The death tax, the family farm and the case for ending a tax on dying

Only in Washington could somebody look at the one event in life that is truly unavoidable, grief, and see a revenue opportunity. Think about the sales pitch. "We have identified a moment when the family is at its most distracted, the paperwork is at its thickest, and the taxpayer is, regrettably, unable to object. Let's send the bill then." If a private company did that it would be a scandal and a class action. When the government does it, it gets a dignified name: the estate tax.

Folks, I want to walk through this one carefully, because the people who defend the tax tend to rely on a picture that does not match the facts. The picture is a hereditary billionaire sipping something expensive. The facts are a farmer, a hardware store, a trucking company, and a lawyer's invoice.

What the tax is, and what it is not

The federal estate tax is a tax on the transfer of a person's property at death. The estate pays it, before the heirs get what is left. Above an exemption amount, which Congress sets and has changed many times, the rate is a flat 40 percent on the excess. The exemption is large enough that most estates owe nothing, and I will not pretend otherwise. If the argument for repeal depended on every family being hit, it would be a bad argument. It does not.

It is related to, but not the same as, the inheritance tax, which some states levy on the person who receives the property, and to the gift tax, which stops people from avoiding the estate tax by giving everything away before they die. The three are siblings. The federal government taxes the estate and the gift, and a handful of states have their own estate or inheritance taxes.

A word on the name. Opponents call it the death tax. Defenders say that name is propaganda. It is a fair complaint about a rhetorical choice, and I will tell you why I use it anyway: because the tax is triggered by death, and by nothing else. If you do not die, you do not owe it. If you want to know what a tax does, look at what triggers it. This one is triggered by dying with property.

A little history

The first American estate-type taxes came and went with wars. Congress levied death duties to pay for the military buildup in the 1790s, taxes at the time of the Civil War, and a war tax in 1898 during the Spanish-American War, and each time repealed them when the emergency passed. The permanent federal estate tax dates to the Revenue Act of 1916. The original law was modest: a tax of 1 percent on the smallest taxable estates, rising in steps to 10 percent on very large ones.

Here is the pattern worth noticing. Like the income tax, and like the withholding system that came later, the estate tax began with its earlier forms tied to wartime, was aimed at the very wealthy, and stayed. Over the following decades the rates rose and the exemptions moved with the politics of the time. That the tax began under a promise of narrow reach tells you nothing against it by itself. But it should make us attentive to how often Washington says "just this once, and just those people" about a revenue source.

Number one: it does not raise much

The first and plainest fact is that the estate tax is a small part of federal revenue. In recent years it has come to well under 1 percent of federal receipts, less than half a percent in 2019 by one published estimate, and it is a minor entry in the Treasury's tables of receipts by source. You can look it up in the Treasury's monthly statements or in the budget's historical tables. To put it in family terms: a government that collects trillions of dollars each year gathers, from this tax, an amount that rounds to a footnote.

You might ask why a tax that raises so little is worth defending. The answer given by supporters is about fairness and about stopping the concentration of wealth, and I will come to it. The honest point is this: if the argument for the tax were a revenue argument, it would have been dropped long ago, because the revenue does not matter to the budget. Repeal would be paid for by trimming a rounding error of spending. The debate is about ideas, not money.

Number two: the planning industry

The second fact is the one nobody puts on the poster. A tax that is easy to avoid for people with the right advice produces an industry of advice. Estate planners, trust lawyers, appraisers, accountants, and insurance agents sell their services to people with substantial assets, and their entire business is to structure transfers to reduce the tax. Wealthy families set up trusts, make gifts in installments, buy life insurance held in special trusts so that the proceeds sit outside the taxable estate, and discount the value of closely held business interests through valuation techniques.

Every dollar spent on that effort is a dollar that does not go into a new factory, a new tractor or a new hire. It is deadweight. It does not build anything and it does not feed anyone, and the government does not receive it either. Economists call it a compliance and avoidance cost, and here it is a large cost relative to the revenue the tax brings. The people who can afford top advisors do well. The people with a business worth a few million dollars and no advisor on retainer do worse. That is a quiet unfairness inside a tax advertised as fairness.

Number three: the farm and the family firm

This is the heart of it, and I want to be careful, because both sides tend to exaggerate. Let me describe the mechanism rather than flourish an anecdote.

A farm is land, buildings and equipment. It can be worth a great deal on paper and produce a small income, because the value is in the ground and the income is the margin on a crop. A family farm worth several million dollars may earn a family a living and little more. When the owner dies, the estate is valued at the market price of the land, which may be high because of nearby development, not because of what the farm earns. The tax is computed on that value. The cash to pay it has to come from somewhere. The farm does not have it, since the farm's wealth is the land.

So the family has options, none of them pleasant: sell part of the land, borrow against it, or pay for insurance and planning decades in advance. Congress has recognized the problem. The tax law includes special provisions, such as an option to value farm and ranch land by its use as a farm rather than its highest and best use, and a provision allowing the tax on certain closely held business interests to be paid in installments over a number of years. These exist because legislators saw the problem. They are conditional, complicated and require lawyers to use, and they fall away if the heirs sell or stop farming within a set period. A relief that comes with a stack of conditions is itself an admission that the underlying rule does harm.

I want to be fair to the evidence. How many farms are actually lost to the tax each year is a disputed empirical question, and analysts have found that the number of farm estates that owe any tax is small, largely because the exemption is high and the special rules help. The defenders are right that the horror story is rare in the data. But look at what that means. If the farms that owe tax are few, it is because families spent years and money arranging their affairs to avoid it. The absence of a disaster is not proof of an absence of cost. The cost is paid in advance, in lawyers' fees, in cautious decisions about investment, and in the reluctance to expand a business that would push an estate over the line. A tax that works by threat shows up as behavior, not as a collection statistic.

