Kill The Estate Tax!

By Daniel Kadlec

Years ago, Tim Luckey's great-grandfather started a farm in Tennessee. When Luckey's grandfather and then his father inherited the farm, both paid inheritance tax. Someday Tim hopes to inherit the farm, and when he does, he will probably pay the tax again, as will his children, years down the road--all for the same 650 acres.

Brad Eiffert owns a lumberyard in Columbia, Mo. He pays $36,000 a year for a life-insurance policy just so his children can inherit the yard unencumbered and not have to borrow from savings--or even sell the business--just to pay the estate tax.

Stories like these and other inequities are at the root of the newfound momentum in Washington to junk the estate tax, which currently reaches rates as high as 55%. The House passed a repeal bill in June, and with few changes, the Senate signed off on it last month. President Clinton has vowed to veto the bill, which he calls a tax break for the superrich, and there does not appear to be enough support for an override. Still, the issue promises to have legs.

Both George W. Bush and Al Gore have staked out the "death tax" as a campaign issue. Bush wants to repeal it outright. Gore has reacted by proposing to double the exemption, to $5 million per family for a business left in an estate. Both positions reflect a sudden urge on the part of government to help family-owned businesses. Maybe it's because the unleashing of the Internet has put a spotlight on entrepreneurial pursuit and its value in an economy in which small businesses continue to provide the most jobs. Maybe it's because in flush times we can afford to do what's right.

The plain truth is, this tax is an embarrassment. It amounts to multiple taxation on enterprise and hard-earned savings. We get taxed when we earn. We get taxed when we spend. We should not get taxed when we save. The estate tax was instituted in part to help fund World War I. News flash: the war is over. We won. Peace is at hand, and we have a budget surplus.

But resistance to repeal has deep populist roots that are hard to dig out. And there is no point denying it: repealing the estate tax would benefit the superrich. Short of communism, any plan to get rid of a tax that many see as immoral is bound to help billionaires. So what? The barrels of ink spilled on this point miss the mark.

The Clinton-Gore position is an attempt to dodge the populist backlash and still do something for small-business owners and farmers. The increased exemption is a start, but it has a serious flaw: the exemption can be difficult to get. For example, heirs must be active in a business for a set amount of time. What if they'd rather go to college? Or are disabled?

In survey after survey, owners cite the estate tax as a top concern. They are worried that heirs will have to sell the business to pay the tax. Critics of repeal rightly point out that only 2% of all estates are subject to the tax, thanks to exemptions already in place, and that only 3% of the estates taxed are family farms or businesses.

That, however, fails to account for the untold number of businesses that get sold prior to an owner's death--precisely to avoid the estate tax. By selling before death, a small-business owner may avoid the death tax in exchange for paying a capital-gains tax at a rate of just 20%. Proceeds from the sale remain subject to the estate tax, but liquid assets are far more easily sheltered through trusts, charitable contributions and annual gifts.

Statistics also do not address the waste of paying accountants and lawyers to prepare for the estate tax, or of insurance policies, like Eiffert's, bought to ensure that the estate tax gets paid. In the five years ending in April 1999, family-owned businesses in New York spent an average of $125,000 on estate preparation, according to the Public Policy Institute of New York State. The institute estimates that the average family-owned business would have created 14 new jobs during that time span had it not spent so heavily on estate planning.

Other studies paint a grimmer picture. The National Association of Women Business Owners puts the number of lost jobs nationally at 39 per small business over the past five years. It found that to prepare for the estate tax, half of all small businesses pay for insurance, 40% forgo investment, 40% plan to sell all or part of the business and 33% plan to incur debt--all choices that hurt the economy.

Critics argue that repeal will cost the Treasury $105 billion over 10 years--a revenue shortfall that the middle class will have to make up. But that is a) far from proved and b) a pittance next to the $2.2 trillion projected budget surplus over the next 10 years (not counting the Social Security surplus), which strongly suggests there would be no shortfall at all.

Still concerned about the privileged getting too big a break? Take solace in the fact that the current repeal bill would hit the superrich with an additional levy on capital gains that common folk will never see. So it would not be a total free ride for the well-to-do, while for small-business owners, it would be welcome relief.

Daniel Kadlec covers Wall Street and personal finance for TIME. He appears each Tuesday on CNNfn at 12:20 p.m. E.T.