Death—the Ultimate Free Lunch 

Today’s puzzler: The family (plus a couple of interlopers) is gathered for a holiday dinner. Grandpa stands up to speak. “In this wonderful country,” he says, “our family has been blessed. We have prospered. Our wonderful children have married wonderful partners and given us many wonderful grandchildren. Your grandmother and I love you all very much.” He then goes around the table giving each family member and in-law (but not, alas, the interlopers) a kiss and an envelope containing two checks.

Question: What was the amount on the checks?

(Tick. Tock. Tick. Tock. Tick. Tock. Tick. Tock.)

Time’s up. The answer: The checks were all for $10,000.

“Egad, Holmes! How in blazes did you know that?”

“Elementary, my dear Watson. The two checks were the vital clue. Why two? Because the law exempts gifts of up to $10,000 a year, per recipient, from the confounded Estate and Gift Tax—or ‘death tax,’ as the Republicans so wittily call it. The grandparents were clearly attempting to take maximum advantage of this law by issuing separate checks from each of them to each family member. Inclusion of the in-laws merely confirms the hypothesis.

“Just think, Watson! If Grandpa and Grandma do this for just 10 years, with four children, their spouses, and 12 grandchildren, $4 million will escape the clutches of the big-spending Democrats!”

Even by current low standards, the campaign to abolish the estate tax has been remarkably disingenuous. It does not take Sherlock Holmes to know that with a minimum of foresight and offspring, and no fancy footwork, you can pass on several million dollars tax-free—not the official exemption of $675,000 (already scheduled to rise to $1 million).

But the most deceptive argument in the debate is that it is unfair to tax the same money twice—once when you earn it and again when you die. Writing in last Friday’s Wall Street Journal, economist Martin Feldstein grandly calculates that if you start with $1,000, you pay income tax on it, you sock it away for 30 years and pay income tax on the interest, then you die and your estate pays the death tax … the effective tax rate on your $1,000 is a shocking 77 percent.

Feldstein calls this “very unfair.” And maybe it would be, if it ever happened. Professor Feldstein has surely made far more than $1 million over the years telling wealthy Republicans things they like to hear. May he live long and prosper. But were he struck down tomorrow—possibly by the sight of President Clinton vetoing Congress’ estate tax abolition bill—I bet there aren’t many dollars in his estate that will have come through a tax gantlet of anything like 77 percent.

The truth is that most of the accumulated wealth that is subject to the estate tax was never taxed at all as income. Repeat: never taxed at all. If the estate tax is abolished, the average billionaire’s billion-and-first dollar will be subject to a cumulative tax rate of zero. By comparison, the very first dollar earned by someone frying burgers at McDonald’s is subject to the FICA tax of about 15 percent. (Investment income is exempt from FICA.) Tendentious comparisons of this sort are often dismissed these days as outmoded “class warfare,” unless the complaint is about unfairness to the rich. Nevertheless, taxing Dollar one at 15 percent and Dollar billion-and-one at zero percent seems, to quote Feldstein, “very unfair.”

The reason most inherited wealth was never taxed as income is that it consists of so-called “appreciated property.” The simplest example is shares of stock. If you buy at $100 and die at $120, your $20 profit is never taxed as income. When your heirs sell the stock, their profit is calculated as if they bought at $120.

Stocks aren’t the best example, though. The best examples are the poster children of the campaign to abolish the estate tax: farmers, “small”-business owners, and people who have suffered the terrible tragedy of buying a house cheap and watching it become phenomenally valuable. When the owners die, not a penny of the value of these farms, businesses, and houses has ever been subject to the income tax. We can have a metaphysical argument about whether this is fair or not. But it is simply wrong to say that subjecting these assets to the estate tax means taxing them twice.

Naturally, Feldstein claims that abolishing the estate tax would actually increase total tax revenues. By cherished Republican tradition, this Free Lunch Guarantee must be part of the argument for any tax cut. Feldstein—actually, the most sober of leading Republican economists—at first hangs a nervous little “probably” on it, but the assertion gains certitude with repetition.

So, how does he figure? The usual free-lunch argument is that lowering the tax on some activity will stimulate more of that activity. But the proposition that lower death duties will encourage more people to die is both implausible and unappealing. There’s also the problem that a tax rate of zero will not bring in any revenue no matter how stimulating it may be.

Feldstein, undeterred, tries a new twist: The estate tax, he argues, encourages people to make deductible contributions to charity, so abolishing the estate tax will make them stingier, which will mean fewer income-tax dollars lost to the charitable deduction. Possibly true, but I’d like to see the Republicans this fall campaigning on a call to increase tax revenues by discouraging donations to charity. And, as a special treat, Feldstein throws in a similar argument that abolishing the estate tax will encourage rich parents to hoard their wealth until the end, rather than helping out their children in lower income-tax brackets. Another good one for the campaign trail.

Grandpa is right: This country has been good to most of us—and spectacularly good to a few. Is it really so unreasonable for the luckiest 2 percent to pay some taxes on their good fortunes at least once in a lifetime? Even if they happen to be farmers or small-business owners or winners of the real-estate lottery?