The same goes for the small manufacturer, the family-owned restaurant group, the local dealership, the construction firm. All hold wealth in assets that are not cash. All face the same question when the founder dies: how do we pay the government without selling the thing the founder spent a life building? For related arguments on land and enterprise, see the sugar program makes every family pay more so a few growers earn more for a case of Washington's tangled hand in agriculture, and the regulation bill a ten-person company pays that a giant can shrug off for how the smallest firms bear the heaviest fixed costs.

Number four: it taxes money that was already taxed

The money in an estate was, for the most part, earned. The decedent paid income tax on wages and profits when they came in. The dividends and gains were taxed when they were realized. Property was subject to local property taxes for years. Then, at death, the remainder is taxed again at up to 40 percent.

I am not saying double taxation is always wrong. Income taxed when earned and again when spent through sales taxes is a double tax of a sort, and nobody proposes abolishing sales taxes on those grounds. But the death tax has a distinct moral feature. It falls on savings, the very thing that responsible people are urged to accumulate and pass on. A tax on the income you spend punishes consumption. A tax on the wealth you leave punishes thrift. For a country that wants more capital and more family stability, that is the wrong thing to discourage.

There is also the oldest argument of all, which comes from the Judeo-Christian tradition that we on this side take seriously: providing for one's children and grandchildren is a duty and a joy, not a loophole. The book of Proverbs says a good man leaves an inheritance to his children's children. A tax that treats that provision as a taxable event, for the pleasure of the government, sits uneasily with that moral tradition.

The steelman: dynasties and the republic

The best argument for the tax is not about revenue. It is about republican principle. It goes like this.

Inherited wealth, accumulating over generations, creates an aristocracy of birth. A republic is founded on the idea that people should rise by merit. A tax on large estates keeps the starting line more even, prevents the concentration of economic and then political power in a few families, and honors the founders' distrust of hereditary privilege.

It is a serious argument, made by serious people, among them some conservatives of an earlier generation. Here is my answer, in order.

1. The Founders attacked hereditary privilege with law, not with a tax at death. Virginia abolished entail in 1776 and primogeniture in 1785, laws Thomas Jefferson championed. Those were rules that kept great estates intact in one family by forbidding division. The Founders did not need a death tax to break dynasties. They removed the legal props that held them together. The Constitution itself, in Article I, Section 9, forbids the United States from granting any title of nobility. The answer to aristocracy was to deny it legal protection, not to tax every family's death.

1. American fortunes do not behave like dynasties. Wealth in a dynamic economy is hard to hold. Businesses rise and fall, heirs divide estates among many children, and new fortunes appear as old ones fade. The picture of a permanent hereditary class sits poorly with a country where large fortunes so often start with one generation's work.

1. The families that dynasties are made of are the ones who can afford the planning. A tax with a 40 percent rate and a loophole-rich structure falls most heavily on those least able to avoid it, the owners of illiquid family businesses and farms, and least on the owners of liquid fortunes who can fund trusts and charitable foundations. If the target is the concentrated dynastic fortune, the tool is blunt and often misses.

1. If the concern is untaxed gains, fix that directly. Much of the wealth in large estates is unrealized appreciation, gains that were never taxed because the owner never sold. The law's "step-up in basis" at death wipes out the gain for the heirs' tax purposes. That is a real issue, and a debate about it belongs in the capital gains rules, discussed in capital gains taxes and the lock-in effect that keeps money frozen in place. It is not a reason to tax the transfer itself at 40 percent regardless of how the wealth was earned.

1. Equality of starting line is not the same as equality of outcome. The family that sacrifices to leave something behind has done what a free society hopes its members will do. A policy that treats that as a social problem has mistaken a virtue for a vice.

Where this fits in the larger argument

A final reflection, in the spirit of the larger fight over taxes. We have a system in which a few people pay most of the income tax, a fact laid out from the IRS tables in Who actually pays the federal income tax, read straight from the IRS tables, and in which the code is a sprawling thicket that rewards those with the best advisors, as we argue in tax complexity is a subsidy for lobbyists, and the code shows how it works. The estate tax is a compact example of both problems: a high-rate tax that raises little and spawns an industry of avoidance. When a tax has those properties, the right response is not to patch it, but to end it.

I would add one point about the Constitution. Congress's power to tax is broad, and the Sixteenth Amendment settled income. Whether an estate tax is within Congress's power was addressed long ago, and I do not claim it is unconstitutional. My argument is prudential and moral. Wise governments tax in ways that do not penalize the building of a business or the keeping of a farm. See the Constitution for the text of the taxing power and decide whether it was meant as a license to tax the family at the graveside.

The case in brief

1. The federal estate tax, begun in the Revenue Act of 1916, raises well under 1 percent of federal receipts, so ending it would barely register in the budget.
2. It supports a large planning industry of lawyers, appraisers and insurers whose fees are deadweight cost, falling hardest on families without top advisors.
3. Farms and closely held firms hold wealth in land and equipment, not cash, so the tax forces sales, borrowing or costly advance planning, even where special provisions soften the blow.
4. It taxes money already taxed once, and it penalizes thrift and the provision for children that a healthy society wants to encourage.
5. The Founders broke dynasties by abolishing entail and primogeniture and by banning titles of nobility, not by taxing death, and any concern about untaxed gains should be met in the rules on gains.

What you can do: look up the estate and inheritance tax rules of your own state on its department of revenue website, then ask your state legislator whether the state taxes death and what it raises.