Estate Taxes Appear to Increase Avoidance and to Reduce Wealth Accumulation

Estate taxes do have a negative impact on the accumulation of wealth. An estate tax rate of 50 percent (just below the current top rate) is associated with a reduction in the reported net worth of the richest half percent of the population of 10.5 percent.

Part of the original tax cut plan of President George W. Bush is elimination of the estate tax, with its projected $294 billion of revenues, in steps over the next ten years. Whether this is a good idea depends in part on the impact of the tax on the economic behavior of well-to-do Americans.

Opponents of this tax argue that it reduces the incentive to accumulate wealth. Why work so hard to earn and then save income if so much of it will go to Uncle Sam at death, rather than, say, your children? Why not just spend the money? Supporters of the tax tend to downplay the salience of these incentives. They ascribe wealth accumulation to motives that are immune to taxation, including future security and enjoyment, the power that wealth confers, the inability to spend the money so fast, the desire to manage a large business, or the posthumous glory of dying rich. Furthermore, the Joint Economic Committee of Congress in a 1998 report asserted: "Virtually any individual who invests sufficient time, energy and money in tax avoidance strategies is capable of avoiding the estate tax altogether." And, only 2 percent of estates are big enough to be subject to this tax.

In The Impact of the Estate Tax on the Wealth Accumulation and Avoidance Behavior of Donors (NBER Working Paper No. 7960) coauthors Wojciech Kopczuk and Joel Slemrod note that efforts devoted to avoidance should be counted among the costs of levying the estate tax, to be weighed against the revenue it raises. In this paper, the two economists examine the impact of the estate tax on the size of reported estates, using both aggregated and individual data from estate tax returns that span 1916 to 1996. During these years, the marginal tax rate on estates has varied widely, as have the allowable deductions. In 1981, for instance, the Economic Recovery Tax Act provided for an unlimited deduction for bequests to surviving spouses. Under previous law going back to 1948, the deduction for spousal bequests was limited to one-half of the adjusted gross estate.

Using the aggregated data, the authors conclude that when the estate tax is levied at a higher marginal level, the size of the reported largest estates does shrink, relative to national wealth. This response could occur because those anticipating being hit by the estate tax are spending more money and effort to avoid the estate tax and having some success. Or, it could be that they are accumulating less wealth by working or saving less. This evidence, the authors write, is suggestive rather than definitive because of the difficulty of controlling for other factors related to the size of estates and of ascribing causality to an observed association.

When they analyze individual tax returns, though, the authors conclude that estate taxes do have a negative impact on the accumulation of wealth. An estate tax rate of 50 percent (just below the current top rate) is associated with a reduction in the reported net worth of the richest half percent of the population of 10.5 percent when its effect is fully realized many years later, they calculate. It is not possible to say how much of this is due to increased avoidance and how much to reduced wealth accumulation. However, the fact that the reported estate is most strongly associated with the tax rate in effect during the decedent's prime working years suggests that some impact on wealth accumulation exists.

-- David R. Francis