Fortune issue: September 6, 1999

First Principles

TAXES: AN ECONOMIC LESSON

Why Shouldn’t We Die Tax-Free?

Shame on you, Larry. I know you know better. In debates over tax policy, the Treasury Department has long fueled partisan fires by producing large quantities of meaningless numbers. But now that you--the most talented economist of your generation--are Treasury Secretary, I expected something better. Instead, you’re giving us politics as usual, especially over the Republican plan, passed recently by Congress, to eliminate the estate tax. I know the estate tax cut accounts for less than 10% of the $792 billion congressional tax package, but it matters a great deal to Americans who hope that their children--not the government--will inherit the fruit of their labor. The Administration’s reaction to it is symptomatic of the sad state of the current debate in Washington.

When I was your student and later your colleague on the Harvard faculty, you understood that taxes profoundly affect how people behave. Like all economists, you rejected the idea that taxes stay where Congress puts them, that the burden of a tax sticks to the person who actually writes the check to the government. You derisively called that silly notion the "flypaper theory." You knew that when the government taxes car companies, for instance, the burden falls not only on the company shareholders but also on car buyers and car workers, and most likely on other industries as well. The same is true with any tax.

Yet the flypaper theory is alive and well in your Treasury Department. When you and your Administration colleagues criticize Republican tax plans as a giveaway to the rich, you assume that a tax cut goes where Congress says it goes. But you know it’s not so.

The most preposterous claims coming from Treasury revolve around the estate tax. A while back, you got into trouble by calling Republican plans to eliminate this tax "selfish." It was fortunate that you apologized for that cheap shot, but it would be even better if Treasury offered a serious analysis of this tax.

What do you give us now? Treasury’s current assessment of the congressional tax bill assumes that the entire burden of the estate tax falls on the decedent. That’s right--the rich dead guy supposedly takes the tax hit. But what about the impact on the estate’s beneficiaries, who are younger and often less wealthy? And what about the impact on capital accumulation and economic growth? Remember what you wrote in the 1981 study you co-authored with Larry Kotlikoff: "Intergenerational transfers account for the vast majority of aggregate U.S. capital formation." If bequests are so important for the economy, why do you want to tax them so heavily--at tax rates that can exceed 50%? Wouldn’t eliminating the tax stimulate growth and raise incomes for everyone, even those never lucky enough to receive a bequest?

While I’m at it, let me also remind you of another study from your academic days--a paper by Doug Bernheim called "Does the Estate Tax Raise Revenue?" that you put in a volume you edited in 1987. According to current Treasury figures, the estate tax raises a mere 1.4% of federal revenue, in part because the wealthy hire legions of lawyers and accountants to get around it. But Bernheim’s study suggests that even that small number is an overestimate. A more accurate number might be zero.

To refresh your memory, Larry, here in your own words is how you summarized this study in the editor’s introduction: "The federal estate tax could conceivably reduce federal tax revenues. Because of its many exemptions and tax-avoidance schemes that are legally permissible, the tax raises only a small amount of revenue. The estate tax also encourages people to take avoidance actions, such as making gifts to their children, that reduce income tax collections. But standard estimates of the revenue raised by the estate tax do not include its negative impact on income tax collections." Of course, you could close up those loopholes to make this a real tax revenue generator, but that would risk choking off capital accumulation and economic growth.

So there is really no reason for the Clinton Administration to oppose eliminating the estate tax. The tax restrains the economy, doesn’t fall on the rich nearly as much as your staff seem to think, and doesn’t even raise much revenue. Maybe you can change your boss’ mind about this one. Clinton killing the death tax could be like Nixon going to China--a good policy move that plays against type. And it wouldn’t be a bad legacy for a Treasury Secretary either.

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N. GREGORY MANKIW is a Harvard economics professor and author of Principles of Economics.