The House approved an Estate Tax Relief bill this week, with what passes for bipartisan support these days (20% of the Democrats voted with nearly all of the Republicans). While stopping short of complete repeal of the tax, it does put in place important features to greatly reduce the burden of estate and gift taxes by increasing exemption amounts and reducing tax rates.
As previously discussed here (and tangentially here), the actual financial contribution of estate taxes, even at fully-reinstated rates, to the federal budget as a whole is minimal. The wailing from the left about the massive loss of tax revenue is greatly exaggerated. But of course, the revenue aspect of the estate tax seems not to be the primary motivation for its supporters. Instead, they see it as a way to deter an "aristocracy", going so far as to claim that as an original intent for estate taxes.
So I thought I'd research the history of the federal estate tax and learn about the real original intent. What was it originally for, anyhow? Fortunately, a detailed (pronounced: BOOOOORING) report on the history of the tax was prepared for Congress a few years ago.
Here's a summary:
The estate tax we have today is essentially a highly modified form of a tax that was instituted in 1916. However, there were estate or inheritance taxes established at three previous times in our nation's history. In all such cases (including the 1916 tax) these were implemented as temporary revenue enhancements because of military conflicts. Based on the original rates and collection mechanisms, the argument that an estate tax has a original basis in deterring and aristocracy is remarkably weak, however the tax may have been reinterpreted since then.
The so-called "Quasi-War" with France in the late 1790's necessitated a buildup of naval forces for defense. The extra revenue needed was raised via a series of stamp fees (similar to the Stamp Act of 1765 which had played a large role in triggering the American Revolution), including stamps required for receipts of the disposition of estates (with various important exemptions). While structured differently than the current estate tax, this had the effect of imposing taxes on estate transfers with practical rates no higher than 0.5%, and did not apply to transfers to close relatives. After the end of the Quasi-War, these stamp taxes were repealed in 1802.
In 1862, again facing unusual military expenses in the middle of the Civil War, Congress enacted an Inheritance Tax. While this was not levied on the estate of the deceased, but rather on the beneficiaries, the tax was triggered based on the total value of the estate. Rates ranged from 0.75% for close relatives up to 5% for distant relatives or unrelated parties, but were increased in 1864 as war-related expenses increased. The taxes were repealed in 1870 with the Civil War long over.
With the Spanish-American war in 1898, the U.S. again turned to estate taxes for wartime revenue. Tax rates were graduated from 0.74% to 15%, depending on both the size of the estate and the closeness of kinship from beneficiaries to the deceased. The estate tax was repealed in 1902.
Which brings us to 1916, and the birth of the modern estate tax. The federal government had seen declining revenues from trade tariffs due to interruptions in international trade as a result of World War I, and instituted a graduated estate tax with rates ranging from 1% to 10% for net estates over $5M. With U.S. entry into the war in 1917, rates were increased to between 2% and 25% on estates over $10M, though the estates of individuals killed in military service were exempted completely.
After the war in 1918, the continued existence of an estate tax was debated. However, unlike at the end of previous war periods, the estate tax was retained and modified to reduce the rates on lower-value estates but expand the base by including additional assets as contributions to an estate.
In 1924 the estate tax rates were raised, with a top rate of 40% for net estates over $10M. In 1926 the rates were cut again, ranging from 1% to 20%, with increased exemptions and credits. Rates were again increased in 1932, resulting in a range of 1% to 45% on estates over $10M. A series of rate increases followed, and by 1941 the range was from 3% to 77% on net estates over $50M.
By 1976, the rates and exemptions had been altered such that the top rate was 70% on estates over $5M. In 1981, the top rate was scheduled to be gradually reduced to 50%, though subsequent legislation in 1984 and 1987 froze that reduction at 55%.
In 2001, Congress passed legislation that would gradually eliminate the estate tax entirely, but this legislation was set to expire in 2011, thus restoring the 2001 estate tax unless further action was taken.
Which brings us up to date -- the latest legislation essentially revises the estate tax yet again, with reductions in the rate and increases in the exemption. It ties the estate tax rate to the capital gains rate, and indexes the exemption to inflation. It's the latest in a very long line of adjustments, and a compromise between those who want to leave the estate tax as-is (at 2001 levels, in other words) and those who want to bring this latest chapter of US estate tax history to a close by repealing it entirely (for the fourth time).
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