Wills, Trusts & Estates Prof Blog

Editor: Gerry W. Beyer
Texas Tech Univ. School of Law

Friday, November 12, 2010

Letting the Estate Tax Die

Estate Tax Professor Richard Thaler wrote an article, which I previously blogged about, that noted that only 3 estates in 1,000 would be subject to the estate tax at a $3.5 million exemption level. He further added that those subject to the tax could afford a good attorney to increase the effective size of their exemption even further.

Professor Casey Mulligan countered with an article demonstrating that the potential for avoidance behavior is precisely why the proposal for a $3.5 million exemption is so damaging to the economy. He demonstrates that taxes affect behavior, and thus the economy, by using telephone-service taxes as an example:

Consider a business with, say, 1,000 telephone calls a day and no telephone tax. If the government began to assess a penny tax on each call the business pays for — outgoing, incoming 800 and collect calls — and the business did nothing in response, the business would owe $10 a day in telephone tax.

But the business would probably consider alternative means of communicating with customers and suppliers and might soon no longer have 1,000 calls a day. It might, for example, switch some or all of its calling to an Internet-based system. Or it might give customers additional incentives to place orders or make inquiries on its Web site, rather than call using its toll-free number.

These actions might reduce taxed calling to, say, 800 a day, from 1,000, and thereby reduce the telephone tax bill by $2 a day (see the middle column of the table below). But those actions would be costly to other parts of the business; some customers might be lost because they were not called, or revenue might be reduced through the incentives given to get customers to use the Web. Those additional costs would be roughly $1 a day.

Ultimately this telephone tax brings $8 a day to the public treasury, but it costs the company $9: $8 sent to the treasury and $1 in tax-avoidance behavior. The taxpayer is harmed more than the amount received by the public treasury, because the taxpayer took costly actions to make sure that the tax liability was not even higher.

     .   .   .

This business propensity to avoid the tax by seeking other communication means would be the same if the tax law provided a tax exemption for the first, say, 400 calls a day, because reducing calls from 1,000 to 800 would still result in a tax saving of $2 per day. The only difference is that public treasury would get less revenue with the tax exemption in place: $4 per day rather than $8. And the tax exemption means that each $8 brought the treasury costs the taxpayer $10 rather than $9 (with the exemption it takes two days to get $8 in revenue, rather than one day).

Tax exemptions (like the estate tax exemption) and other loopholes manage to reduce the revenue collected by the treasury without necessarily affecting the taxpayer’s marginal tax rate. Estate tax exemptions thus raise the excess burden on taxpayers beyond the revenue surrendered to the treasury.

Casey B. Mulligan, Letting the Estate Tax Die, N.Y. Times, Nov. 11, 2010.

Special thanks to Jim Hillhouse (WealthCounsel) for bringing this to my attention.


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