Political Economy: Playing Political Chicken with the Estate Tax

Political Economy: Playing Political Chicken with the Estate Tax

CQ Politics
4/11/09

Tax wonks with a macabre sense of humor are having a field day with the game of chicken now being played out on Capitol Hill over the estate tax. At either end of the political spectrum, the absolutist position in this fight is to allow current law to stay in place in all its quirky glory — and then see where the chips fall.

The problem is, the estate tax will switch from on to off to on again between now and 2011. The current law is, in a word, stupid. It will not permit the federal government to collect any tax at all on the estates of people who die after midnight this coming Dec. 31. But Uncle Sam will then be able to impose the heftiest levy in a decade on the estates of those who leave this world after midnight on Dec. 31, 2010.

The sick joke is that rich folks ought to definitely watch their backs next year, lest their greedy heirs decide to, er, take advantage of this special, one-off tax break.

The responsible position, of course, is to prevent this yo-yo effect in estate tax policy from occurring at all. But that would require lawmakers to decide to act both responsibly and soon, something the absolutists may not choose to do.

This current situation was cemented in place in 2001 by the Republicans running Congress and the administration of President George W. Bush . Their intent was to eliminate the estate tax forever, but budget rules wouldn’t permit that. Instead, they phased down the scope of the tax, year by year, and voted to repeal it for 2010 only. The expectation was that whoever was in charge then would make the repeal permanent. Oops. Bush and the GOP leaders didn’t count on losing control. Now, there’s no consensus about what to do.

Democratic leaders think the logical approach is to make permanent the estate tax as it applies for 2009. That’s not good enough for the Republicans, plus a small cadre of Senate Democrats who are their allies in this fight. So we have a standoff that poses the very real threat of a repeal next year and high estate taxes later.

Here’s what the Urban-Brookings tax Policy Center estimates would happen under different scenarios for the 2011 tax year:

If the Obama administration gets its way, the law as it stands for 2009 will be fixed in place, with a yearly adjustment to account for inflation. Only those estates larger than $3.5 million will be subject to taxation. And with a tax rate of 45 percent, about $18.4 billion total will be collected from a bit more than 6,000 estates.

But if a proposal adopted two weeks ago as part of the Senate’s fiscal 2010 budget resolution were to become law, only estates larger than $5 million would be taxed, and at a rate of 35 percent. This plan, which garnered the votes of 41 Republicans and 10 Democrats, would yield $11.6 billion in revenue from fewer than 4,000 estates.

Democrats, many of whom are annoyed at the prospect of paring the estate tax any more than has already happened, are threatening to refuse to go along with the Senate budget proposal and suggest allowing pre-2001 law to take effect instead after the one-year repeal.

If Congress does nothing, and the one-year repeal is allowed to stand, estates larger than $1 million will be taxed at a 55 percent rate after 2010. That would generate about $35 billion from 46,000 estates, the vast majority of which are smaller than $3.5 million.

What a Mess

The big question is: Who will blink? And if no one does, who suffers? Probably not the lawmakers.

From a distance, the Obama proposal and the Senate-adopted proposal don’t look all that different. Principally, both would exempt all but the very wealthiest families from the estate tax. But there are some differences worth noting. Foremost is that the Senate-adopted plan would tax only two-thirds as many estates and bring in only two-thirds as much revenue.

There’s no clear justification for shrinking the scope of the tax the way the Senate plan would. In fact, the Senate plan would raise so little revenue that in a few years the political fight would probably resume over the desirability of repeal. In addition, the most obvious argument in defense of the Obama proposal is that it would maintain policy from this year into the future.

Experts generally agree that the fewer changes in tax law the better.

But there may be a broader point here. Congress really isn’t talking about the underlying premise of this tax. If there is a reason to tax estates, lawmakers need to decide what makes one small enough to be exempt or, for that matter, large enough not to be.

Moreover, lawmakers could take on the question of taxing the heirs themselves for what they receive, and not the estates. But that would bring into play the question of how to value capital assets — stocks and real estate — that are passed along. Currently, those who inherit capital assets generally can value them as if they were just purchased, limiting the potential for capital gains taxes. If there were new rules on the pass-through of assets, would they apply to everyone equally?

Congress has allowed this fight to deteriorate into something akin to a schoolyard dare. It will be interesting to see if the grown-ups can settle it before it gets bloody.


From a distance, the Obama proposal and the Senate-adopted proposal don’t look all that different. Principally, both would exempt all but the very wealthiest families from the estate tax. But there are some differences worth noting. Foremost is that the Senate-adopted plan would tax only two-thirds as many estates and bring in only two-thirds as much revenue.

There’s no clear justification for shrinking the scope of the tax the way the Senate plan would. In fact, the Senate plan would raise so little revenue that in a few years the political fight would probably resume over the desirability of repeal. In addition, the most obvious argument in defense of the Obama proposal is that it would maintain policy from this year into the future.

Experts generally agree that the fewer changes in tax law the better.

But there may be a broader point here. Congress really isn’t talking about the underlying premise of this tax. If there is a reason to tax estates, lawmakers need to decide what makes one small enough to be exempt or, for that matter, large enough not to be.

Moreover, lawmakers could take on the question of taxing the heirs themselves for what they receive, and not the estates. But that would bring into play the question of how to value capital assets — stocks and real estate — that are passed along. Currently, those who inherit capital assets generally can value them as if they were just purchased, limiting the potential for capital gains taxes. If there were new rules on the pass-through of assets, would they apply to everyone equally?

Congress has allowed this fight to deteriorate into something akin to a schoolyard dare. It will be interesting to see if the grown-ups can settle it before it gets bloody.