Thursday, June 08, 2006

Non-death of the non-death tax

By now, most interested readers may already know that efforts to have the Senate approve permanent repeal of the estate ax failed today. (I refuse to call it the "death tax" for two reasons: the renaming is Orwellian language manipulation, and it is less accurate than the old name. The tax really is levied on estates. No one owes the tax solely by reason of dying. For that matter, the gift tax, which has nothing to do with death, is part of the same instrument.)

Under current budgetary circumstances, repealing the estate tax would have been utterly insane. The U.S. fiscal gap makes such a move preposterously bad policy absent offsets to make the change at least revenue-neutral. I also would object to the repeal distributionally if one rules out compensating changes to replace the lost progressivity. And doing it while Medicaid is being cut for supposed deficit reduction reasons is obscenely hypocritical.

Nonetheless, in a sane political and budgetary environment the merits of keeping the estate tax would be a much closer call than many on the left believe. Suppose the fiscal system's overall progressivity would be about the same either way. This assumption could be reasonable, under the right circumstances, for several different reasons. There might be an express political trade-off at some point. The long-term political equilibrium might be such that less progressivity in one way means more in another. And simply as a guide to clear thinking, one should separate the question of how progressive the fiscal system should be from that of this particular instrument's merits.

Suppose we are thinking about efficiency, also known as reducing deadweight loss (i.e., instances where someone is made worse off and no one is made better off). The great virtue of the estate tax as an efficient device for accomplishing redistribution is that some bequests are accidental. People without strong bequest motives may die before they have fully used up their wealth. Since they are not thinking about a tax levied after they die, work and saving are not deterred by the estate tax to the extent that this is the true story.

The great vice of the estate tax, relative to other means of accomplishing comparable overall progressivity, is that deliberate bequests have positive externalities. Suppose you are choosing between blowing all your wealth before you die on conspicuous consumption or leaving it to your kids. The former means that the money is paid out once for market consumption. The latter involves your getting some consumption value out of making the bequest (since we are positing altruism or other warm feelings towards your kids), and then they get to use it in market consumption. So in effect consumption occurs twice rather than once. This point is often put moralistically, as in: Why should we favor the Malcolm Forbes types who throw huge parties before they die over those who scrupulously leave more to their kids. But it is a straight welfare economics point as well.

Anyway, this tradeoff makes the merits of the estate tax an interesting issue for tax policy debate. But in Washington, things go forward or not on a much cruder and more basic level.

21 comments:

Mark Witte said...

In the interest of minimizing the DWL of taxation, why lower the tax rate on estates that were accumulated under the existing tax code? As such, reducing the estate tax would create a Ricardian rent for everyone who accumulated their estates under the expectation of paying such a tax.

From an efficiency standpoint, it would be better to tax current wealth under the current tax rules, and tax future accumulation of estates at a new, lower rate.

Of course, such transitional complexity comes at a cost itself.

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