The Estate (aka 'Death') Tax Explained

Like so many, I've been sadly ignorant over the years about many economic issues, including on the estate (aka 'death') tax.  Ezra Klein, one of God's gifts to us, explains in very simple terms  the estate tax on his blog:

The basic insight behind the estate tax is that wealth concentration is a problem. That was true in 1916, when the tax was enacted, and it's true today, when it's being neutered. As Ray Madoff explains, the going theory came from Louis Brandeis, who said, “We can have concentrated wealth in the hands of a few or we can have democracy, but we can’t have both.” Andrew Carnegie himself testified in favor the estate tax's creation.

The way it works is simple enough. There's an exemption level beneath which estates are not taxed, and a tax rate that applies to every dollar the estate is worth above the exemption. In 2001, we had a $675,000 exemption and a 55 percent tax rate. So if you were inheriting an estate worth $700,000, you had to pay a 55 percent tax on that final $25,000. The estate tax's levels, however, have been changing because the Bush tax cuts -- as you can see in the table on the right -- have been phasing it out. In 2002, it was $1 million, and 50 percent. By 2009, the exemption was up to $3.5 million, and the rate down to 45 percent. And in 2010, the estate tax was repealed.

But not for long. If no action is taken, it returns in 2011 with an exemption of $1 million and a rate of 55 percent. If that seems like weird tax policy -- a single year in which death carried a huge tax break -- it is. But it was never about tax policy. It was a political strategy: Republicans wagered that Democrats wouldn't be able to bring the estate tax back after it had expired.

The dominant alternative to the estate tax's return -- which had support from both Republicans and, sadly, Democrats -- was the Lincoln-Kyl bill: A $5 million exemption with a 35 percent rate. This is the language that has been included in the tax deal.

So how much does this cost? With a $1 million exemption and a 55 percent rate -- in other words, what will happen if we do nothing -- the estate tax would raise about $700 billion over the next 10 years. The Lincoln-Kyl version would raise less than $300 billion. And the compromise most Democrats have coalesced around -- which was the 2009 level, with a $3.5 million exemption and a 45 percent rate -- would've brought in a bit less than $400 billion.

It's important to keep in mind the cramped space of this debate: If the tax goes back to its scheduled levels, it'll tax 2 percent of estates, If the Lincoln-Kyl levels are put in place, it'll tax 0.25 percent of estates. But the difference between the hundreds of billions the tax could raise and the miniscule number of estates it would affect explains the immense energy Republicans and some Democrats (notably Blanche Lincoln, who has traditionally raked in campaign money from the Walton family) give to the issue. In a report called "Spending Millions to Save Billions," Public Citizen and United for a Fair Economy estimated that a handful of the country's richest families had spent more than $400 million lobbying for the tax's repeal -- and of they were successful, they stood to save more than $70 billion.

For the rich, fighting the estate tax is simple a good investment. And it looks like it's paying off.