Revenue & Spending
Inheritance Tax Renewal to Be Part of "Fiscal Cliff" Discussions
With the federal budget on the precipice of a "fiscal cliff" of pending budget cuts and tax increases that could take place starting Jan. 2 and tip the economy into recession, many budget watchers are waiting on the outcome of this year's elections to determine how to proceed. One issue up for discussion is the renewal of the inheritance tax (also known as the estate tax).
A Brief History of the Inheritance Tax
Created in 1916, the inheritance tax helps prevent the over-concentration of wealth and has been an important source of federal revenue. It also encourages billions of dollars in charitable donations, since charitable gifts reduce the taxes on large estates.
The inheritance tax had a top rate of between 10 percent and 45 percent for the first 15 years it operated. But in the post-Depression era and WWII, Congress upped the top tax rate on inherited wealth several times, peaking at 77 percent, which is where it stayed for the next 34 years.
The inheritance tax came under attack in the 1970s, and the exemption level that triggers the tax steadily climbed through the 1980s while the top tax rate plummeted. Rates and exemptions stayed constant roughly through the 1990s, but President George W. Bush's 2001 and 2003 tax cuts whittled the inheritance tax to its current levels. In 2010, the inheritance tax temporarily disappeared completely, costing the nation billions in lost revenue.
Where We Stand Today
Under current law, which was enacted in 2010, the existing inheritance tax rate is 35 percent on amounts over $5 million (this amount is adjusted annually for inflation). However, this law is expected to expire at the end of the year, along with several other Bush-era tax cuts. If that happens, the inheritance tax will revert to 2001 levels – a rate of 41-55 percent on amounts over $1 million, according to the Tax Policy Center, a joint project of the Urban Institute and Brookings Institution.
Most Republicans and business groups support maintaining or lowering the current rate. Organizational supporters include the National Federation of Independent Business (NFIB) and the American Farm Bureau Federation. They are among 50 groups in the Family Business Estate Tax Coalition, which opposes inheritance taxes in general. On the far right, Sen. Orrin Hatch (R-UT) is calling for repealing the inheritance tax entirely.
On the other side, the Obama administration and many congressional Democrats support rolling back the existing law to 2009 levels, when the rate was higher than it is now, at 45 percent, and the exemption was lower, at $3.5 million. According to a report by the Center on Budget and Policy Priorities, the 2009 levels would bring in an additional $119 billion in revenue over the next ten years and average $1.1 million in additional revenues from each of the wealthiest 0.3 percent of estates. 99.7 percent of estates would still face no inheritance tax if the law reverted to 2009 levels.
However, if the inheritance tax were allowed to rise back to the level it was in 2001, before the Bush tax cuts, much greater revenues could be found for program funding and deficit reduction. In the year 2000, the inheritance tax exemption was only $675,000 per spouse, and the top estate tax rate was 55 percent. The Congressional Budget Office (CBO) projects that this would collect $516 billion in revenue over ten years – over half the funds needed to prevent the automatic cuts of sequestration. Rep. Jim McDermott (D-WA) is leading the push for the inheritance tax to be rolled back to the levels before the Bush-era tax cuts were enacted in 2001. OMB Watch is among over 70 organizations that are part of Americans for a Fair Estate Tax, a coalition that has endorsed McDermott’s bill, the Sensible Estate Tax Act (SETA). In a March letter, the coalition urged Congress to either enact the bill or do nothing and let the pre-2001 inheritance tax rules come back into effect.
Opponents of inheritance taxes charge that going back to pre-2001 levels will force the breakup of family businesses and family farms. However, a 2005 analysis by CBO of the pre-2001 rules indicated that only one percent (or 520) of the estates taxed in 2000 were family-held businesses, and just three percent were the estates of farmers.
Little Support for Spending Cuts
Exploring as many revenue options as possible is critical in the months ahead, since polls show the American public has little appetite for specific spending cuts. A recent poll of registered voters by Ipsos Public Affairs conducted August 27-31 found that the American public supports very few cuts in spending of any kind.
Voters were asked: "As you may know, the US federal budget has a significant deficit. Here are the main expenses for the government. In your view, which of the following areas can we afford to cut back on? (Select all that apply)."
The answers, in descending order, were: defense and military (35 percent); alternative energy development (31 percent), other (28 percent), education (12 percent), Medicare (10 percent), Social Security (nine percent), and law enforcement (nine percent). No category received majority support, and a full sixth of registered voters (16 percent) chose no categories for spending cuts.
Even Republicans were loath to suggest cuts. Almost half (49 percent) endorsed cuts to alternative energy development and about a third (36 percent) endorsed cutting "other programs." No other category received the support of more than 22 percent of registered Republicans, and that was military spending.
Among Democrats, defense and military (49 percent) received the most support for cuts, followed by "other" (23 percent). No other category received more than 19 percent. Similarly, independents also led with defense spending (38 percent), followed by “other” (25 percent).
Cuts in Medicare, which have been the subject of great interest during the election, received the highest support among Republicans (16 percent) and lowest among Democrats (five percent), suggesting widespread bipartisan opposition to cuts in the program.
Editor's note: This article has been updated since its original publication date to clarify the inheritance tax exemption rate in 2009.