In Lehmann's Terms

Sure things -- death, taxes, and specious arguments about the death tax

Brad DeLong approvingly quotes Edmund Andrews' piece in the New York Times on estate tax repeal, slated to be among the first bits of business taken up by the Senate when it returns from the August break. While there is no question that the populist rhetoric employed by the administration and its allies in support of repeal does mistate the case significantly (populist appeals used to obfuscate and distort an issue? No, sir, the Left would NEVER do that!) I don't see  how Andrews'  piece is any less misleading than the "Republican con game" DeLong wishes to assail.

As Michael J. Graetz and Ian Shapiro of Yale recount in "Death by a Thousand Cuts" (Princeton University Press), their entertaining account of the repeal movement, opponents of the estate tax have already achieved a remarkable political feat by building broad public support for abolishing a tax that currently affects only 2 percent of all estates...

Only 2% of estates PAY the estate tax. The percentage that the tax's existence "affects" is significantly larger, since most individuals with estates sizeable enough to be subject to the tax have the foresight to plan around it.

The nonpartisan Joint Committee on Taxation estimates that full repeal would cost $290 billion over the next 10 years, but that calculation understates the true cost because full repeal would not occur until 2011.

Once the estate tax was fully repealed, the Treasury would lose more than $70 billion a year in today's dollars. Over the first 10 years of full repeal, the cost would total more than $700 billion, plus interest.

That's a remarkably precise projection to offer on a subject that no sane person believes he could predict with any measure of reliability. Estate taxes are applied to assets, not income. The bulk of those assets are in real property. Are you willing to bet that the same sort of run-up seen over the last five years in housing prices will continue unabated through 2021? I'm certainly not.

It's not at all inconceivable that aggregate inflation-adjusted asset prices will drop, rather than rise, over the coming decades or that the Joint Committee's estimate is an overstatement of future potential  estate tax liabilities, rather than an understatement.

Assuming that the government is still running an annual deficit in 2011, which is more likely than not, the total 10-year cost would be close to $1 trillion.

Holy broken window fallacies, Batman! Leaving aside the fact that consideration of whether to tax inheritances should be an altogether separate issue from whether the budget is balanced (there's no reason estate tax proceeds couldn't be offset by taxes on income or consumption or by, oh, you know...SPENDING cuts, just to throw a wild idea out there) you can't just tack on debt financing to the "cost" of estate tax repeal (I still bristle and grit my teeth at this nomenclature that regards NOT taking people's money away from them as a "cost") without making at least a cursory attempt to account for the effect of having those funds available for investment in productive ventures.

For that matter, you can't assess what the government would lose by estate tax repeal without accounting for the ways the present system cannibalizes income taxes. Among the more obvious of these are the effects of the gift tax exemption -- which allows tax-free gifts of up to $11,000 per-year to as many people as the giver wishes -- that often results in transfers of  interest- and dividend-yielding assets from givers who would have paid the highest marginal income tax rates to recipients who tend to be in the lowest income brackets and thus pay much lower rates.

Or, for that matter, you can't ignore the much ballyhooed charitable trust exemption. Opponents of repeal often point to the impact repeal would have on charitable bequeathments. I tend to think they overstate the case somewhat, but if the impact truly is significant, then having those funds invested in taxable, income-bearing assets is bound to produce more tax revenue than if  they were held by a tax-exempt trust or foundation. 

And neither does it take into account the taxes that would be collected either on new investments that would otherwise never have been made were the estate tax still in place,  nor the potential gains from redeployment of millions that would have otherwise been devoted to compliance with the tax, or the many billions that would have been spent on the estate planning industry -- a huge deadweight cost if ever I saw one.

It is for these reasons that Alicia Munnell, a former member of President Clinton's Council of Economic Advisers, estimated that the revenues generated by the estate tax were more or less a wash when compared to the costs of imposing it.

A compromise being floated by Senator Jon Kyl, Republican of Arizona, could be almost as expensive. Indeed, because of a strange wrinkle, the compromise could end up being far more generous to many heirs than outright repeal...As a practical matter, Mr. Kyl's approach would eliminate the estate tax for more than 99 percent of all families and greatly reduce taxes for the few who owed anything at all. If the $3.5 million exclusion were in effect in 2000, the Congressional Budget Office estimated, only 3,676 estates - about 0.15 percent of all estates - would have had to pay any tax. But the proposed compromise also comes with an important twist that could make it more expensive than the $53 billion a year estimated by Congressional tax scorers.

The twist is that the proposal would retain a big tax break that is supposed to disappear along with the estate tax. That break is known as the "stepped-up basis," and it means that an heir does not owe any capital gains taxes on any increase in value of property during the life of the person who died.

