The Perverse Death/Estate Tax

From Econ Prof. David R. Henderson. He shows how the death tax actually costs the government money. 

I remember reading about 20 years ago in, I think, an NBER study that the estate tax costs the federal government revenue. You might think that claim must be incorrect. A quick look at the data shows, after all, that in 2014, the federal government’s death/estate tax revenues were $19.3 billion, or 0.6 percent of total federal revenue. So how can I say that the tax costs the federal government revenue?

Answer: the unseen. That is, the tax causes people to make other adjustments, typically well before death, that reduce the government’s tax revenues from other taxes. One standard way is to put assets in your children’s name. But then your children are typically in a lower income tax bracket than you are. So the income from the assets is taxed at a lower rate than if you didn’t transfer the assets and the feds raise less revenue from the income tax.

The estate tax causes the government to lose revenue in other ways too. One way is that it reduces the incentive to accumulate capital and the lower capital stock leads to lower productivity than otherwise. Lower productivity means lower total output and, with lower total output, federal corporate and income tax revenues are lower. And it’s not proportional. If the growth rate falls by, say, 0.1 percentage point, federal corporate and income taxes fall by more than 0.1 percentage point: a good guess would be that they would fall by about 0.15 percentage point. Economists refer to this relationship as the elasticity of the taxes with respect to output. Why this more than proportional fall? Because the higher income that would have been taxed would have been taxed at people’s marginal tax rates–and marginal tax rates substantially exceed average tax rates. A given fall percentage drop in this income, therefore, leads to a higher percentage fall in tax revenues. 

This somewhat dated piece by David Block and Scott Drenkard of the Tax Foundation, “The Estate Tax: Even Worse Than Republicans Say,” gives other reasons that the death tax could cost the government revenues, as well as showing other perverse results of the tax.

Via EconLog