people want to come to Australia that our net immigration rate is almost the same as our birth rate)

Erik

Depends how think about it.

We generally tax people on the receipt of funds.

Get paid for work you did - income tax

Sell property for a profit - cap gains tax.

Receive money as a gift or as inheritance... we don't tax the recipient directly, instead we have 2 transfer taxes - an estate tax and a gift tax. To be completely consistent we should tax the recipients, but for ease of administration we tax the givers and decedents instead.

Avi

@Kai - inheritances are unearned income: the recipient did not do anything besides being born lucky and not alienating their parent or other family member!

Compare that to the many grinding and painful kinds of jobs people do -- garbage collecting, cannery work, fast food, low-end retail, telemarketing -- and it seems deeply unethical and unfair not to tax inherited money.

Nick Fortescue

@Kai (nr 4)
Double dipping happens all the time. You pay income tax on income, then sales tax when you use that income to buy something. It isn't an anomaly.

Steve

1. Estate taxes are rarely double dipping. They are usually taxing unrecognized capital gains (like the Wal-Mart family who have never been taxed on their huge wealth) or inherited wealth.

2. The tax that currently applies to about 0.1% of Americans is about to be spread to the other 99.9%. Only in America could politicians be bought off by the 0.1%.

Nik

Kai, it makes sense because the government needs money and they have to get it from somewhere. There is lots of "double-dipping" in taxes. For example, you pay sales tax on purchases paid for with money that has already been subjected to income tax. At the end of the day, it doesn't matter if it's "fair".

Joe Smith

The old rich folks in Australia who lived a little longer probably simply hung on to spite the government and it had nothing to do with how the heirs treated them. It seems to be fairly well recognized that people manage to hang on for special dates - a reduction in taxes could be a special date for an old rich guy.

The simple decision to give or not give a "do not resuscitate" instruction might be all it would take.

Peter W

As a tax lawyer and amateur economist, I like the carry-over basis replacement to the estate tax. This scheme reduces the rate to 15% - 20% but broadens the base. More importantly, it makes the tax truly voluntary: if you don't want to be taxed don't sell your assets.

Marc

All the defenders of the estate tax have been dead on; I don't have anything more to add except to point out that the estate tax, as it currently exists, exempts a whopping $2 million. In other words, only the very rich, who have managed to build up more than $2 million in a lifetime, will get taxed at all.

That might seem unfair, but given how much of the rest of our tax system (like sales tax) regressively impacts the poor much more than the rich, this is a crude but effective instrument towards rebalancing the scales.

Also: the previous commenters have used examples of people like Bill Gates, who has most of his net worth tied up in stocks which aren't being taxed. But don't forget about the Paris Hiltons of the world. She will likely die rich simply by virtue of the fact of being born rich. While she's paid taxes on the interest, her investments, and her "acting" income, the bulk of her net worth is probably still the inheritance money from Daddy. If she [shudder] has children, and there wasn't an estate tax, then that money could pass down indefinitely from Hilton to Hilton without ever being taxed.

The estate tax is a way to make sure that the tax burden falls on *everyone*, even the Paris Hiltons.

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pablo

I prefer this formulation of the question: Why do we have estates at all? The passing of the possessions of one person, after they die to people chosen by them personally or by social or legal custom, seems unnecessary.

The receipt of great wealth as the result of luck rather than labor decreases the strength of merit-incentives in society as a whole, and the loss of estate-tax income, given equal governmental financial obligations, requires taxes that are quite often much more distorting than any estate tax would be. Taxes on negative externalities (pollution, etc.) should be the first choice, and taxes on luck-of-the-draw (estate inheritance) should be second, in order of preference.

Tracy

As a regular person rather than an economist or think tank participant, the simple issue is the rate at which the estate is taxed. It just seems extreme. 15% seems reasonable.

rob

Estate tax is completely anti-capitalist. At any rate the taxation threshold is far too low.

Anybody can save $3,500,000. Max out your 401k starting at age 25 and continuing til age 65 and you're talking about $4.27 million, even at a conservative 8% return. A married couple each maxing out their 401k would have twice that much, $8.5 million. If they then draw that down for 30 years at 2% per year, then even with conservative investments earning 4% per year they can expect that principal to grow further to $22 million before death.

A married couple maxing out their 401k for their working lifetimes and then conservatively drawing on that nest egg for 30 years can easily die with a combined $20 million estate. What silver spoon were they born with? What unfair advantage did they get? Didn't they do everything we wanted of them? Why should they not be permitted to pass on the fruits of their frugality and discipline to their children?

Estate taxation is about one thing and one thing only: envy. It should be abolished.

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Gordon

re - the 'less certain' in the title.

Still certain - amounts and timing is what changes.

Even with estate tax abolished the tax man will get his hands on some, sales tax on the funeral?!