The ‘fiscal cliff’s’ estate tax fight, explained

December 30, 2012

The Senate is set to reconvene Sunday afternoon in a last-ditch effort to devise a "fiscal cliff" compromise before Dec. 31, with Senate Majority Leader Harry Reid (D-Nev.) and Senate Minority Leader Mitch McConnell (R-Ky.) working through the weekend to come up with a "small deal." One of the latest sticking points has been over the estate tax, a small but politically charged part of the George W. Bush tax cuts. Here's a look at what's at stake and what the policy consequences are likely to be.


From left, Nicky and Paris Hilton with their father, Rick Hilton. (Matt Sayles -- AP)

The estate tax has been gradually phased out since 2001, dropping from 55 percent to its current rate of 35 percent on real estate, stocks and other assets that are inherited, with an exemption that's grown from $1 million to $5.2 million. Neither party wants to go back to Clinton-era levels for the estate tax: Reid has defended the Democratic preference of reverting to the 2009 levels, with a 45 percent rate and a $3.5 million exemption, while Republicans want to keep the current rates, which were extended in 2010.

As my colleagues have reported, Hill aides say Democrats are likely to make concessions on the estate tax to Republicans — who loath high rates on what they've dubbed the "death tax" — in exchange for keeping the Bush tax cuts at the president's preferred threshold of $250,000. Republicans are also helped by the fact that some Democrats from rural districts fear a high estate tax would punish family farms and other small businesses.

Only a small handful of Americans would benefit from the more generous estate tax that Republicans are pushing for: Just 7,450 more estates — 0.3 percent of the country's total — have benefited from the rates that were cut in 2010, according to the Center on Budget and Policy Priorities. The GOP proposal to keep the estate tax rates where they are, rather than reverting back to the 2009 levels that Democrats want, would cost $119 billion more over the next 10 years, the Treasury Department and Office of Management and Budget estimate.

However, Republicans have rallied behind the lower rates by arguing that a high estate tax reduces capital investment, savings, and income mobility, and burdens small family businesses who may have to liquidate their assets to meet their tax liabilities. "Effective taxation requires efficiency to achieve the greatest amount of revenue, but at the least distortion of output, employment, and growth. And yet, the estate tax fails on both counts," the House GOP's Joint Economic Committee concluded earlier this year.

Critics like the CBPP counter that the evidence of the estate tax's impact on private savings is ambiguous, and they point to a 2005 Congressional Budget Office study revealing that very few family farms would be subject to the estate tax at all. About 100 farming estates are subject to the estate tax this year, Reuters notes, citing the Joint Committee on Taxation, and President Obama's proposal would increase the number of farms subject to the tax to about 300. Some Democrats have dubbed it the "Paris Hilton tax" that bequeaths wealth to a tiny handful of privileged heirs.

My colleague Zach Goldfarb has more on the competing GOP and Democratic estate tax proposals here.

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Neil Irwin · December 30, 2012