The intent of Kyl's bill is to avoid the perverse effect likely to proceed from eliminating the step-up provisions of the code  along  with  estate tax  --  it would mean that those who initially got in under the estate tax exemption and paid no tax on their inheritted estate would, with repeal, suddenly be expected to pay potentially large capital gains based, not on the asset's value at inheritance, but based on profits over its INITIAL value.

My biggest problem with the Kyl compromise is that it would seem to signal the senator feels no pressing need to cut the capital gains tax, itself, below the 15% threshold.

And then we come to this :

That's why it is misleading for opponents of the estate tax to claim that it is a double tax on earnings that have already been taxed once.

In many cases, that's not true. "A lot of assets that passed through very large estates have never been taxed and never will be," said Mr. Graetz of Yale. "It's a very big issue."

So, in other words, despite having paid income tax on the original earnings, and sales taxes on things purchased with those earnings, and further income taxes on interest and dividends that investments made with those earnings yielded, and property and luxury taxes on the holding of assets purchased with those earnings, unless you ALSO pay capital gains taxes on the appreciation of those assets -- which ends up largely being a tax on inflation, despite the fact that everyone must already pay that tax through the reduced value of savings -- AND another tax on intergenerational transfers of those assets, then the assets were "untaxed."

Talk about your creative accounting schemes.

I've never really understood the apoplectic fits that the estate tax issue tends to inspire in the Left.  It's true that Republicans have been disingenuous in selling the notion that the tax applies to many more people than it actually does, but how is that any worse than selling opposition to repeal based, not on any sort of substantive policy or economics basis, but purely on the basis of class envy?

For my part, I tend to think that, at a time when savings have dropped essentially to zero, enforcing a tax that encourages excess consumption by penalizing long-term capital formation just might not be the best idea.

Sit right back and you'll hear a brief...

A bit of aimless web-surfing led me to stumble across this nugget, a reprint of a 17-year-old Santa Clara Law Review piece that looks at some of the legal underpinnings governing that prime piece of fictional Ancapistan real estate known as Gilligan's Island.   Some highlights:

Gilligan on equity compensation and the vagaries of the tax code --

In Episode 13, entitled "Three Million Dollars More or Less," Gilligan wins $ 3 million from Mr. Howell in a golf game. When it comes time to pay, Mr. Howell uses a convoluted explanation of the federal tax laws to convince Gilligan that receiving stock in a (worthless) oil company is better than getting cash

Gilligan on joint-and-several liability --

Finally, in Episode 85, entitled "Court Martial," a radio broadcast informs the castaways that a board of inquiry convened to investigate the loss of the Minnow has found the Skipper guilty of negligence. To prove to the Skipper that he was not at fault, the Professor suggests the castaways reenact the final hours of the storm. Doing so reveals that it was Gilligan's failure to secure the anchor to the boat that caused the sinking. This discovery leads both the Skipper and Gilligan to experience unbearable guilt. Just as things are at the blackest, however, good news arrives: after further study, the board has changed its verdict and concluded that the real cause of the wreck was a faulty weather report that had failed to predict the storm.

Gilligan on Lockean homesteading --

In Episode 16, entitled "Plant You Now, Dig You Later," Gilligan unearths a treasure chest while digging a barbecue pit for Mr. Howell. When Mr. Howell claims that he owns the chest because Gilligan found it while working for him, the Skipper insists that Gilligan is the owner because he discovered it. To settle the matter, a courtroom (complete with a judge's bench, witness stand and an American flag made out of flowers and starfish) is built and a trial held before the Professor (who substitutes one of Mr. Howell's capes for a judge's robe). Following a hard-fought contest, he rules that the chest should be treated like the island's other natural resources and, as such, belongs to all the castaways. Unwilling to share the chest, Mr. Howell immediately buys out the other castaways for $ 500,000. Much to his chagrin, the chest is then opened and found to contain nothing but old cannonballs.

Gilligan on estate planning and moral hazard --

In Episode 74, entitled "Where There's a Will," Mr. Howell rewrites his will to thank the others for their attentions during a recent illness. The new instrument leaves a large bequest to each of the castaways: Ginger receives a diamond mine, the Professor is given a railroad, Mary Ann is promised two plantations and a fleet of cars to travel between her properties, Gilligan is granted an oil well and the Skipper becomes the owner of Denver. Through a series of miscues, Mr. Howell subsequently becomes convinced that the castaways are planning to kill him to collect their inheritances. All is put right, however, when he later learns that the "old bore" they intend to kill is a wild boar to be served at a dinner honoring him for his generosity.

