Taxation of estates and inheritances is one of the most controversial issues in tax policy. While this type of taxation is viewed by some as an integral part of a system that guarantees equality of opportunities, others describe it as a "death tax" and argue that it is both inherently unfair to levy a tax at death and that it is particularly costly to do so, highlighting its adverse effect on wealth accumulation, discrimination against savers, negative consequences for the survival of small businesses, and a multitude of avoidance opportunities.
From an economist's point of view, estate taxation touches on a wide array of important topics. It is a form of a tax on capital. It is heavily progressive, with U.S. federal tax rates currently approaching 50 percent and exceeding 70 percent in the past. It is closely tied to the propagation of inequality and the impact of redistribution. It affects the intergenerational mobility of wealth. Its impact and its cost depend on the presence and nature of a bequest motive. How individuals plan for leaving an estate depends also on their acceptance and attitudes toward their own death, thus providing a natural place for looking for examples of the importance of psychological considerations. The U.S. estate tax is nominally a tax on individuals, but its incidence depends on family structure and interrelationships. The tax has been dubbed a "voluntary tax," highlighting that tax avoidance and administration issues are also very important.
Estate taxation has figured in economic research in three different ways. First, one may be interested in understanding how the actual estate tax affects economic decisions. Second, there is an important theoretical question regarding the role that this type of taxation should play in the tax system. Third, the existing data on estate taxpayers provides a source of information that can shed light on central economic, but non-tax, issues. In my research, I have pursued each of these directions.
In a few of my papers, I looked at how transfer taxation affects economic decisions. The notion that the estate tax forces people to make difficult late-in-life, even deathbed, decisions, has its place in the political discourse about the tax, but is it really true? Using linked estate and income tax data, I studied how estates of people who suffered from a lengthy illness differ from estates of those who died instantaneously. (1) I found that the size of the reported estate (of wealthy estate taxpayers) is as much as 20 percent lower for decedents whose terminal illness lasted months or more, but I also showed that this effect is unlikely to be explained by medical expenses or lost wages. Instead, I found strong evidence pointing to a flurry of estate planning activity following the onset of a terminal illness, that results in a reduction in the value of the reported taxable estate and therefore tax liability.
How strongly do estates respond to estate taxation? By exploiting more than 80 years of IRS data covering multiple tax regimes, and age variation of estate tax decedents, Joel Slemrod and I estimate an elasticity of reported estates with respect to the net-of-tax rate of about -0.16, suggesting that the estate tax does in fact reduce reported estates, either because it curtails wealth accumulation or induces tax avoidance, or both. (2) Note, though, that (as has been argued in the taxable income elasticity literature, including my own work) both avoidance and wealth accumulation channels entail similar short-term efficiency costs, although the longer-term implications are likely very different. (3) In another joint paper, we also show that the estate tax has important implications for charitable contributions. (4) Finally, we demonstrated that the reported timing of death is sensitive to tax considerations: in a four-week period surrounding estate tax reforms, more taxable deaths are observed during the "low-tax" regime than during the "high-tax" regime. …