Order Code RS20609
Updated January 29, 2003
CRS Report for Congress
Received through the CRS Web
Economic Issues Surrounding the Estate and
Gift Tax: A Brief Summary
Jane G. Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
Summary
Supporters of the estate and gift tax argue that it provides progressivity in the
federal tax system, provides a backstop to the individual income tax and appropriately
targets assets that are bestowed on heirs rather than assets earned through their hard
work and effort. However, progressivity can be obtained through the income tax and
the estate and gift tax is an imperfect backstop to the income tax. Critics argue that the
tax discourages savings, harms small businesses and farms, taxes resources already
subject to income taxes, and adds to the complexity of the tax system. Critics also
suggest death is an inappropriate time to impose a tax. However, the effect on savings
is uncertain, most farms and small businesses do not pay the tax, and complexity could
be reduced through reform of the tax. This report will be updated as legislative
developments warrant.
The estate and gift tax has been the subject of legislative interest for several years,
with increases in the exemption enacted in 1997. Proposals to reduce or eliminate the tax
were adopted in the 106th Congress, but were vetoed by the President. President Bush had
also proposed eliminating the tax and the Ways and Means Committee reported out a bill,
H.R. 6 that would phase out the tax. Similar provisions were included in the Senate bill
and the final tax cut bill, H.R. 1836, signed by the President on June 7, 2001, although
this legislation retained a gift tax with a large exemption.1 The entire bill is to sunset on
2010, but there are proposals to make the change permanent.
The estate and gift tax is a comparatively small source of federal tax revenue,
accounting for 1.5% of federal receipts. Estates and gifts to spouses are exempt from tax
1 For a more extensive discussion of estate and gift tax issues see CRS Report RL30600, Estate
amd Gift Taxes: Economic Issues. See CRS Report RS20592, Estate Tax Legislation: A
Description of H.R. 8 by Nonna A. Noto for a further information on H.R. 8 and other proposals.
See also CRS Report 95-416, Federal Estate, Gift, and Generation-Skipping Taxes: A
Description of Current Law, by John R. Luckey.
Congressional Research Service ˜ The Library of Congress
CRS-2
as are gifts to charity. The first $675,000 of the net estate and gift value is exempt from
tax (this exemption rises to $1,000,000 by 2006) and is in addition to an annual gift
exclusion of $10,000 per donee. Taxable estates are subject to rates from 37% to 55%
and there is also a credit for state estate taxes.
Arguments for the Estate and Gift Tax
Perhaps the principal argument in support of an estate and gift tax is its contribution
to progressivity in the income tax system. The estate tax is the most progressive of any
of the federal taxes. According to the latest data from the Internal Revenue Service, out
of the approximately 2.3 million deaths per year, only 1.9 % of estates pay estate tax (and
only 4.3 % file a return). These numbers can be contrasted with the income tax where
about 70 % of families and single individuals owe tax. In addition, in 1997 about 56 %
of those paying an estate tax had gross estates valued at more than $1 million. Because
the exclusion is rising to $1 million by 2006, the share of decedents’ estates paying estate
taxes will fall somewhat; the fall would be greater but for the growth in wealth that has
been fueled by a rising stock market. Progressivity in the tax system, however, could also
be altered through changes in the income tax.
Another argument made by proponents of the estate and gift tax is that, to the extent
that inherited wealth is seen as windfall to the recipient, such a tax source may be seen by
some as fairer than taxing earnings that are the result of work and effort.
Finally, many economists suggest that an important rationale for maintaining an
estate tax is the escape of unrealized capital gains from any taxation, since heirs receive
a stepped-up basis of assets. Families that accrue large gains through the appreciation of
their wealth in assets can, in the absence of an estate tax, largely escape any taxes on these
gains by passing on the assets to their heirs. The base of the estate tax is, however, quite
different from the base of the capital gains tax, and the rates are higher.
Arguments Against the Estate and Gift Tax
An important criticism of the estate and gift tax is that it reduces savings and
economic growth. However, as is also the case for the income tax, neither economic
theory nor empirical evidence clearly indicate that the estate tax reduces savings. For
example, while the estate tax may discourage saving for bequests because the cost of
making a net bequest (in terms of forgone consumption) increases, the tax also requires
a greater amount of saving to achieve a net target. Estate and gift taxes are unlikely to
have much effect on assets accumulated for precautionary purposes. Bequests can also
reduce saving by heirs, because they increase resources for consumption.2
2 For an analysis of these savings effects and indications of a limited and uncertain effect from
empirical data see William G. Gale and Maria G. Perozek, Do Estate Taxes Reduce Savings? and
Wojciech Kopczuk and Joel Slemrod, The Impact of the Estate Tax on Wealth Accumulation and
the Avoidance Behavior of Donors, both papers presented at the Brookings Conference on Estate
and Gift Taxation, May 4-5, 2000.
CRS-3
A second major argument against the estate and gift tax is that it burdens family
businesses and farms and makes it more difficult to pass on these assets to the next
generation who can continue the business. However, only a small portion (less than 5%)
of businesses and farms are likely to be affected; many of those have sufficient liquid
assets to pay the tax. In addition, extensions of time to pay the tax are allowed.3
Critics also argue that death is not an appropriate occasion to impose a tax; indeed,
the tax is sometimes referred to as a “death tax.” Another argument is that wealth has
already been taxed through income taxes, though this is not the case for unrealized capital
gains. Finally, critics assert that the complexity of the tax not only imposes
administration and compliance burdens but undermines the progressivity of the tax.4 Of
course, this latter argument could also be a justification for reforming rather than reducing
or abolishing the tax.
Other Issues
Two other economic effects of the tax that might be considered in evaluating
changes are the possible negative effect on charitable contributions (because charitable
contributions are deducted from the estate and gift tax base) and the effect on state and
local estate taxes. Currently, a credit is allowed against estate and gift taxes for state
estate taxes; eliminating the federal estate tax may create pressure on states to reduce
these taxes which will now become a more visible burden on their residents.
3 For analyses of the estate tax data see CRS Report RL30600, Estate and Gift Taxes: Economic
Issues; CRS Report RS20593, Asset Distribution of Taxable Estates: An Analysis, by Steven
Maguire; and Estate Taxes, Life Insurance, and Small Business by Douglas Holtz-Eakin, John
W. Phillips, and Harvey S. Rosen, National Bureau of Economic Research working Paper 7360.
4 For a discussion of avoidance methods and an estimate that indicates reasonable compliance
and administrative costs, see Charles Davenport and Jay Soled, Enlivening the Death-Tax Death-
Talk. Tax Notes, July 26, 1999, pp. 591-629.