Monday, October 26, 2009

The Incredible Shrinking Estate Tax

As yet another sign of the country’s economic woes, this year there were just 5,500 Americans who left behind taxable estates. This equates to less than one-quarter of one percent of all U.S. deaths, which is the smallest percentage since the great depression. Why is the percent of taxable estates so low? Well TaxVox has put together an interesting article explaining the trend, as well as the as graph comparing deaths subject to tax and exemption levels, both of which are listed below.

In part, that tiny fraction reflects the current recession’s devastation of assets—the Fed estimates that the total value of household and nonprofit assets fell by about one-sixth between 2007 and the first quarter of 2009. But changes in estate tax rules over the past decade have played a much larger role than economic swings.

The Economic Growth Tax Relief and Reconciliation Act of 2001 (EGTRRA), best known as the Bush tax cuts, phases the estate tax out over a decade. The act raised the effective exemption incrementally from $675,000 in 2001 to $3.5 million in 2009 and dropped the top tax rate from 55 percent to 45 percent. The levy disappears entirely in 2010, only to return in 2011 under pre-EGTRRA law—a $1-million exemption and 55-percent top rate. The Obama administration has proposed making the 2009 parameters permanent and indexing them for inflation. Others would set a higher exemption and a lower tax rate.

So what’s happened?

For decades before 1976, only estates worth $60,000 or more owed estate tax. That threshold remained constant in nominal terms, so more and more estates had to pay the tax as economic growth and inflation boosted household wealth. In 1943, just under 1 percent of deaths led to estate tax payments; by 1976, that share had grown to 7.65 percent (see graph).

Congress doubled the effective exemption to $120,000 in 1977 and raised it gradually to $600,000 in 1987, where it stayed for ten years. As the exemption rose, the share of estates owing tax fell to just 0.9 percent in 1987 before growing again because of the fixed exemption. In 1997, when a bit more than 2 percent of estates owed tax, Congress again enacted a series of increases in the exemption that would have reached $1 million in 2006. Deaths resulting in estate tax liability stabilized until EGTRRA set off the latest inexorable drop in taxable estates.

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