In less than three weeks, the hated death tax is scheduled to expire—with the rate falling from 45% to zero for 2010. Then the tax will be resurrected in 2011 at a rate of 55%. This bizarre policy dates back to 2001 when Democrats wouldn't let President Bush permanently kill the death tax, so Republicans bet that if the tax were eliminated for one year, it would never come back.
Well, the moment of truth has arrived, and House Democrats recently voted 234-199 to cancel the 2010 repeal and hold the rate permanently at 45% with a $3.5 million exemption. Senate Majority Leader Harry Reid now wants to do the same. But to suspend the Senate's health-care debate and turn to the estate tax, he needs 60 votes. All Republicans and some Democrats are saying no. Blanche Lincoln of Arkansas and Jon Kyl of Arizona will accept no more than a 35% permanent rate with a $5 million exemption.
We've long argued that the economically optimal and fairest death tax rate is zero. The tax is applied to income that was already taxed when it was earned, so it is a double tax on savings and capital. The correct way to tax a gain in the value of assets bequeathed to an heir is with a capital gains tax of 15% when the assets are sold, rather than at the time of the funeral of the original owner.
Democrats also say their rate would apply only to the richest 2% of estates. But a new study by economists Anthony Davies and Pavel Yakovel of Duquesne University finds that the estate tax "impacts small firms disproportionately versus large firms" by encouraging well-capitalized companies to gobble up smaller ones at the owner's death. The study shows the result is to "promote the concentration of wealth by preventing small businesses from being passed on to heirs." [The Effect of Estate, Inheritance, and Gift Taxes on the Survival of Small Businesses: A Panel Data Analysis.]
Republicans and willing Democrats shouldn't give up on eliminating the death tax. The Kyl-Lincoln amendment to create a permanent 35% rate is far better than the confiscatory House bill. But the best strategic outcome now is to let the death tax expire in January as scheduled under current law, and return to this debate next year when the tax rate is zero. Then let liberal Democrats explain to voters on the eve of elections that they must restore one of the most despised of all taxes.