Estate Tax Increases Fairness

The one tax that conservatives seem to hate more than any other is the estate tax. Before the significant estate tax relief enacted in 2014 is even fully phased-in, they want to cut the tax again. However, the estate tax is an effective way to prevent the accumulation of extraordinary levels of wealth in the hands of a very fortunate few and limit the deleterious effects associated with extreme wealth concentration. Furthermore, the estate tax—dollar for dollar—does more to reduce tax regressivity than any other tax in the state, since it falls upon only a small sliver of the state’s wealthiest households.

The estate tax is a tax on the transfer of wealth upon death. Amounts given to charity or to a spouse, as well as debts, funeral expenses, and estate administration costs are excluded. Of the remaining “taxable estate,” a considerable portion is exempt from taxation. In 2014, the exemption amount was increased from $1 million to $1.2 million for deaths occurring in 2014 and by $200,000 in subsequent years, until reaching a $2 million exemption for deaths occurring in 2018. To facilitate the transfer of farms and small businesses to succeeding generations, an additional amount—up to $5 million total (including the standard exemption described above)—of farm and small business estates is further exempt. Minnesota’s estate tax is imposed based on a graduated rate schedule, with the highest rate (16 percent) imposed on the highest value estates.

In 2014, the Minnesota gift tax was also repealed, although gifts in excess of an annual exclusion amount are included in a decedent’s Minnesota taxable estate.

According to a 2014 estate tax report prepared by non-partisan staff at the Minnesota Department of Revenue (MDOR), only 5,600 (2.5 percent) of the 229,000 deaths in Minnesota from 2007 to 2012 resulted in an estate tax payment. Because of the large exemptions and the graduated rate structure, the tax is concentrated among high value estates, with the very largest estates having the highest effective tax rates, defined as the total estate tax liability as a percentage of gross estate value.

Estate tax

The effective tax rates shown above do not reflect the estate tax relief enacted in 2014. By the time that the 2014 provisions are fully phased-in in 2018, the number of estates subject to the tax and the tax paid by them will decline relative to what is shown in the chart. In fact, taxable estates of $2 million or less will pay no estate tax. (MDOR estimates that the 2014 estate tax changes will reduce FY 2017 estate tax revenue by 30 percent; the revenue loss due to the 2014 changes should be even greater when the higher exemption levels are fully phased-in.) Even prior to the 2014 estate tax relief, the Minnesota estate tax did not exceed five percent of gross estate for any income group. Thus, Minnesota’s estate tax was only modestly reducing, but by no means eliminating, the intergenerational transfer of wealth—and even then only among estates of extremely high value.

As noted in the 2015 Minnesota Tax Incidence Study (MTIS), Minnesota’s state and local tax system is regressive, with the highest income households paying the lowest amount of taxes as a percent of income. If the estate tax were eliminated or further reduced, Minnesota’s tax system would grow even more regressive. The estate tax is by far the most progressive of all Minnesota taxes, being nearly four times more progressive than the next most progressive state tax, the individual income tax.* Even though the estate tax comprises only about 0.9 percent of total state tax revenue during the current biennium,† it is still highly efficient at reducing statewide tax regressivity. Based on North Star analysis of projected 2017 data from the 2015 MTIS, the degree of state and local tax regressivity in Minnesota would increase by fifteen percent if the estate tax was eliminated.‡

The estate tax also helps to prevent the intergenerational accumulation of wealth in the hands of a tiny minority. In recent decades, income and wealth has become increasingly concentrated at the top of the economic spectrum, while the income and purchasing power of lower and middle income households have eroded. Even a robust estate tax alone would not have prevented this trend, but it is does play a role in mitigating excessive wealth concentration.

Bill Gates Sr., the father of the world’s richest person, presents a powerful moral rationale for the estate tax, noting:

…the person who accumulates wealth in this country was not able to do that independently. The simple fact of living in America, a country with stable markets and unparalleled opportunity fueled in part by government investment in technology and research (something my family has plenty of firsthand experience of), provide an irreplaceable foundation for success and have created a society which makes it possible for some men, women and their children to live an elegant life… So I believe that those of us who have benefited so greatly from our country’s investment in our lives should be asked to give a portion of our wealth back to invest in opportunities for the future. Society has a just claim on our fortunes and that claim goes by the name estate tax.

Gates and others have noted that if estate taxes are cut or eliminated, the foregone revenue will be recovered either through increases in other taxes paid by families with far less wealth, through cuts in public spending on education, infrastructure, and other assets, or through a combination of both.

Another argument in favor of the estate tax is that it provides a way of taxing income that would otherwise go completely untaxed. For example, in the absence of an estate tax, the growth in stock value above the price at which it was purchased could be passed onto the subsequent generation without being subject to any tax. The same income would be taxed as capital gain if it were sold prior to death. (Even with an estate tax, much of this unrealized gain still goes untaxed because of the large estate tax exemptions.) The MDOR estate tax report notes that among estates with value in excess of $5 million, most estate value is in the form of these unrealized gains.

The estate tax has been a positive feature of Minnesota’s tax system—reducing tax regressivity, mitigating the intergenerational concentration of wealth among an elite few, allowing the state to tax unrealized capital gains that would otherwise go untaxed, and requiring the wealthiest households that benefit most from a stable society to make a more appropriate contribution toward the maintenance of that society. However, a consideration of the estate tax would be incomplete without addressing the criticisms of the tax. These will be examined in part two of this series.

 

*The Suits index is a measure of tax regressivity, with an index of +1.0 denoting a perfectly progressive tax, an index of -1.0 denoting a perfectly regressive tax, and an index of 0 denoting a proportional tax. Based on projected 2017 data from the 2015 MTIS, the Suits index for the estate tax is +0.862, which is 3.7 times greater than the next most progressive tax—the individual state income tax—with a Suits index of +0.231. (Suits indices reported here are full sample.)

Estate tax revenue as a percent of total state tax revenue is projected to decline to 0.76 percent of total state tax revenue in the upcoming biennium (FY 2018-19), as estate tax revenue continues to shrink as the estate tax exemption increases as prescribed in the 2014 legislation.

Based on the 2015 MTIS, the Suits index for Minnesota’s entire state and local tax system is -0.035 based on projected 2017 data. If the estate tax was eliminated, the combined Suits index for the remaining state and local revenue would be -0.041. (Suits indices reported here are full sample.)