Gilligan on Miranda --

In Episode 27, entitled "New Neighbor Sam," the castaways become terrified after overhearing a group of gangsters. When it turns out that the "voices" are coming from a parrot, the Professor and the Skipper decide to interrogate the bird to learn what else it knows. Jumping to its defense, Gilligan insists that the bird be allowed to speak to an attorney before answering any questions.

Gilligan on discovery --

In Episode 52, entitled "Not Guilty," a crate washes up on the island. Inside are some old newspapers from Honolulu which report that someone aboard the Minnow might be a murderer because each had been shopping in the same store on the same day as Randolph Blake, a man who turned up dead just as the Minnow had set sail from Honolulu. With their imaginations running wild, the Professor proposes that the castaways reenact the scene in the store to determine the killer's identity. To their great relief, doing so proves that the incident had been an accident: slamming the store's door had released the trigger of the spear gun that had killed Blake.

Gilligan on immigration --

In Episode 38, entitled "Beauty Is as Beauty Does," the castaways hold a beauty contest to select Miss Deserted Island. When the others are unable to agree upon a winner from among Ginger, Mary Ann and Mrs. Howell, Gilligan casts the deciding ballot for Gladys, a chimpanzee he had found on the island. His reason for doing so rests on solid legal grounds: as the tournament's only native, Gladys is the sole contestant eligible to win the title.

And finally, in what serves as a disturbingly apt parable for our current times, Gilligan on Liberty vs. Security:

In Episode 83, entitled "Gilligan Goes Gung Ho," the castaways decide they need greater law-and-order. Therefore, they appoint the Skipper to be their sheriff and Gilligan to be his deputy. Adopting a "by-the-book" approach, Gilligan soon has the castaways under arrest. Unfortunately, his zeal costs them one of their best chances to be rescued: while they languish in jail, a rescue plane flies over the island.

Captain Obvious and His Trusty Sidekick

Dean Baker and David Rosnick over at the Center for Economic and Policy Research have a new brief that purports to look at what effect the "progressive indexing" proposal that President Bush has been endorsing of late would have on rates of return for Social Security.

Their conclusion?

The rates of return went down.

The proper, measured reaction of anyone who isn't completely comatose?

Duh.

What possible alternative result were they expecting of a proposal for significant cuts in benefits adjustments and no change in the tax base? This required an analysis? Someone's got an awful lot of free time on his hands.

Of course, the comparison they're making is to the projected rate of return that would be realized if both current benefits and current contributions remained constant. But, as I hope most have come to grasp at this point, the current benefits and contributions can't remain constant.  There's that whole looming insolvency issue and all...you know, as I recall it, the only reason anyone's having this discussion in the first place.

There's only a limited number of options for sorting out that whole insolvency thing -- tax hikes, raising the retirement age, etc. -- and far as I can tell, they ALL would contribute to a lower rate of return. So the proper comparison is not to things as they stand -- an arrangement which is untenable -- but to the lower returns that would be realized if, for instance, benefits remained constant, but the payroll tax went up the 6 or 7 percentage points needed to balance the system. And that includes the huge opportunity cost of the returns that would have been realized on those funds if they didn't have to be devoted to Social Security.

Speaking of Social Security and rates of return, I'm just curious: at what point did a memo get circulated among the left-wing public intellectuals instructing them not to recognize the existence of foreign markets? Witness Krugman, for instance:

To get a 6.5 percent rate of return, you need capital gains: if dividends yield 3 percent, stock prices have to rise 3.5 percent per year after inflation. That doesn't sound too unreasonable if you're thinking only a few years ahead.

But privatizers need that high rate of return for 75 years or more. And the economic assumptions underlying most projections for Social Security make that impossible.

The Social Security projections that say the trust fund will be exhausted by 2042 assume that economic growth will slow as baby boomers leave the work force. The actuaries predict that economic growth, which averaged 3.4 percent per year over the last 75 years, will average only 1.9 percent over the next 75 years.

In the long run, profits grow at the same rate as the economy. So to get that 6.5 percent rate of return, stock prices would have to keep rising faster than profits, decade after decade.

I would note, first of all, that such sluggish long-term growth rates hardly present a rosy outlook for our ability to meet the obligations imposed by Social Security and the other public entitlements programs, with or without private accounts. An economy that can't manage 3% growth in its equities market can't very well shoulder a tax burden that grows much faster than that.

But, that said, there's no particularly good reason why the investments of Social Security's private accounts have to be solely tied to the domestic growth rate, since there's no particularly good reason to limit oneself to domestic investments.  The Chinese and Indian economies are certainly expected to grow faster than 1.9% annually over the 75-year frame, and one would expect, at some point down the line, the African and Middle Eastern economies to join them.

CALPERS and the other big public pension funds have done a fine job of capturing the higher growth rates of the emerging markets in the past, so why couldn't Social Security be counted on to do the same in the future?