The year to throw mama from the train5 min read . Updated: 24 Oct 2010, 10:49 PM IST
The year to throw mama from the train
The year to throw mama from the train
If you happen to be a wealthy American with ambitions to start a multigenerational dynasty, 2010 offers the tax avoidance opportunity of a lifetime. To seize it, all you have to do is die within the next three months.
You read that correctly. Thanks to a stopgap 2001 law that Congress failed to amend in 2009, US plutocrats can leave an unlimited fortune to their heirs this year—but this year only— without paying a penny in estate tax. Draw a breath in 2011, however, and your heirs will owe the US government 55% of any legacy above $1 million (Rs 4.45 crore). Hence, one of history’s most macabre tax avoidance incentives. As some wags put it, 2010 is “the year to throw mama from the train".
Also Read Eric Schurenberg’s earlier columns
The absurd state of affairs might indeed be funny if only the debt-ridden US treasury didn’t so desperately need the $23 billion the estate tax would raise. And if only it weren’t such a perfect example of the ideological impasse that keeps Washington from exercising sorely needed fiscal discipline. And if only US mid-term elections were not a month away, which could mean that permanent repeal of the estate tax was a real possibility. India may not have its own estate tax, but if it ever wants to create one, it might want to pay attention.
Some background: The US has periodically taxed wealth passing between generations practically from the nation’s birth in the late 18th century. The modern estate tax dates from 1916, when Congress revived the concept to raise money for the 1914-18 war. The fundamental element is an inheritance tax, levied on assets that pass from you to your heirs. The law as practised in 2009—and presumably again in 2011—also includes two supplementary taxes designed to keep you from evading the inheritance tax: A lifetime gift tax, which covers assets you give away while living, and a “generation-skipping" tax, which covers assets you give in trust to grandchildren. All three are due the year you die.
In a way, the estate tax is the most American of taxes. Unlike a tax on income or consumption, it creates no disincentive to earn as much as you can or to spend as profligately as possible—the flip sides of the American dream. The estate tax does discourage the formation of multigenerational family fortunes, but that too is American, fully in keeping with the nation’s idealized image of itself as a place where you succeed or fail on the strength of your efforts, not the size of your trust fund. Warren Buffett, who has more to lose than most from an estate tax, has repeatedly stated that parents do their children no favour by bequeathing them excessive wealth. “A very rich person should leave his kids enough to do anything," he says, “but not enough to do nothing." (Buffett plans to give most of his wealth away to charity, and he and Microsoft founder Bill Gates have been travelling the world encouraging other billionaires to do the same; India’s wealthiest can expect a visit next year.)
Moreover, because the law exempts a large portion of wealth from taxation, only the wealthiest Americans ever actually pay it. In 2009, for example, the tax only applied to the portion of your estate that exceeded $3.5 million; a simple tax planning manoeuvre effectively extended the tax-free allowance to $7 million for married couples. You can further reduce the taxable portion of your estate by donating to charities ranging from religious institutions to universities, museums and theatres—and most wealthy American families do so. As a result, less than 2% of families that experienced a death in 2009 owed a penny in estate taxes. This feature accords with the progressive streak in US politics: It is only fair, say the progressives, that the rich should bear a heavier burden of supporting the government. Not only can they more easily afford the cost, but as society’s winners, they also benefited disproportionately from a government that promotes economic opportunity, rule of law and respect for private property.
So why was the law repealed in 2010, and why is it under attack today? Because the progressive streak is not the only force at work in US politics. Anti-government sentiment also runs deep among US conservatives, and for them taxes, as the enablers of big government, are inherently suspect. Frustration with the government and its inability to pull the US out of the economic doldrums has fuelled the growth of the rabidly anti-tax Tea Party movement—even though few Tea Party members are wealthy enough to face the estate tax.
The intellectual case against the estate tax is that it creates incentives that are inefficient or counterproductive. Most obviously, it discourages people from saving. Why amass a fortune, after all, if more than half of it will pass to the government at your death? That logic, however, fails to account for the effect an estate tax repeal would have on the prospective recipients of their parents’ wealth. How much would you save, for example, if you knew that you would one day inherit, say, Mark Zuckerberg’s billions tax free?
The most powerful case for repealing the estate tax, however, is emotional. In a masterstroke of political marketing, conservatives have labelled the estate tax the “death tax". It’s brilliant: Only the rich have estates but everyone dies. Conservatives have claimed that the estate tax falls too heavily on small businesses and family farms.
Conjuring images of sobbing widows forced to sell the family homestead to meet an estate tax bill gives repeal advocates another emotional trump card. While such victims of estate taxes exist largely in the imagination of anti-tax campaigners—the American Farm Bureau once admitted to The New York Times that it couldn’t name a single family that had to sell the farm to meet estate taxes—they have more emotional resonance than the real victims of estate tax repeal. Those, of course, are the future generations of taxpayers who’d face higher taxes.
As the November congressional elections close in on the final month, the battle over estate tax repeal has begun to assume some of the absurd quality as the current state of the law itself. In the face of a $1.6 trillion annual budget deficit, two-thirds of Americans say they favour repeal of the estate tax, a tax that fewer than 2% of them would ever pay. The betting is that deficit arithmetic will probably force Congress to reinstate the law, at least at its 2009 levels—that is, a 45% tax rate after a $3.5 million dollar exemption—but anything can happen. The Republicans are expected to capture one chamber of Congress in the November mid-term elections, and that could change the equation. Death and taxes may be certain, as the American philosopher/statesman Ben Franklin said. But death taxes? In an election year, not so much.
Eric Schurenberg is editor-in-chief, CBS Interactive Business Network, and former editor of Money.