When the Levy Breaks

By Tim Fernholz

Permit me to bend your ear about one of my favorite subjects: the estate tax! Congress, in its infinite wisdom, accidentally lifted the estate tax for the next year, which should bring great joy to the handful of very wealthy people affected by the tax. Reading The Wall Street Journal's coverage of the situation─RICH CLING TO LIFE TO BEAT TAX MAN is certainly a headline for the ages─you'd think this is pretty dire. But I'm having a hard time sympathizing with the 5,500 people in the country whose estates fall into the range of the tax.

Until Jan. 1, the tax takes up to 45 percent of any estate worth more than $3.5 million, or $7 million for a couple, though the "effective rate" including loopholes is 20 percent. Conservatives call it the "death tax"─it's always death with them, isn't it?─but as Michael Kinsley convincingly argued last spring, the estate tax is unique among levies in that it actually incentives work and investment, something conservatives ought to value.

The tax was scheduled to sunset as part of the Bush administration's tax-cut package, and Democrats tried to keep the current law in affect for the next year; Republicans hoped to raise the exemption to $10 million per couple and lower the top rate by 10 percent, and in the end nothing was done. If Congress continues to do nothing, there's another wrenching automatic change in 2010: The exemption is lowered to $1 million and the top rate becomes 55 percent, meaning more people pay more money. Consistency, that hobgoblin of small minds, is no problem on Capitol Hill.

While all this sounds pretty abstract to the other 300 million or so people in the country who don't have a several-million-dollar estate coming their way, the debate over this tax is still important because, whether Americans like it or not, taxes are going up in the near future in order to manage the deficit and national debt─there's just no other way around it; even with spending cuts, moderate tax increases are going to be part of the future. Both the public and politicians prefer big government and low taxes, but the two can't go hand in hand for long (see Bush, George W.). Even though realistic observers shouldn't give much credence to the huffing and puffing of debt scaremongers, fixing the structural deficit is a long-term necessity if, Lord help us all, Congress can get around to it.

But Republicans and moderate Democrats (I'm looking at you, Blanche Lincoln) currently devote ridiculous amounts of time and energy, including procedural maneuvers usually reserved for big-time legislative changes, to repealing the estate tax. They support a handout to millionaires while touching populist notes on the horrors of the bank bailouts or complaining about the budget deficit. If this prosaic hypocrisy, with dozens of senators using their valuable time to protect a few thousand millionaires, is the standard for a relatively small portion of the tax code, imagine an attempt to fix the whole mess.

Even worse, despite complaints about family farms and small businesses going under because of the tax (there are only 13 farms that might be affected), the real irony is that next year's repeal puts more financial pressure on those farms and businesses than the tax itself: the Center on Budget and Policy Priorities has released an analysis showing that, in place of the narrowly targeted estate tax, onerous new capital gains tax requirements are set to affect more than 70,000 estates. The bottom line is that family farms and small businesses will, on balance, be much better off if Congress extends the current rules for the estate tax and the capital-gains treatment of inherited assets," Chuck Marr, the center's tax expert, writes.

That's the state of play in Washington today. Imagine what's going to happen when someone has the chutzpah to suggest we need a value-added tax, or maybe that corporations ought to pay taxes, too, or simply that we need to eliminate loopholes in order to broaden the tax base. But let's start small. In the new year, the Senate is set to try to fix the estate tax again, among other tax issues. Do you think they'll find a way to compromise without giveaways, loopholes, or unexpected consequences?

Me neither.