Many of the senators voting against permanent repeal of the
estate tax on June 12 cited "fiscal responsibility" as their reason for
doing so. It was often said that permanent repeal would "cost" the federal
government $740 billion -- money that is needed to pay future Social
Security benefits and other critical government needs.
Casual listeners to this debate no doubt thought that passage of
this legislation would have led to an immediate loss of $740 billion in
revenue. Given that the budget is now in deficit, the loss of so much
revenue would indeed have been a valid reason to vote against it. But this
was not the case.
It was seldom mentioned by opponents of permanent repeal that
the debate involved changes in law that would not occur until the year 2011.
Moreover, the widely cited $740 billion revenue loss is an aggregate figure
for the years 2013 to 2022.
The reason this is an issue at all is because Senate rules
prohibited enactment of a permanent tax cut last year without a 60-vote
majority. Since supporters of the tax cut did not have quite that many
votes, they had to settle for a 10-year phase-out of the estate tax, with
outright repeal in 2010. Because the repeal could not be made permanent, the
estate tax re-emerges in 2011 as if it had never been repealed at all.
Since this debate will come up every year until Congress adopts
a permanent fix, it is worth spending some time establishing its parameters.
For starters, it is worth knowing that the $740 billion figure was not
produced by the Treasury Department or Congress' Joint Committee on Taxation
(JCT), the two agencies that produce official revenue estimates for tax
legislation. Rather, it comes from a vigorous opponent of estate tax repeal
called the Center on Budget and Policy Priorities.
What the CBPP economists did was take the JCT's estimate of how
much revenue would be lost in 2012 if estate tax repeal is made permanent
and assume that this impact would be the same in future years as a share of
the gross domestic product (GDP). They then made some assumptions about the
growth of GDP from 2012 to 2022 and got their $740 billion figure.
According to the Congressional Budget Office (CBO), GDP will be
$17.3 trillion in 2012. The JCT says that estate tax repeal will cost $56
billion that year, so simple arithmetic tells us that total GDP will be
about $230 trillion over the years in which this seemingly large $740
billion revenue loss will occur. Over this same period, total federal
revenues will be around $50 trillion. In the proper context, therefore, the
"huge" revenue loss from estate tax repeal is very small.
But the CBPP economists also overestimated their original figure
by failing to take into account higher revenues from carryover basis. This
is a provision Congress enacted as part of estate tax repeal expressly to
recoup some of the revenue lost to repeal. Under carryover basis, heirs
would pay capital gains taxes on the value of their inheritances, calculated
from the date when the asset was originally purchased by the decedent.
Under current law, if I buy some stock for $10 and it is worth
$100 at my death, estate tax would apply to the full $100 value, but no
capital gains tax would be levied on the $90 increase from when I bought it.
When my heir sells the stock, he would pay capital gains tax as if he bought
it for $100.
Under carryover basis, my heir would inherit my $10 original
purchase price along with the stock. If he later sells it, he will pay
capital gains taxes as if he bought the stock himself for $10. He would then
pay up to 20 percent tax to the federal government on almost all the gross
sale of the stock.
What this means is that a significant amount of the revenue loss
from estate tax repeal will be recouped through higher capital gains taxes
over time. It is difficult to calculate a precise figure, but the JCT
estimates that the revenue now lost when the tax basis for capital gains is
stepped up at death will "cost" the federal government $50 billion in
2006 -- two thirds of the $75 billion expected from the estate tax.
In short, if step-up basis were eliminated altogether and
capital gains taxes were levied at death on the increase in asset values
during a decedent's life, then the federal government would get two-thirds
of the revenue from the estate tax.
There are good reasons why carryover basis is an unsatisfactory
replacement for the estate tax -- the record-keeping requirement is
horrendous, for example -- and I would have preferred if Congress had not
adopted it. But having done so, it is disingenuous of estate tax repeal
opponents to just ignore its revenue impact while using nominal values 20
years from now to artificially inflate the cost of permanent repeal.
