No Need for States To Fear Estate Taxes

By Albert B. Crenshaw
Sunday, July 3, 2005

Here's some news: A couple of economists from top colleges have found that rich old people tend to move out of states with high estate taxes and into states with low or no estate taxes.

But wait. Before you say, "Well, duh, more economists proving the blindingly obvious," and before you wave their study at your local elected officials, be warned -- the study provides much less comfort to tax cutters than you might expect.

And that, in turn, is notable because estate taxes, which are levied on assets a person leaves behind at death, are now a serious issue for many states.

For decades, federal law gave states a free ride via a special credit that in effect allowed states to tax estates without actually costing the estate any money. Then in 2001, Congress changed the law to phase out the special credit, thus potentially subjecting a growing number of estates to meaningful state taxes. In some cases, those state taxes are on top of federal taxes. In others, estates have to pay state taxes when they owe nothing to the feds.

If the federal estate tax is repealed, which it is scheduled to be for a single year (2010), and which some in Congress would like to make permanent, states that now tax estates will face the choice of repealing their own tax and losing that revenue, or keeping the tax and perhaps seeing wealthy residents pack up and move.

In fact, that choice will likely be there even if the federal tax is not repealed. If, as seems increasingly likely, Congress opts to keep the estate tax but with a greatly increased exemption, states with much smaller exemptions will have to choose between raising theirs or taxing estates that the federal government does not.

For policymakers, the question therefore is, which is more costly, repealing or cutting their own tax, or risking the departure of upper-bracket taxpayers?

This the question that Joel Slemrod of the University of Michigan Business School and Jon Bakija of Williams College have tried to answer by looking at past changes in state estate taxes and correlating them with the number of estate tax returns filed from the various states.

Their conclusion: Higher taxes do cause some people to move and take their taxes with them, but the number is modest and not nearly enough to offset the revenue gained by keeping an estate tax.

Their findings, as they put it, "while admittedly rough, do suggest that although behavioral responses can be expected to reduce the net revenue raised by [keeping an estate tax], it is unlikely that states would put themselves anywhere near the wrong side of the Laffer curve by doing so."

(The Laffer curve is named after economist Arthur Laffer, who posited that higher taxes produce higher revenue only up to a certain point, beyond which higher taxes actually produce less revenue because taxpayers work less or flee or do other things that don't generate taxes.)

This isn't great news if you've been hoping your lawmakers would decide to go with the federal flow toward elimination of the estate tax, or at least toward a much larger exemption.

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