The House

has voted once again to phase out the federal estate and

gift tax. The 1999 tax cut vetoed by President Clinton

included the phase-out of the so-called death tax, but

this year the estate tax phase-out was separated from

other measures and passed by more than a 2-1 margin.

Arguments for Repeal

Several factors explain the

popularity of repeal. The estate tax prevents small

businesses and farmers from passing their businesses on

to the next generation. It penalizes saving and capital

formation. And it greatly discourages the creation of new

wealth by America's most innovative, productive

entrepreneurs.

The estate tax once enjoyed

broad support on the grounds that it prevented an

excessive concentration of wealth. The fear was that huge

amounts of wealth would remain in the hands of the same

few families, generation after generation. Fortunately,

the economy each year is generating vast amounts of new

wealth and large numbers of newly rich people, solving

the concentration-of-wealth problem far more efficiently

than the estate tax ever could.

The Misleading Estimates

of Estate Tax Revenue

With all this against it,

the estate tax has one last remaining ally, and that is

the belief, supported by official estimates, that its

repeal would cost the U.S. Treasury substantial revenue.

Complaints from the White House focus on this issue.

In fact, eliminating the

estate tax certainly would not cost the Treasury nearly

the amounts that official estimates show. There are five

reasons why, and the first two come under the general

heading of robbing the income tax to avoid the estate

tax.

Reasons to Repeal

1. The gift tax robs the

income tax. Under current law a taxpayer may distribute

up to $10,000 tax-free each year to any person he or she

chooses. Typically, the donor's personal income tax rate

is much higher than the rate paid by the children or

grandchildren who are the recipients. Thus, the income

subsequently earned on these gifts is subject to a much

lower tax rate.

2. The estate tax erodes

the income tax base. The estate tax may dramatically

increase bequests to charities as taxpayers try to avoid

paying up to 55 percent of their accumulated savings to

the federal government. These assets end up producing

capital income for tax-exempt charities instead of

remaining in the estate where taxpaying recipients would

have earned the money.

Of course, charitable

organizations serve valuable social purposes, and not all

such bequests are motivated by the estate tax.

Nevertheless, the income tax consequences of tax-driven

bequests are significant and should not be ignored.

3. The disincentive effects

of the estate tax on entrepreneurial activity. Some years

ago the Tax Foundation studied the estate tax's effect on

entrepreneurial activity, and we found that the estate

tax's 55 percent rate had roughly the same effect on an

entrepreneur's incentive to earn as doubling the top

effective marginal income tax rate.

Thus, an entrepreneur

facing a 31 percent statutory income tax rate behaves as

if he is facing an effective 62 percent income tax rate.

As that rate rises and additional work yields less

after-tax return, entrepreneurs become more likely to

retire prematurely. Then they pay no income or payroll

taxes on wages and create no new wealth.

4. Estate planning is

phenomenally expensive. Official revenue estimates take

no account of the enormous amounts of money (deductible

from the income tax) that taxpayers spend on estate

planning. Since individuals worried about estate planning

are likely to be in the upper-income tax brackets, the

value of their estate tax planning deductions is great.

Absent the estate tax,

these individuals would likely shift the amounts spent on

estate planning to non-deductible expenses, or they would

save them. Either way, current or future income tax

receipts would be higher.

5. Compliance costs for

taxpayers and the IRS. Finally, if the estimators

produced a truly comprehensive estimate for estate tax

repeal, they would also account for the savings to the

IRS which spends millions of dollars each year attempting

to collect estate tax revenue. The resources devoted to

estate tax compliance would likely be redirected into

other areas of tax collection, areas that the estimators

have historically scored as increasing collections

significantly.

[Bill Ahern is

communications director for the Tax Foundation, a

nonpartisan, nonprofit organization headquartered in

Washington, D.C., that has monitored fiscal policy at the

federal, state and local levels since 1937. Visit them on

the Internet at www.taxfoundation.org.]