CRS report: Estate and Gift Taxes--Economic Issues

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) repeals the estate tax in 2010. During the phase-out period, the new law increases the exempt amount to $3.5 million by 2009, lowers the top rate to 45% by 2007, and repealed the federal credit for state death taxes in 2005. The federal gift tax remains though the rate is reduced to the top personal income tax rate. After repeal of the estate tax, carryover basis replaces step-up in basis for assets transferred at death. The legislation includes an exemption from carryover basis for capital gains of $1.3 million (and an additional $3 million for a surviving spouse). However, the estate tax provision in EGTRRA automatically sunsets December 31, 2010. Thus, the estate and gift tax will be reinstated in 2011 as it existed before EGTRRA. In the 109th Congress, H.R. 8, which passed the House on April 13, 2005 (and it's Senate companion S. 420), would eliminate the sunset provision in EGTRRA, thus making repeal of the estate tax permanent. Repeal of the sunset (as in H.R. 8) would retain the EGTRRA changes to the taxation of capital gains of inherited assets and the gift tax. Supporters of the estate and gift tax cite its contribution to progressivity in the tax system and to the need for a tax due to the forgiveness of capital gains taxes on appreciated assets held until death. (The estate tax accounts for 1.2% of federal tax receipts.) Arguments are also made that inheritances represent a windfall to heirs that are more appropriate sources of tax revenue than income earned through work and effort. Critics of the estate tax argue that it reduces savings and makes it difficult to pass on family businesses and farms. Critics also argue that death is not an appropriate time to impose a tax; that much wealth has already been taxed through income taxes; and that complexity of the tax imposes administrative and compliance burdens that undermine the progressivity of the tax. The analysis in this study suggests that the estate tax is highly progressive, although that progressivity is somewhat undermined by avoidance mechanisms. Neither economic theory nor empirical evidence indicate that the estate tax is likely to have much effect on savings. Although some family businesses and farms are burdened by the tax, the estate tax applies to only a tiny fraction (approximately 3% or 4 %) of businesses that have, in most cases, sufficient liquid assets to pay the tax. Only a small percentage of estate tax revenues are derived from family businesses. Even though there are many estate tax avoidance techniques, it also is possible to reform the tax and reduce these complexities as an alternative to eliminating the tax. Thus, the evaluation of the estate tax may largely turn on the general appropriateness of such a revenue source and its interaction with incentives for charitable giving, state estate taxes, and capital gains and other income taxes. A number of alternative revisions are discussed including past proposals to reduce tax rates and exemptions as well as proposals to reduce the opportunities for tax avoidance and broaden the estate and gift tax base. This report will be updated as legislative events warrant.

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