Is the Estate Tax Really “Double Taxation?”

Estate taxes reduce wealth inequality by taxing a portion of huge intergenerational wealth transfers, as noted in the previous installment in this series. Nonetheless, conservatives consistently call for reductions to or elimination of this tax, partly on the grounds that it constitutes “double taxation.” Armed with this assertion in 2017, conservatives reduced this tax both at the state and national levels.

While conservatives hate double taxation of wealthy estate taxpayers, they don’t seem to mind double taxation of the rest of us.

The Incredible Shrinking Estate Tax

The estate tax has fallen in recent years, both at the federal level and in Minnesota. Major cuts to the state estate tax in 2014 and 2017 have, as expected, cut estate tax revenue, both in gross and as a portion of total general fund resources, according to Minnesota Management & Budget:

Assuming no changes to estate tax law, estate tax revenues should increase over time, as the first wave of baby boomers—now in their seventies—pass on, leaving estates subject to the tax. Estate tax law, however, has changed; revisions enacted in 2014 gradually increased the general estate tax exemption from $1 million to $2 million, while changes enacted in 2017 will increase the exemption to $3 million by 2020.* These changes have overwhelmed the current baby-boom driven proclivity of the tax to increase, leading instead to a significant decline in estate tax revenues. The 2017 estate tax reductions alone should reduce 2020 estate tax revenue by an estimated 26 percent.

Real Double Taxes

Estate tax opponents complain that the tax constitutes “double taxation” because the tax is levied against bequests, much of which has already been subject to the income tax. By the same token, however, if the avoidance of “double taxation” is the hallmark of good tax policy, then the sales tax should be eliminated. Sales taxes are paid from taxed income. Moreover, while estate taxes fall almost exclusively on extremely high income households, sales taxes fall more heavily on low- and moderate-income households. Conservatives don’t seem to mind this double standard.

Further evidence of conservative schizophrenia over the concept of “double taxation” was on display during the debate over regressive federal tax legislation enacted last month. This act doubled the federal estate tax exemption to $11.2 million per person. However, the same legislation sharply curtailed deductions for state and local income and property taxes; this move will cause many taxpayers to pay federal taxes on the same dollars that they used to pay their state and local income and property taxes. Minnesotans in particular will feel the pinch, due to our relatively high per capita state and local taxes.

Fake Double Taxes

Those that benefit most from recent estate tax reductions effectively avoid even single taxation on much of their estate value. When an asset, such as stock, is inherited, its basis is readjusted to the value at the time of inheritance. This readjustment—referred to as “step-up in basis”—has the effect of reducing the capital gains tax on an asset that has appreciated in value between the time it was purchased and the time it was inherited. For example, an investor purchases shares at $1 and leaves them to an heir when they have grown to $5. Because this asset receives a step-up in basis, the capital gains tax will not be based on growth in value from its original $1 purchase price, but instead from the $5 value when it was inherited. The appreciation in value from $1 to $5 effectively avoids the capital gains tax.

A significant portion of the value of many estates is in the form of unrealized capital gains (i.e., the growth in stock value above the price at which it was purchased). In the absence of the estate tax, the value of these unrealized gains could be passed on to the next generation without being subject to any taxation. Among estates worth more than $500,000, over a third of estate value is in the form unrealized capital gains; among estates in excess of $5 million, over half of the estate value comes from these unrealized gains.† The 2014 Minnesota Estate Tax Study, prepared by Minnesota Department of Revenue (MDOR), concludes that:

The estate tax can function as a backstop to the income tax. Because the basis of appreciated assets is “stepped up at death,” much of the earnings from those assets is never taxed.

A typical Minnesotan earning $50,000 a year will pay state and local income taxes on their earnings. Meanwhile, an heir or heiress can receive an estate valued at ten or potentially even one hundred times this amount without paying a single dime in state or federal income or estate or capital gains taxes on this windfall. This is the epitome of an unfair tax system.

We will explore additional right wing criticisms of the estate tax—as well as reasons to maintain and to rebuild it—in the third and final part of this series.

 

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*In addition to the general exclusion, Minnesota estate tax law allows an additional exclusion for farms and small businesses, which raises the total effective exemption for these entities to $5 million.

These findings are based on a review of literature presented in the 2014 Minnesota Estate Tax Study prepared by the Minnesota Department of Revenue.