Death Tax Repeal a Hoax

by Llewellyn H. Rockwell, Jr.

Every once in a while, it appears that Congress does something good for the American people. Such a moment came on Friday when the House passed the "Death Tax Elimination Act of 2000." Sounds wonderful, especially these days when future estates are accumulating rapidly due to economic expansion. Have the Republicans overcome their spineless nature to finally stand up for principle?

I'm afraid not. The final bill was far worse than advertised.

Like the "Freedom to Farm" bill of a few years ago, this one looks great on the surface. And, certainly, it is economically and morally urgent that the estate tax be repealed. It brings in nothing of any practical relevance for the government – which raises the question of why it exists at all. The answer has to do with ideology. It feeds the ravenous and envious appetites of egalitarians who can't stand the idea that anyone can be born with a financial advantage. They want every generation to begin with "equal opportunity," a phrase that originated in the socialist literature.

In fact, the freedom to bequeath and inherit is essential in a free society. It permits the rise of a segment of society capable of challenging the state in its social, cultural and economic status. It encourages the formation of a natural elite that is financially independent and socially secure. It's no accident that big-government types love the inheritance tax; the fastest path to achieving unquestioned obedience to government is to wipe-out intermediating institutions like family dynasties of substantial financial means.

The current law that loots the dead when their estates grow beyond $600,000 is an affront to justice and economic good sense. What a sham – a crime – that people have to pay high-priced lawyers to figure-out ways to get around the law, performing legal acrobatics merely to pass-on their estates to their kids, lest the government get what should stay in the family. The exemption is scheduled to rise, but far too slowly.

Alas, Congress has not liberated us. It's true that the original bill authored by Rep. Jennifer Dunn, R-Wash., is a winner. It cleanly eliminated the tax in stages, not fast enough, but enough to be worthy of support. The tax would fall by five percentage points per year until it is gone in 2010. At least that would permit people who are planning their estates now to count on the ability to pass sizeable amounts of wealth on to their children.

But then, two weeks ago, the pillaging House Ways and Means Committee, under the despotic rule of Bill Archer, got hold of the bill and gutted it. He didn't change the name; it still claimed to eliminate the tax, albeit much more slowly than the original version. No five-percentage-point reductions for him. No, he wants to take miniature steps of one, two and three percent. That's bad enough, but we are used to the Republican leadership trimming the proposals offered by lower-ranking members. That's the history of Republican Congresses.

But, this time, Archer wasn't satisfied to water down the bill. His committee has actually converted it from a tax-cutting bill to a tax-shifting bill. It might even be a tax-raising bill: the new version might actually make the present situation seem preferable. There is no a priori reason to think that the final bill that passed would cut taxes at all.

This fact wasn't exactly announced in a press release. Indeed, it is buried in an amended section under the title "repeal of step-up of basis at death," a way of saying that the children of the dead are about to be burgled. The economist who discovered this is Bruce Bartlett, a senior fellow at the National Center for Policy Analysis and an adjunct scholar of the Mises Institute. He may be the only independent economist in America who actually reads these tax bills with a critical eye and in detail.

Here's what Bartlett found. The Archer substitute bill imposed a new death tax to replace the present one, exactly on the year of its final elimination. The amended bill requires the beneficiary to pay a new capital gains tax, calculated based on present value minus the original purchase price. The basis is changed from the point of bequest to the original point of purchase. Hence, if your dad wills you a plot of land today and you sell it, you owe a tax based on the value accrued during his, not your, lifetime.

The Congress has merely renamed the tax, just like they renamed welfare and farm subsidies a few years go. Now, the inheritance tax will be merely folded into the capital gains tax. This is great from the government's point-of-view; it takes the pressure off them and changes the subject. But it doesn't change the reality.

The accounting costs of complying with the final bill, with its new replacement tax, would be egregious. (As Bartlett says, there may or may not be records.) Can you imagine researching the entire price history of inherited property? At the end, the tax may be very high indeed. In fact, the deceased may have held onto the property precisely to keep from having to pay the high capital gains tax.

The idea of repeal the step-up on basis is to close what is decried as a "loophole" in the law, which forgives capital gains tax when a person dies, with the new owner starting with a clean slate. The theory is that everyone should owe capital gains taxes – whether living or dead.

But this is preposterous. The dead, being dead, don't benefit financially from the increase in value of their property in their lifetimes because they never sold it. As for the heir, he should not be taxed for changes in value that occurred before he actually became the owner, otherwise he is being punished for the fact that his benefactor was a good investor.

Others argue that forgiving the capital gains tax at death causes people to hold on to property longer than economic fundamentals would dictate. But if that is the case, there is another way out besides piling one distortion on top of another: repeal the capital gains tax. That way, we can be sure that people's economic calculations are made without respect to the tax consequences.

Aside from moral problems and accounting difficulties, the new bill introduces strange new incentives. The elderly person suddenly faces a choice between selling property now and paying the tax or passing a potentially large tax liability onto the children. This diminishes the value of the property of the living and thus reduces the incentive to accumulate wealth and give it to the next generation. The present death tax does that too, but at least under the current system, there is an element of certainty about what the tax will be. Under the Archer Tax, no one will know for sure.

But the larger question is: why did anyone push for this misnamed bill? Many members knew nothing of the amendment put in by Archer. They thought they were voting for a clean repeal. But others did know; they hoped to get the credit for having "abolished" an awful tax, while the real story, the "repeal of step-up of basis at death," is sprung on us years down the line.

If Congress couldn't repeal the estate tax, a better path would have been to simply continue raising the exemption or speed-up the increases in the exemption already scheduled under present law. At minimum, there should have been no new tax! Once again, we are reminded that the reality of the Republican Congress doesn't live up to its reputation.