The death tax threatens the way of life for multi-generational farmers and ranchers.

The estate tax threatens the way of life for multi-generational farmers and ranchers. (Photo: Environmental Stewardship)

For over 125 years, Kevin Kester’s family has raised cattle on his family owned ranch in idyllic northern California, but the Internal Revenue Service is threatening that way of life for future generations.

When Kester’s grandfather passed away, the estate tax kicked in, and the IRS went after the heirs on all his assets. Since the land and business value was not liquid, the tax obligation generated a financial hardship for the family, and they had no choice but to sell a small portion of their land as well as the development rights to another portion. Further, they couldn’t invest in their own operations and had to lay off employees.

“Because of the amount of money owed the federal government, it hamstrung financially our operating capabilities,” says Kester. “And instead of hiring, we had to let employees go.”

He and his family are a living testimony of why the estate tax is so unpopular. In fact, when polled by Gallop during the 2016 presidential campaigns, fewer than one-fifth of constituents supported its retention and a majority favored its complete elimination.

That full repeal is now on the table in Congress, as lawmakers debate the revenues versus the drag on the economy. Also known as the “death tax,” any decision should look beyond emotionally charged rhetoric that would divide and distract us from the documented impacts.

The 40 percent estate tax makes up 0.6 percent of federal revenue, and is only collected from a few thousand households every year. According to the IRS, that number for 2015 was 4,918, or 0.18 percent of all deceased — yet it has a disproportionate impact both on economic development and public discourse. In particular, since the estate tax applies to a bequeathment of at least $5.45 million, one could easily assume that its impact is limited to only the super wealthy. However, any tax has secondary or less visible impositions, and the precise burden is known in economics as tax incidence.

As demonstrated by the Kester case, the recipients of inheritance may have assets but lack revenue. They are then hit with the tax imposition at a vulnerable time, when they are struggling to deal with the loss of a loved one. In addition, that deceased family member may have been instrumental to the business, which makes survival from the 40 percent hit that much harder. As a result, heirs often must downsize or even sell off the business entirely.

“We are land rich and cash poor, so — in the eyes of the IRS — we are rich and taxed accordingly,” explains Kevin Kester, the fifth-generation cattle rancher in Northern California. “We almost lost our ranch.”  

Fortunately, Kester and his family were able to overcome this common occurrence and save the ranch through hard work and sacrifice. However, they are paying the toll financially and psychologically and will struggle to invest in their business and pass it on to their own descendants.

“Every generation wants to leave the ranch or farm in a better condition for future generations,” said Kester, citing a common refrain among his community.

In addition to physical assets such as real estate, the tax applies to financial assets such as stocks. Naturally, the marginal rate of more than one-third — after all corporate and personal income taxes have already been paid — encourages people to spend their money on consumer goods rather than savings and investments. This reduces the capital stock in the economy, a key element that distinguishes developed nations from poor ones. In particular, workers require higher levels of capital to be productive, which then allows them to command higher wages.

The Tax Foundation has devoted in-depth attention to these secondary effects over the years, beyond the visible revenue stream. They estimate that elimination of the estate tax would increase capital investment by 2.3 percent; GDP would rise by 0.8 percent; wages would go up 0.7 percent; and the US economy would see an additional 159,000 jobs.

Repealing the tax also means an explicit loss of revenue of about $17 billion per year, although that will be at least partially offset by higher revenues elsewhere. When one takes into account the revenues from increased wages and income, the Tax Foundation estimates a net loss of $19 billion over a full decade.

That paltry figure, when compared to total federal revenues, also does not take into consideration the costs of enforcement and compliance. This final piece of the puzzle is particularly important, because Americans now spend 8.9 billion hours annually filing taxes, including 376 million hours on the estate tax alone — which roughly equals the value of the entire revenue generated.

“Having dealt with the death tax on multiple occasions,” says Kester, “I can assure you that it’s not easy to settle the estate of a loved one while coping with the loss of that loved one.”

One must justify the existence of a tax on the basis that the same revenue could not be collected from other taxes. Fewer taxes mean lower costs of enforcement and compliance, not to mention a lower cost on allocative efficiency in the wider economy. The estate tax scores distinctly poor in this regard, since it generates few revenues which are easily offset by the costs of compliance, enforcement, and allocative efficiency.

Even if one is still concerned about the 0.6 percent up-front loss of revenues, there are other less destructive revenue streams available. That could either be the very slight raising of rates on personal income taxes or the removal of targeted exemptions, which are also extremely unpopular among constituents (but popular with donors).