A money grab at death drives outmigration
Death and taxes may be certain, as the old saying goes, but death taxes are not.
Most states have repealed their estate and inheritance taxes that drive high-net-worth individuals out of state, incentivize costly and inefficient tax planning strategies, break up private businesses, and sacrifice ongoing tax collections from wealthy households for a volatile and unpredictable revenue stream.
Some lawmakers in Madison, however, led by members of the Assembly’s Socialist Caucus, want to implement an estate tax with a top rate of 20 percent. Currently in draft form before being introduced, their legislation would propel Wisconsin to a tie with Hawaii for the second-highest state rate in the nation.
More than 30 states (including Wisconsin) eliminated their estate taxes when state-level taxes ceased to be credited against federal tax liability in the mid-2000s. Since then, only one state, Hawaii, has reinstated an estate tax, while states such as Delaware, New Jersey and Ohio — which imposed estate taxes for some time after the federal credit’s expiration — later repealed them. Only 12 states still impose estate taxes, though two of Wisconsin’s neighbors, Illinois and Minnesota, are among them.
An estate tax is a tax on Wisconsinites’ end-of-life gifts, but it’s also a gift to Florida and to every other state that stands to benefit from the outmigration of Wisconsin residents seeking to preserve the value of their estates for the next generation.
An estate tax’s intended taxpayers are highly mobile. Nearly all are retirees, no longer tethered to a place of work. They are well-off, possessing the resources and the motivation to avoid a tax that erodes their bequests. These are people who can and do move in response to estate taxes, depriving their home states of years of revenue from income taxes, sales taxes, and other taxes.
Economists Jon Bakija and Joel Slemrod calculated that if the typical wealthy retiree who would otherwise be subject to an estate tax moved five years prior to death, the state’s revenue losses could be as much as 1.73 times as large as the tax revenues that might have been collected from that person’s estate.
For estates over $5 million, the threshold for liability under the Wisconsin proposal, Bakija and Slemrod found that for each percentage point on an estate tax rate, the number of federal estate tax returns filed in a given state fell by nearly 4 percentage points. The proposed Wisconsin top rate is 20 percent.
When high-net-worth individuals leave, Wisconsin’s economy takes a hit. But an estate tax does economic damage even when some taxpayers remain.
Estate tax compliance costs are high (and may approach the amount of revenue that such taxes yield), and affected households engage in extensive and costly tax planning to reduce estate tax liability. These avoidance strategies take multiple forms — for example, tax-advantaged gifts and transfers, shifting assets and investments, and adjusting business practices to take advantage of favorable tax valuation provisions — but all of them create economic drag, as they represent investment and allocation decisions made only to avoid tax and not on their own economic merits.
All this led one scholar, writing for the Brookings Institution, to observe that “because estate tax avoidance is such a successful and yet wasteful process, one suspects that the present estate and gift tax serves no purpose other than to give reassurance to the millions of unwealthy that entrenched wealth is being attacked.”
At the state level, of course, such wealth is partly attacked and partly shooed away. And to the extent that wealth is attacked, the harm isn’t limited to wealthy households.
A 1995 survey of family business owners found that owners spent an average of 167 hours and $33,137 (over $71,000 in today’s dollars) planning for estate taxes. Business owners overwhelmingly reported that the expectation of future estate tax burdens limited the growth of their operations and reduced hiring. And while one might want to take business owners’ self-reported concerns with a grain of salt, the economic evidence backs them up.
Study after study finds that estate taxes create economic deadweight losses — costly compliance and avoidance activity that benefits no one — as well as reducing investment, undercutting family-owned businesses and job creation, and driving wealthy taxpayers out of state.
Economic simulations indicate that the federal estate tax has roughly the same effect on entrepreneurial incentives as a doubling of income tax rates, even though the federal estate tax generates less than 1 percent of federal revenue. Wisconsin lawmakers’ proposal would increase estate tax burdens by up to 50 percent over federal levels, yielding a combined top estate tax rate of 60 percent.
While the proposed Wisconsin estate tax purports to exempt family farms, it provides no such protection to other family-owned businesses. Unlike income taxes, which are levied on cash flow, estate taxes are imposed on asset value. A company might have significant value on paper but be cash-poor. Heirs to illiquid businesses can be forced to sell land, equipment, or the entire business to pay estate tax liability.
Even farmland isn’t truly exempt: estate tax liability is only waived if heirs are qualifying family members and hold the land for at least 10 years.
If Wisconsin adopts an estate tax, its economic rivals will be the beneficiaries. Lawmakers in Madison should recognize what their peers across the country have come to realize: death may be unavoidable, but death taxes aren’t. Levying a large and largely avoidable tax on a highly mobile and highly motivated population is economic malpractice.
Jared Walczak is a Senior Fellow at the Tax Foundation, where he spent five years as Vice President of State Projects, and president of Walczak Policy Consulting.
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