One of the less talked about components of "Fiscal Cliff" that will have to be considered by lawmakers before the end of the year is the pending hike in the estate tax. The way the law is currently written, if no action is taken before January 1, 2013, far more estates will be subject to the tax, and they will pay higher rates as well. The current exemption level of $5.12 million is slated to drop to $1 million and the current top tax rate will increase from 35 percent to 55 percent.
While presidential hopeful Mitt Romney favors complete repeal of the estate tax, President Barack Obama also recognizes that hiking rates as high as 55 percent would have damaging effects on the economy; he favors lowering the exemption to a more modest $3.5 million and raising the top rate to 45 percent.
There are few taxes that are as polarizing as the estate tax. A 2009 poll by the Tax Foundation found that the estate tax is viewed by taxpayers as the most "unfair" of all federal taxes, but at the same time, the estate tax seems to be a rallying point for those that agitate for redistribution through the tax code.
Despite this seeming rift, there is a large and growing body of research by economists that generally lean left-of-center pointing toward repeal of the estate tax.
Nobel laureate economist Joseph Stiglitz, who served as chairman on Bill Clinton's Council of Economic Advisors, authored a paper which argued that the estate tax actually increases inequality by reducing savings and driving up returns on capital (which largely benefit wealthy holders of capital).
Economist Larry Summers, former Treasury Secretary under President Clinton, co-authored a paper in 1981 that showed that the estate tax has severe impacts on the accumulation of privately held capital. Using Summers' methodology, a July 2012 study by the Joint Economic Committee Republicans showed that since its inception, the estate tax has reduced the capital stock by approximately $1.1 trillion.
The estate tax also encourages firms to structure as corporations instead of as family businesses, because corporations do not pay estate taxes when the person at the helm changes, but family businesses can be subject to rates of over half the value of their estate when a deceased owner transfers the business to their heirs.
This observation should be disconcerting to left-leaning voters, who recognize that smaller, family businesses have ties to their communities, but it should also concern right-leaning voters, who should see this as a distortion of the market process.
Perhaps the worst aspect of the estate tax is how uneven its impact is in practice. By utilizing careful estate planning, many wealthy taxpayers are able to shield much of their income from taxation upon their death. The people that tend to get hit the hardest are those that die unexpectedly, or, like farmers, have their assets tied up in illiquid holdings.
The estate planning industry has grown in size over the years as estate law becomes more complex. Three studies have even found that the compliance costs associated with the collection of the estate tax are actually higher than the amount of revenue the tax brings in! Almost the entire estate planning industry can be thought of as economic waste, because it would not exist without the estate tax, and the high-skilled labor and capital utilized in that industry would be applied to other, more productive economic endeavors if the estate tax were repealed.
Upon careful examination, we find that at worst, the estate tax can break down family businesses and increase inequality, but even at its best, it simply creates large compliance costs, which are a drag on the economy.