The federal estate tax boils people’s blood on both sides of the aisle, but often for the wrong reasons. Democrats argue that the rich shouldn’t be able to create family dynasties by concentrating wealth. Republicans argue that the estate tax generates less than 1 percent of federal revenues and so might as well be abolished.
Neither of these arguments gets to the heart of why the estate tax is so dangerous. What Democrats miss is that the rich have available to them all sorts of accounting and legal tools to avoid, or at least mitigate, their tax bills. Lowering the estate tax exemption will not take more from the rich. It will simply reach into the pockets of the not-so-rich who are less able to avoid it.
What the Republicans miss is that, like the income tax before it, the estate tax is only one legislative tweak away from becoming a tax on everyone. Politicians established a clear precedent with the income tax. In arguing for the 16th Amendment, they assured voters that the income tax rate would start at 1 percent and only apply to the rich. Within a generation, the income tax rate started at 19 percent and applied to almost everyone. In light of this, the argument that the estate tax only applies to a few rich people rings hollow. Politicians have a solid track-record for transforming taxes on “the rich” to taxes on absolutely everyone.
The real damage from the estate tax isn’t what it costs people when they die, but how it alters their behaviors while they still live. Where that damage falls on family businesses, the tax discourages business owners from creating jobs.
When a business owner dies, the estate tax is levied on the value of the business. If much of the business’s value lies in productive assets like machinery, buildings, and land rather than cash, the heirs may have to sell these productive assets just to pay the tax. And as assets are typically worth more to the business than the cash that their sale raises, the business is doubly harmed by having to liquidate necessary physical capital at bargain prices.
The good news is that, according to estimates based on IRS data, only between 250 and 1,000 inherited family businesses owed estate taxes in 2016. The bad news is that that’s just the tip of a very large iceberg.
The larger effect of the estate tax occurs long before the business owner dies. The estate tax encourages business owners to divert resources that otherwise would have gone into expanding their businesses or hiring toward preparing heirs to avoid or afford estate taxes. Based on demographic data, for every business owner who dies and whose business owes estate taxes, there are 38 more who would have owed estate taxes had they died sooner. That brings the total number of family businesses living under the shadow of the estate tax to between 10,000 and 35,000.
Family businesses affected by the estate tax are among the 1 percent most valuable businesses, and that means that they are also likely to be among the 1 percent largest employers. According to census data, such businesses employ between 900 and 2,600 employees each. In other words, the family businesses that are most likely to trigger the estate tax when their owners die are providing somewhere between 26 million and 32 million jobs that could all vanish. This is the iceberg.
The estate tax generates less than 1 percent of the federal government’s revenue, yet it threatens tens of millions of jobs. Not only must heirs who inherit family businesses divert productive resources to pay the estate tax, but the family businesses they inherit are commensurately weaker because of efforts taken while their owners were still alive to mitigate the eventual tax liability.
The estate tax raises almost no revenue and it endangers millions of jobs. The one thing it does well is to provide a platform for politicians who want to be seen to be “doing something” about “the rich.” That’s a luxury those of us who work for a living can’t afford.
Antony Davies is associate professor of economics at Duquesne University. James R. Harrigan teaches in the department of Political Economy and Moral Science at the University of Arizona. They host the weekly podcast, Words & Numbers.
