Reform, repeal-and some sharp differences of opinion.
(This is the first in a series of articles about the federal estate tax and what the affluent think about it. To see the full research report, please go to www.ResourceNetworkLTD.com.)
There's precious little that Republicans and
Democrats can agree on these days, and the fate of the estate, or
death, tax-whether it should be reformed or repealed or left as is-is
definitely not on the list.
That's hardly surprising, as it would be difficult to come up with a more potent formula for discord than taxes + death + politics. But the breadth of the debate and the range of "informed" opinion are truly startling. Depending on which side of the argument you come down on, for example, repeal or reform of the estate tax will/will not favor the rich; will/will not increase the federal budget deficit; will/will not be the death knell for tax-deductible charitable giving; will/will not discriminate against farmers and small business owners; will/will not lead to a "trickle down" effect-and so on.
While we're not going to take a position for or against, we did recently conduct a survey with affluent Americans, the people most likely to pay (and, not incidentally, most likely to try avoid paying) the estate tax. All of our survey respondents, 482 in total, had a net worth of at least $1 million and were aware that the federal estate tax was being considered for reform or repeal. Of our respondents, 58% had a net worth between $1 to $10 million, 29% had a net worth between $10 to $20 million and the remaining 13% had more than $20 million. Here are some of our key findings:
71.8% of the respondents said the federal estate tax was "unfair";
77.6% wanted to reform the federal estate tax;
22.4% wanted to repeal the federal estate tax;
71.8% believed that any repeal/reform of the estate tax wouldn't be permanent;
48.7% believed wealthier Americans should shoulder a larger share of the tax burden; and
54.0% employed various legal strategies and structures to shelter their wealth because of the estate tax.
However, as we shall see in subsequent columns, not even the affluent march in lockstep on this contentious issue, and there are considerable differences of opinion when they are further divided into groups based on their total net worth, whether they made their money or inherited it, and whether they believed the federal estate tax should be repealed or simply reformed.
A Short History Of The Estate Tax
The first estate tax in any form was levied in 1797 to help raise money for the Navy, but it only consisted of having to buy stamps for wills and estates. The estate tax reappeared in various forms over the next century to help fund the Civil War and Spanish-American War, but in every case it was repealed soon after the wars ended. The estate tax finally arrived for good as part of the Revenue Act of 1916, which taxed net estates of more than $50,000 ($11 million in today's dollars, according to the Heritage Foundation) at a top rate of 10%. The rate fluctuated somewhat after that-FDR raised the top rate to 70% in 1935-but the estate tax remained more or less unchanged until 2001.
The Estate Tax Today
By 2001, the exemption for the estate tax was $675,000 and the top rate was 55%. As a result of the tax reform bill of 2001, the size of the exemption has been rising each year and the rate of taxation has been likewise declining toward a $3.5 million exemption in 2009 ($7 million per couple) and a top rate of 45%. The tax is then scheduled to disappear completely in 2010 before coming back in 2011 at the pre-2001 rates. However, one of the few points that both sides agree on is that the estate tax will not come back in its pre-2001 form-something's gotta give. Prior to 2011, the estate tax will be reformed or repealed, depending on who can summon the most votes in Congress. In April of this year, the House voted to repeal the estate tax, for the second time in two years, but the bill remains stalled in the Senate.
It should also be noted that, whether one believes in sharing the wealth or not, the estate tax is indeed the special burden of the affluent. In 2003, for example, it was only paid by about 2% of Americans, generating $22 billion in revenues. But while about 66,000 estate tax returns were filed in 2003, according to the IRS, less than half were taxable. In fact, very few people pay at the maximum rate or anything close to it. In 2003, according to the IRS, the estimated effective estate tax rate was only 18.6%, a testament to the number of deductions and shielding strategies available. Indeed, some economists suggest that the amount of money spent on such strategies and estate tax revenues all but cancel each other out.
In our study, we surveyed 483 affluent individuals, all of whom knew about the debate over repealing or reforming the federal estate tax. Of that group, 83.2% were self-made millionaires and the other 16.8% inherited their money.
When it came to the main question, "do you believe that the estate tax should be repealed or reformed?" the answer was no shock given the fact that affluent Americans are the ones who pay the estate tax: 77.6% of the respondents voted for reform and the other 22.4% for repeal. No one thought it should remain unchanged.
A Matter Of Faith
When we asked the respondents specific questions about the estate tax, more than 70% agreed that it was not only "unfair" but a form of double taxation that less-affluent Americans are not subject to (Figure 1). Even so, almost half felt that wealthier Americans should bear a larger share of the tax burden by giving more back and, along the same lines, they thought that a progressive tax, where the more you had or made the more you paid, was a good idea. They disagreed, however, that the current tax system benefited them more than their fellow Americans in lower tax brackets.
As an aside, one of the oft-cited arguments for those promoting repeal is that the estate tax is punishing to small business owners and farmers who are sometimes forced to sell their businesses to cover estate taxes. In this case, despite the fact that more than three-quarters of the respondents were business people, there was no such evidence, with only 0.8% saying they knew someone who had sold their business or farm for that reason.
Repeal Vs. Reform
When it came to what would be done, the respondents showed just how little faith they had in the lasting power of politics, with more than 70% agreeing that any action on the estate tax would be temporary. Two-thirds felt that repeal or reform would increase the budget deficit, yet less than one in five thought repeal or reform would lead to new taxes of user fees, despite the shortfall. Regarding other hot topics, less than one-third thought that repeal or reform would bring an end to the high cost of estate planning necessitated by the tax, and a similarly small percentage thought that repeal or reform would reduce charitable giving, although it has been estimated that it could fall by as much as $10 billion a year should the estate tax be repealed (Figure 2).
Finally, we found that better than half of the affluent respondents said they used various legal strategies and structures to avoid the estate tax (slightly higher than the 48.2% who said they used such tactics because of income tax) (Figure 3).
When it came to two of the other popular arguments for abolishment or reform-the fact that the estate tax forces the affluent to spend money or transfer assets so that the government doesn't get it-the data showed otherwise. In fact, less than 5% said they had transferred assets and less than 1% said they were spending more. Lastly, in yet one more indication that the very wealthy are not like the rest of us, an impressive 43.3% had enough clout to have actually talked to a politician about repealing estate taxes.
For financial advisors, this information and perspective is valuable on two fronts. When it comes to minimizing taxes, the affluent are interested if not downright obsessed, so any topical data can be used to further build a relationship. From a more practical and profitable standpoint, knowing how the affluent feel about various aspects of estate taxes can lead directly to products and services, such as charitable giving and estate planning, to name just two examples.
Hannah Shaw Grove is managing
director with Merrill Lynch. Russ Alan Prince is president of the
consulting firm Prince & Associates.