Here's how the estate tax should work ....

It’s certainly nice for you to decide that people should have ‘no problem’ paying off a loan the 55% of the size of the entire net worth of the company over 15 years, but in my experience there are a hell of a lot of companies that could not survive that. What evidence do you have that this kind of burden is ‘no problem’?

In my experience, most small businesses operate on tiny profit margins and are usually cash-strapped and under-capitalized. I’m not nearly as sanguine as you about the ability of those businesses to absorb the kind of bill you’re talking about while maintaining their viability - especially when the owner and manager of the business has just died and the people taking it over are on a learning curve and a man short.

Two words: Local Knowledge. As in, the knowledge locked up in the owner’s head and passed down to his children in the family business. You have no appreciation for how important this is - and neither do a lot of people who buy businesses. Best practices, customer ties, knowledge of how to make finicky old machinery work properly, knowledge of the local market and the value of various advertisements, which products sell and which don’t in the local region, etc.

In short, when a business changes hands (especially when it’s forced to change hands), there’s a definite hit to productivity and efficiency. Often so much that the new owners simply fail and destroy a business that may have been operating at a profit for decades.

You might want to read this paper put out by the Tax Foundation, a non-profit, non-partisan think tank. Their conclusion:

One of the reasons the estate tax is so inefficient and so readily leads to tax avoidance is because it’s a deferred tax that you can see coming from a long, long way away. If you have a business worth $3.5 million, and that’s the exemption on the estate tax, then every dollar you grow your business after that point has a 55% marginal tax rate.

If you hit the $3.5 million mark when you’re 50, that may lead you to stop investing in the business early, or it may even cause you to retire early, divest the business, and start sheltering the money elsewhere. Perhaps you’ll start gifting your relatives in small amounts to wind down the estate while they pay tax only at the their marginal rate. Perhaps you’ll sell off the business and put the money in a trust. Or maybe you’ll just stop saving and start blowing the money on hookers and blow. Whatever. The point is that you have years or decades to plan your avoidance strategy for the estate tax.

The ultimate effect is that the estate tax hurts job creation and the economy as a whole, making it less progressive than you’d think. The Tax Foundation says that studies show that when you add all these effects up, the estate tax actually costs the economy $60 billion per year net.

I can tell you that from personal experience, the only reason I would have for building up a large estate would be so I could give the money to my daughter. If I can’t do that, I’m not working my ass off 16 hours a day to build a business. And if I was 55, and I had $10 million in the bank, I’d stop working and I’d start taking my daughter on trips, or I’d buy a house for her, or whatever. I’d do whatever I could to make sure she got maximum benefit from my work, and that the government got as little as possible.

That may mean that even though the economics my business would be improved through additional investment, I’m not going to do it. Even if it made sense to hire 10 people to expand my business, I won’t do it. 10 people means more work and more risk. I’m not about to do that work and take that risk so the government can take it all when I die.

This is why Canada’s system is so much better than yours. By taxing estates at the normal marginal tax rate for individuals, there’s no incentive to liquidate businesses or avoid tax. I will pay the same in tax if I spend my estate today than if I leave it to my daughter. It makes our tax more efficient. There’s no estate tax - there’s just tax on income and capital gains. The only difference is when you die your capital gains have to be realized and the estate has to pay for them.

What I found out is that the only country with a tax rate higher than 55% is Japan, at 70%.

Canada, Australia, New Zealand, China, and India have no estate tax. The OECD average estate tax is something like 25%. If the U.S. estate tax is 45%, it will be higher than all countries except for Taiwan and Japan.

I assume you guys wanted to let the estate tax go back to its 2001 level of 55% with an exemption of 1 million. That would make the U.S. estate tax the second-highest in the world - and Japan’s a special case anyway because its society is structured very differently. But it would put the U.S. at a capital disadvantage with every other country in the OECD, and at a huge disadvantage with its neighbors, since neither Canada or Mexico have estate taxes.

I say that there is good evidence that the estate tax is one of the worst taxes in this regard, because you have such a long time to plan to avoid it, and because it is aimed squarely at the most productive members of society. There is plenty of evidence that the societal cost of the tax exceeds the revenue collected from it - follow some of the cites in the tax foundation paper if you’d like.

In addition, the compliance cost for the estate tax is high because the rates change so much, meaning that people with large estates have to re-plan constantly.

Look out for the gift tax…

Well, I’m on your side of this particular debate but there are several taxes that have less drag on economically productive activity; some would say that a cigarette tax or a liquor tax might fit that bill.

You can’t run the government on sin taxes but they’re not a real drag on economic activity.

I think you got whooshed (or I did). Estate taxes have some pretty good policy underpinnings, the problem is that it is so full of holes that anyone with less than about 10 million dollars could escape the estate tax. I would be on board with estate and gift tax reform but what Obama did was give the Republicans what they couldn’t get with a Republican White House, a Republican Senate AND a Republican House.

I agree that in today’s world there are bigger barriers to social mobility than the estate tax but I don’t think its actually as easy as you seem to think it is to escape the estate tax. I don’t do estate planning but the people I know who do this stuff still bitch about the estate tax. That’s why the heirs to the Mars family fortune donate a million dollars a year to politicians to get rid of it. If anyone had timeto plan their estate, ti would be folks like these4 and yet they seem to think that the estate tax will affect them.

Sam, putting aside the fact that it’s 35% and that the first $5 million is exempt, the 55% or 35% or whatever is the top marginal rate. Nobody’s actually paying that percentage.

You mean 55% of the size of the entire net worth of the company IN EXCESS OF $5 MILLION over 15 years assuming that the excess is not left to the spouse (which is what virtually everyone does).

The fact that during the Bush administration they were digging DEEEEEP to try to find an example of this sort of hardship and they could not come up with a single example.

Aren’t worth $10 million.

The tax foundation is pretty much against EVERY tax.

And that would work fine as well but the same folks that wanted a 35% estate tax rate don’t want to replace estate taxes with a deemed disposition tax. They simply don’t believe that taxes will remain as low as they are today and they prefer to have the 35% rate.

I was OK with 3.5 million and 45%, I didn’t see why we had to give Republicans something they couldn’t get when they had the majority in both houses as well as the White House.

I think you are overestimating how much taxes like the estate tax will affect behaviour. But lets say the estate tax is horrible, how would you replace that revenue?

When you talk about people with really large estates, the top marginal rate and the effective rate are essentially the same.

Every time I hear the word small business I automatically substitute the words rich crony. It makes Republican talking points much more believable.

Good. Then it should be easy to name one that’s less of an economic drag.

It’s not 55% of the size of the entire estate, unless the estate is so huge that the initial $5M exemption doesn’t mean shit.

Take a business, an estate’s sole asset, that turns a profit of $1M annually. Let’s say 5% is a decent rate of return these days, things being what they are, so we value the business at $20M for estate tax purposes. Minus the $5M exemption, we’ve got a $15 million taxable estate. Tax it at 55%, that’s a tax burden of $8.25M, which it has 15 years to pay. The business is going to make $15M over the next 15 years.

Even if you add in some interest, there’s a pretty good cushion there. The heirs don’t have to sell the business, they don’t have to borrow against it, they’re richer than they were without it. Like I said, no problem.

You argument may have some merit, but the example you give does not validate it. You just turned a 1M profit per year business into a .45M profit per year business. Meanwhile, any competitor this business has that is doing roughly as well, has > 2x in capital it can invest to improve that business and run the inherited business into the ground.

Every year?

That would be the death tax without the death.