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April 15, 2005

Putting a Face on the Estate Taxpayer

Nestegg: April 15, 2005

Editor's Update: 4/15/05 9:22 pm: A computer error by the editor caused this post to disappear for several hours this afternoon.  Apologies.

Yesterday, the House of Representatives again voted to repeal the estate (or death) tax.  I won't argue the merits of having or repealing this tax here.  Instead, I want to give a brief "profile" of one family affected by the estate tax, my own.  Because I come from a family that does not like to talk about money, I am using a pseudonym in this posting in order to prevent embarrassment to my relatives.
  We've read stories, mostly apocryphal, about families forced to sell their farms or small businesses in order to pay the estate tax.  It's proven hard to find real examples of such families, but their plights have been described to us.  More often, we hear (mostly from critics of repeal) that this tax affects only the very wealthy.  Who are these people?  And how would the estate tax affect them?  Well, I've never thought of myself as among "the richest sliver of Americans" (as The Washington Post recently put it), but my family does have a stake in the estate tax, and I'd bet that my situation is more similar to the majority of those who would be affected by this tax than is the situation of the farmer or small business owner.
  First some figures.  To estimate the effects of repealing the tax, it is misleading to compare it to the current tax, which declines until it disappears in 2010 and then is reborn in 2011 Venus-like, in its full original amount.   Repeal should be compared instead to the Pomeroy alternative proposed by the Democrats, which exempts the first $3.5 million of an estate from taxes ($7 million for a couple), and taxes the remaining amount at a rate of 45%.  That tax would affect only .3% of estates, but the effect on those estates would be signifcant, large enough to offset between a quarter and a half of the projected 75-year Social Security shortfall.  For my own family, based on the current value of my mother's estate, it would mean that Uncle Sam would take in excess of $3 million before the remainder is passed on to my brothers and me.

  What does that mean to us?  My father grew up poor and was a successful businessman and investor.  His was a typical "greatest generation" story.  He suffered through the depression, dropped out of college to go to war, put his brother through school, married and raised three sons, and lived modestly.  He never talked about the war or about money, and I never knew until after he died how much he was worth.  My father's greatest satisfaction came from being able to to provide security for his family.
  And provide he did.  My two brothers and I never received any allowance or spending money.  We had to work for whatever we wanted to buy, and we learned to live within our means.  We've all had successful careers, no debt, and we've never asked our parents for any money along the way.  But we were also well provided for.  Our parents paid fully for our undergraduate educations; we were each given a (used) car for our 21st Birthdays; we were each given a substantial gift intended to help us buy our first homes; and much later in life our parents began to give each of us the tax-free allowable gift of $10,000 each year.  We in turn used those gifts (with added money from our own savings) to help create funds that are now paying for our children's college educations.  We have also each managed to create other funds for our children to help them buy their first homes.  And so it goes.
  My father died eleven years ago, and my mother recently moved into a comfortable retirement community.  My older brother was a successful businessman who retired last month (at age 61) in order to spend time flying his two planes and resuming his earlier life as a ski instructor, as long as his knees hold out.  He lives in a very affluent suburb and vacations at his beach house when he is not going to fishing in Alaska or Argentina.  My younger brother is a successful lawyer who doesn't much like travelling.  He spends his weekends at his lovely cabin at a mountain lake two hours from work, and he spends his spare time working for social causes he believes in. I am an academic who enjoys work, travels often, and has enough money saved for a comfortable retirement, although I currently have no desire to retire.  When my mother dies, her estate will be split between the three of us.  Whether we get the full amount, all but $3 million of it, or nothing at all will make no appreciable difference to any of our lives.  It won't affect how we work, when we retire, how we spend our spare time, or what we will give before we die to our own children.  I suppose that with my share I will set up a foundation or something, provided the administrative burden is not too great. 
  As I said earlier, I'll bet that my story is the common one for people who will be directly affected by the repeal of the estate tax.  It will have a noticeable effect on my net worth, but none at all on my quality of life.  I said that I wasn't going to present an argument here, but I can't resist ending with a question.  Can this same claim be made by those who will be affected by an increase in payroll taxes?


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Posted by: Terrier

I must confess that altho I consider the 'death' tax malarkey to be just another example of capital being rewarded just for being capital (a devaluation of work that will ultimately and inevitably lead to the dissolution of our democracy and our nation) I doubt very seriously whether those in favor of this measure care whether it protects family famers OR the super-rich. The super-rich push the measure and they have enough clout to convince those who are just vaguely selfish to do pretty much anything they want. It is issues like this that almost make me glad to reflect on the fact that I am on the downhill slide and won't have to live in an America where the most people make less per hour than a gallon of gas costs.

Posted by: Terrier | Apr 15, 2005 4:08:12 PM

Posted by: RSA

Well, I've never thought of myself as among "the richest sliver of Americans" (as The Washington Post recently put it)

This is an interesting issue of perception. I'd bet you've also never thought of yourself as among the smartest sliver of Americans, but doubtless you are. (Of course, I can only guess, but try looking at, say, your SAT and GRE scores, and treat the percentiles as actually meaning something in the real world.)

