By BILL AHERN
Tax Foundation, Guest Columnist

The House has voted once again to phase out the federal estate and gift tax. The 1999 tax cut vetoed by President Clinton included the phase-out of the so-called death tax, but this year the estate tax phase-out was separated from other measures and passed by more than a 2-1 margin.

Arguments for Repeal

Several factors explain the popularity of repeal. The estate tax prevents small businesses and farmers from passing their businesses on to the next generation. It penalizes saving and capital formation. And it greatly discourages the creation of new wealth by America's most innovative, productive entrepreneurs.

The estate tax once enjoyed broad support on the grounds that it prevented an excessive concentration of wealth. The fear was that huge amounts of wealth would remain in the hands of the same few families, generation after generation. Fortunately, the economy each year is generating vast amounts of new wealth and large numbers of newly rich people, solving the concentration-of-wealth problem far more efficiently than the estate tax ever could.

The Misleading Estimates of Estate Tax Revenue

With all this against it, the estate tax has one last remaining ally, and that is the belief, supported by official estimates, that its repeal would cost the U.S. Treasury substantial revenue. Complaints from the White House focus on this issue.

In fact, eliminating the estate tax certainly would not cost the Treasury nearly the amounts that official estimates show. There are five reasons why, and the first two come under the general heading of robbing the income tax to avoid the estate tax.

Reasons to Repeal

1. The gift tax robs the income tax. Under current law a taxpayer may distribute up to $10,000 tax-free each year to any person he or she chooses. Typically, the donor's personal income tax rate is much higher than the rate paid by the children or grandchildren who are the recipients. Thus, the income subsequently earned on these gifts is subject to a much lower tax rate.

2. The estate tax erodes the income tax base. The estate tax may dramatically increase bequests to charities as taxpayers try to avoid paying up to 55 percent of their accumulated savings to the federal government. These assets end up producing capital income for tax-exempt charities instead of remaining in the estate where taxpaying recipients would have earned the money.

Of course, charitable organizations serve valuable social purposes, and not all such bequests are motivated by the estate tax. Nevertheless, the income tax consequences of tax-driven bequests are significant and should not be ignored.

3. The disincentive effects of the estate tax on entrepreneurial activity. Some years ago the Tax Foundation studied the estate tax's effect on entrepreneurial activity, and we found that the estate tax's 55 percent rate had roughly the same effect on an entrepreneur's incentive to earn as doubling the top effective marginal income tax rate.

Thus, an entrepreneur facing a 31 percent statutory income tax rate behaves as if he is facing an effective 62 percent income tax rate. As that rate rises and additional work yields less after-tax return, entrepreneurs become more likely to retire prematurely. Then they pay no income or payroll taxes on wages and create no new wealth.

4. Estate planning is phenomenally expensive. Official revenue estimates take no account of the enormous amounts of money (deductible from the income tax) that taxpayers spend on estate planning. Since individuals worried about estate planning are likely to be in the upper-income tax brackets, the value of their estate tax planning deductions is great.

Absent the estate tax, these individuals would likely shift the amounts spent on estate planning to non-deductible expenses, or they would save them. Either way, current or future income tax receipts would be higher.

5. Compliance costs for taxpayers and the IRS. Finally, if the estimators produced a truly comprehensive estimate for estate tax repeal, they would also account for the savings to the IRS which spends millions of dollars each year attempting to collect estate tax revenue. The resources devoted to estate tax compliance would likely be redirected into other areas of tax collection, areas that the estimators have historically scored as increasing collections significantly.

[Bill Ahern is communications director for the Tax Foundation, a nonpartisan, nonprofit organization headquartered in Washington, D.C., that has monitored fiscal policy at the federal, state and local levels since 1937. Visit them on the Internet at www.taxfoundation.org.]

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