Billionaires' Heirs Gain As Democrats Fracture On Estate Tax

(Bloomberg News) Senate Democrats, who are united in support of higher income tax rates for millionaires and billionaires, are paralyzed by disagreements on how to tax the estates of the wealthiest Americans.

Lobbied by business owners and billionaires, Democrats including Mark Pryor of Arkansas and Mary Landrieu of Louisiana resisted a proposal from President Barack Obama to tax individual estates of more than $3.5 million -- roughly three in 1,000 -- at a top rate of 45 percent. The split among Democrats, who control the Senate, will give Republicans more influence on the issue after the Nov. 6 election.

"It's something that's really divided and perplexed our caucus about what's the fair way to move forward," said Landrieu, who supports repealing the estate tax and wants to reach a compromise with Republicans. "We don't have the votes to do anything, really, with it."

As a result, when the Senate votes as scheduled at 2:15 p.m. in Washington today on a bill to extend income tax cuts that expire Dec. 31, the proposal will be silent on the estate tax. Democratic leaders in the Senate sidestepped the estate tax to focus on an issue on which almost all of them agree: Obama's plan to let income tax cuts expire for the top 2 percent.

"It really should be a no-brainer," said Michael Linden, director of tax and budget policy at the Center for American Progress, a Washington group typically aligned with Democrats. "You've got people who are otherwise very much in favor of progressive taxation who just get a little queasy about the estate tax."

Democrats who balked at Obama's proposal say they are worried about the effect of increasing the estate tax rate and lowering the per-person exemption to $3.5 million from $5.12 million for farms and small businesses. Republicans favor the $5.12 million exemption, which means a compromise on the issue would be more generous to estates than Obama's plan.

One other reason, said Paul Caron, a law professor at the University of Cincinnati, is the "brilliant" public-relations move by estate tax opponents, who rebranded the issue as the "death tax," making it unpopular even among those who will never have enough wealth to pay it.

Additionally, home-state interests such as Montana ranchers, represented by Democratic Senators Max Baucus and Jon Tester, and the billionaires of Wal-Mart Stores Inc.'s founding Walton family in Arkansas shape lawmakers' positions on the issue, said Michael Graetz, a law professor at Columbia University in New York who co-wrote a book on the politics of the estate tax.

Democrats, who control 53 seats in the 100-member Senate, are trying to muster a majority for Obama's plan to extend most of the income tax cuts first enacted in 2001 and 2003. Republicans can use Senate rules to require a 60-vote threshold, meaning that the income tax plan isn't expected to advance.

The politics of the estate tax center on two numbers: the per-person exemption and the top tax rate. The exemption matters most to business owners, farmers and ranchers who can use it to avoid estate tax liability. For billionaires, the rate is the priority.

This year, the per-person exemption is $5.12 million and the top rate is 35 percent. Obama agreed to those parameters as part of a December 2010 deal with Senate Republicans that also extended expiring tax cuts and created a payroll tax cut.

Under those numbers, which Republicans want to extend, 3,600 estates would pay taxes, or fewer than 0.2 percent of estates, according the nonpartisan Joint Committee on Taxation.

Obama proposed a $3.5 million per-person exemption and a 45 percent top rate, returning to parameters that were in effect in 2009. That would require 7,200 estates, or about 0.3 percent, to pay taxes.

If Congress does nothing, as would be the case if the Democratic bill and no others became law, the exemption would drop to $1 million and the rate would rise to 55 percent. Under that regime, the tax would affect about 2 percent of estates, or 55,200, according to the JCT.

The U.S. is expected to collect $11 billion in estate and gift taxes in fiscal 2012, according to the Congressional Budget Office. Obama's plan would raise $9 billion more, and allowing the $1 million exemption and 55 percent rate to take effect would raise an additional $22 billion beyond Obama's proposal, according to JCT.

Senate Majority leader Harry Reid, a Nevada Democrat, included Obama's estate-tax proposal in the first draft of his bill. He then backed off after hearing objections from some Democrats, including Pryor and Kay Hagan of North Carolina.

"You're not going to address every single issue in any given piece of legislation," Jason Furman, deputy director of the White House National Economic Council, told reporters on a conference call yesterday. "Estate tax will have to be dealt with separately."

The same dynamic occurred in April 2009, as 10 Senate Democrats joined Republicans in a test vote that showed majority support for a $5 million exemption and 35 percent top rate. Among Democrats joining the Republicans on that vote were Patty Murray and Maria Cantwell of Washington and Baucus and Tester of Montana.

Baucus contends a decision on the estate tax should be part of a so-called grand bargain lawmakers will try to reach later on a wide range of tax issues. Reid hasn't said why the Democrats dropped the estate-tax provision, although second- ranking Senate Democrat Dick Durbin of Illinois said it was because of disagreement among party members.

"For whatever reason, I think Democrats get kind of weak in the knees on the estate tax, and I don't understand exactly why," Caron said. "The estate tax really is millionaires and billionaires, so I don't understand the optics and the politics."

Graetz said senators personally know successful business owners who are worried about the tax, and that segment of the population -- not the billionaires -- has become the dominant narrative about the estate tax.

"It's not small business owners that are paying the tax," Graetz said. "It's small business owners that are making the tax so difficult to impose."

Under current rules, the tax would affect about 200 small businesses and 100 farmers, according to the Joint Committee on Taxation. That would jump to 2,700 and 2,400, respectively, if Congress doesn't act. The numbers under Obama's proposal would be 400 and 300, respectively.

Chris Whitcomb, tax counsel at the National Federation of Independent Business in Washington, said his group, which represents small business, is concerned about both the exemption and the rate. The current stalemate creates uncertainty about what the tax will look like in 2013, he said.

Republicans have been trying to take advantage of the disarray among Democrats to accuse them of seeking the $1 million exemption and 55 percent rate.

"My concern is for the small business owners, the ranchers and the farmers of the country that are going to end up suffering under this Democrat proposal," said Senator John Barrasso, a Wyoming Republican.

The death-tax rhetoric has overwhelmed arguments for keeping the estate tax, Linden said. He contends the tax reduces concentrated wealth, is relatively efficient because it doesn't tax people as they earn, and affects only a few people. The closest thing to a consensus view among Democrats, he said, would have been seen as a huge concession a decade ago.

Senator Jay Rockefeller, a West Virginia Democrat, said the tax would affect only a tiny fraction of people in his state.

The political debate on the issue has an "irresponsible life of its own," he said. "It is so absurd."

The Senate Democrats' bill is S. 3412. The Republican proposal is S. 3413.