On wealth, it's hard to find solid numbers online, but one source has it that in the late '90s, 1 out of every 36 American workers was a millionaire. That's 3.5 million millionaires out of 126 million workers, 2.7%. The number would go way down if we included the rest of the population; of course, it would be much tougher to come up with an unambiguous count. Most people, I think, would agree with a characterization of the top 2.7% of earners as the richest sliver, just as those in the 97th percentile of an intelligence test would be considered very very smart.

Posted by: RSA | Apr 15, 2005 4:55:45 PM

Posted by: Stephen M (Ethesis)

just as those in the 97th percentile of an intelligence test would be considered very very smart.

Hmm, just realized that I don't think of them that way. I don't think of people as very smart until they are in the upper part of the 99th percentile.

I think many wealthy people look at wealth the same way.

Posted by: Stephen M (Ethesis) | Apr 15, 2005 11:50:01 PM

Posted by: beedubs

"Whether we get the full amount, all but $3 million of it, or nothing at all will make no appreciable difference to any of our lives."

Really? I find that hard to believe; you would have to be both selfless (not caring about your own material wealth) and solipsistic (not being concerned about the efficient use of resources to make others' lives better). I'll give you the benefit of the doubt on the former; I'm not very materialistic either. But I'll bet that you do care about the efficient use of resources in a way that helps those who are less fortunate than you. Further, I'll bet that you believe that your allocation of resources in the private sector will do more good than the government would do with those same resources (on the margin, given the government's already abundant resources).

Here's a simple test: Add up all of the money you donated to charities last year (call this amount A). Now add up all of the money that you voluntarily donated to the government (don't count taxes, you can't judge your assessment of the best use of resources based on money that you are forced to pay) (call this amount B) (and yes, they do take donations, every year). If A > B then you have implicitly decided that your direction of the use of resources in the private sector will help people more than the government's use of those resources. If A is positive and B is zero (as it is for me) then you implicitly have decided that government spending isn't even close to being as effective as private giving. And if that's the case, let's hope that you get the full amount of your inheritance.

Posted by: beedubs | Apr 16, 2005 12:45:55 AM

Posted by: Shag from Brookline

For purposes of this discussion, would it not be appropriate to provide a definition of "millionaire"? Does it relate to annual income or to net worth or a combination? For comparative purposes, would it not be appropriate to consider the relative value of being a millionaire at different time periods? However defined a millionaire today may be relatively a pauper compared to, say, a millionaire in the 1940s. If one out of 37 adults is a millionaire today, then this may not be elitism. Rather, it may be the luck of having bought a home when prices were low and holding on to it as the housing bubble expands.

Also, perhaps the discussion might focus on the matter of elimination (for the most part) of stepped-up basis. Or is it part of the master scheme to eventually provide for step-up without recognition of a taxable event? This would constitute the Matthew Effect Squared.

Posted by: Shag from Brookline | Apr 16, 2005 7:52:40 AM

Posted by: bakho

The rules in the US are stacked. It takes money to make money. Since it would be counterproductive to change the rules that enable people to make money in the first place, a corrective factor on how much can be bequeathed makes economic sense. In order to keep an economy from stagnating there has to be a redistribution of wealth. The estate tax is important for balancing the natural tendency toward plutocracy in favor of meritocracy.

Posted by: bakho | Apr 16, 2005 10:31:18 PM

Posted by: D.A. Ridgely

Ah, that must be why we still hear people talk about being as rich as Rockefeller and Carnegie instead of being as rich as Gates and Buffet.

Posted by: D.A. Ridgely | Apr 16, 2005 10:46:41 PM

Posted by: Stephen M (Ethesis)

you can't judge your assessment of the best use of resources based on money that you are forced to pay ...

Well, there are significant choices I make that dramatically affect the amount of taxes I pay, the same for my wife. I think it is fair to balance taxes paid against charitable donations, though I pay about twice in taxes than I donate.

Interesting comments though, and interesting perspectives.

However, there is a real difference between those barely in the top 1% or so and making $300K a year and those solidly in and making $2KK a year to $4KK a year. Fascinating, especially since for many people, wealth=increased happiness until they make about 60K to 90K a year, then it tends to flatten out.

I'd really like to read more on the topics implicated here -- a good bibliography anyone?

Posted by: Stephen M (Ethesis) | Apr 17, 2005 12:00:57 AM

Posted by: arbitrary aardvark

Do you really plan to piss away the 3 million? Most people wouldn't. The 3M, put into a trust or 501c3, could do a lot for those causes your brother believes in.
"but the effect on those estates would be signifcant, large enough to offset between a quarter and a half of the projected 75-year Social Security shortfall"
That sounds completely wrong. It seems as if you are assuming people would pay the tax, instead of taking simple and legal steps to shelter the money. A few suckers will fail to plan, but most people with those kinds of funds have accountants or lawyers, who would be committing malpractice to fail to protect the funds from nationalization.
The effect of such a tax policy is not so much x dollars collected, as it is the consequences of making people jump through hoops to have it not taxed.

Posted by: arbitrary aardvark | Apr 19, 2005 1:07:26 PM

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