Reform, repeal-and some sharp differences of opinion.

(This is the second article in a series about the federal estate tax and what the affluent think about it. To see the full report, please go to
    For America's taxpayers and the politicians who represent them, few issues are as controversial and contentious as the federal estate tax. Born in its current form in 1916, it is, in essence, a tax on the estates of only the richest Americans, and it has led to the formation of two pitched camps: one for repealing the estate tax, the other for reforming it.
    President Bush and the Republican-led Congress want to repeal the estate tax because they regard it as an unfair and discriminatory penalty for wealth that discourages investment and economic growth, while punishing, in particular, the families of farmers and small business owners who might have to sell their farms or businesses at a loss to pay estate tax. Those on the reform side of the argument, mostly Democrats, contend that it's the obligation of America's wealthy to give something back, that there should not be an economic aristocracy based on inheritance rather than hard work, that repeal would dramatically reduce charitable giving, and that, with the federal deficit at an all-time high, no source of revenue should be overlooked.
    Since the tax bill of 2001, the individual estate tax exemption has been rising (it's now $1.5 million on the way to $3.5 million in 2009) and the top rate of taxation has been declining (it's now 47% on the way to 45% in 2007). In 2010, there will be no federal estate tax at all, but it's then scheduled to return at pre-2001 levels. The consensus, however, is that something will happen before then. Indeed, there has been conciliatory talk from both sides of late, and indications that an agreement of some sort may be hammered out by summer's end.
    That said, the two sides remain far apart, with the GOP looking for repeal or a tax rate of 15% and an individual exemption of $10 million. The Democrats, for their part, want an exemption of $3 million to $5 million and a higher rate. And, as yet, President Bush is still trumpeting repeal and has not even indicated that reform is an option.
    With that background, we wanted to know what America's affluent-the people most likely to pay the estate tax-thought about it. We surveyed 483 individuals, all of whom were aware of the arguments over the estate tax. Of that group, 281 respondents had a net worth between $1 million and $10 million, 138 between $10 million and $30 million, and 64 more than $20 million.
    As we noted in our last column, the majority of the respondents, 77.6%, felt that the estate tax should be reformed while the other 22.4% were for repeal. We also found that 71.8% thought the estate tax "unfair," 48.7% agreed that the wealthy should bear a larger share of the tax burden, 54.0% said they employed various strategies and legal structures because of the estate tax, and 71.8% thought any change was likely to be temporary.
    This time around, we're going to see where the opinions of the affluent respondents diverged, particularly when they were further segmented by their net worth. (Next month we will see how they differ when segmented by the source of their wealth.)
    First, however, we can make two generalizations that set the stage for the differences in opinion. The wealthiest respondents, those with a net worth of $20 million or more, are more likely to be familiar with (and more likely to have spent money on) strategies to reduce the bite of estate taxes. Furthermore they believe that as the wealthiest of the wealthy, they will always be paying estate taxes unless the tax is repealed ,as they have enough money to be beyond reach of even the highest possible individual exemption being considered.
    Now let's look more closely at some of the differences in opinion between the respondents. Keep in mind that these distinctions are important for the financial advisors who work with the affluent because they illustrate, once again, that the affluent are far from homogeneous and have to be understood and treated on an individual basis. 
    When we asked the 375 millionaires in favor of reform what was more important, raising the individual exemption or lowering the tax rate, we found the vast majority targeted the exemption (Exhibit 1). When we segmented the respondents by net worth, however, the percentages were all but reversed, with 91.7% of those with more than $20 million favoring a lower rate (Exhibit 2). Those with less money were locked in on the exemption because it could conceivably be raised to the point where they might not have to pay any estate taxes. Those at the highest end, as noted, realized they were most probably beyond the reach of any exemption, so they logically favored a lower rate.

    The differences in opinion were similar when we asked the respondents if there were any issues they thought more important than the repeal or reform of the estate tax. As a group, only one issue was cited by more than half: reducing federal income taxes (78.5%). When we segmented the respondents by net worth, however, the least affluent respondents named three issues: reducing federal income tax, fixing the alternative minimum tax and increasing funding for schools (Exhibit 3). In contrast, none of those issues resonated with even one-third of the most affluent respondents.
    When the millionaires were asked for their opinions about the estate tax and the economy, almost half of the respondents (48.2%) believed that a federal estate tax was good for the country and that the wealthy should bear a larger share of the tax burden (48.7%). Slightly less, 39.8%, felt the wealthy owed the government something for living in a society where wealth was possible. When segmented by net worth, the percentages again changed, in part because those at the high end were the ones already likely to be paying the most taxes (Exhibit 4).

    Next, we asked the respondents if they'd taken any action because of the estate tax or taxes in general. As noted last month, very few said they had increased discretionary spending or transferred their assets to heirs during their lifetimes, two of the key arguments behind repeal. However, 54.0% said they employed various strategies and legal structures because of the estate tax, 46.2% said they employed such strategies because of the federal income tax, and 43.3% said they had spoken to a politician about the estate tax. When segmented by net worth, the percentages, once again, shifted seismically (Exhibit 5). Those at the higher end were far more likely to have spent money to protect their wealth from taxes. (In fact, some proponents of repeal have argued that estate tax revenue is eclipsed by the money spent trying to avoid paying it.) Further, the most affluent were far more likely to have spoken with a politician about the estate tax, a measure of their considerable clout.


  Finally, we asked the respondents about the potential impact of repeal or reform of the estate tax on charitable giving and the amount of money they spend on estate planning. As a group, 29.8% said that reform or repeal would reduce charitable giving and 28.8% said it would end costly estate planning.
    In this case, the most affluent were the ones least likely to cut back on their charitable giving, despite the loss of the deduction, showing that they were indeed philanthropic. Further, more than half said their estate planning costs would go down, an illustration of just how much they are currently spending to shield their assets from the federal estate tax.

Hannah Shaw Grove is managing director with Merrill Lynch. Russ Alan Prince is president of the consulting firm Prince & Associates.