The Effect of the Federal Estate Tax Repeal on States

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Tax Policy

The federal estate tax has been around for over 100 years. Both President Trump and the House GOP Blueprint tax reform plans call for eliminating the tax. In this article, the Tax Foundation's Morgan Scarboro discusses the impact of the proposed repeal on the 14 states, and the District of Columbia, that have their own estate taxes.

Morgan Scarboro

By Morgan Scarboro

Morgan Scarboro is a policy analyst with the Tax Foundation's Center for State Tax Policy.

The federal estate tax is potentially on the chopping block, with the House GOP Blueprint and President Trump's tax plan both proposing its elimination. First levied in 1916, the estate tax is imposed on the net value of an estate before it is passed to beneficiaries. If eliminated at the federal level, the 14 states and D.C. that still levy an estate tax will face serious administrative challenges.

The Modern Estate Tax

In 2001, all 50 states and D.C. levied some form of an estate tax, whether it was an independent estate tax or pick-up taxes that were tied to the federal estate tax. At the time, the federal government provided a pick-up credit, where each dollar paid to a state estate tax reduced federal tax liability for the estate dollar for dollar. The credit essentially functioned as a transfer of revenue from the federal government to the states, so states were incentivized to levy an estate tax at least as large as the pick-up credit.

The landscape of the state estate tax system drastically changed when Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA phased out and eventually repealed the state estate tax credit by 2004. At that time, states were faced with a choice: either impose their own estate tax or forgo the tax and its revenue altogether.

Many states simply allowed the repeal of the credit to eliminate their estate tax by default and a few states went a step further and statutorily eliminated their estate tax. But some decoupled from the federal changes and chose to impose their own separate estate tax.

Today, only 14 states and the District of Columbia impose the tax; rates range from 0.8 percent to 16 percent, on top of the federal tax rate of between 18 percent and 40 percent. There is, however, a definitive trend in states raising their exemption level or repealing the tax altogether. Tennessee eliminated its estate tax in 2016; also that year, New Jersey enacted legislation that will phase out the tax by 2018. New York and D.C. are both scheduled to increase their estate tax exemption to match the federal exemption. Lawmakers in Minnesota are also debating an increase to the exemption level, though it would still fall short of the federal exemption.

States that still levy an estate tax should carefully consider their next steps if Congress eliminates it at the federal level. Currently, states lean heavily on the IRS to conduct estate audits and issue regulations and guidance. If the federal government eliminates the tax and no longer provides these services, states will have to accept the full administrative cost of the tax. It will take time and resources for states to develop, implement, and maintain the new audit process and regulations. Estate audits can also be extraordinarily time-consuming. From a revenue perspective, this burden might not be worth it to states as the estate tax, on average, generates only 0.75 percent of a state's total revenue. Estate taxes are also a volatile revenue source, given that the majority of the revenue typically comes from the death of few individuals.

Benefits of the Federal Estate Tax Repeal

The Tax Foundation's Taxes and Growth Model is a tax-scoring model that evaluates the impact taxes have on the economy. The model doesn't produce state-specific results, but these results can be instructive for state policymakers. When modeled at the federal level, the repeal of the estate tax increases long-run economic growth by 0.8 percent, leads to an extra 159,000 full-time equivalent jobs, and after-tax incomes would grow by 1 percent because of the change.

The estate tax acts as a disincentive for business investment, both in terms of business equipment and land. A business owner planning for the estate tax may avoid purchasing new business equipment or opt for smaller, less costly equipment. It can also discourage families from acquiring more land. This effect can be particularly burdensome for those with limited liquid capital, such as farmers and small business owners.

Conclusion

The harmful economic effects and complexity of the tax are problematic, and the elimination of the federal estate tax may also increase administrative costs for states to raise a relatively small amount of revenue. A number of states have already moved away from relying on estate taxes by raising exemption levels or eliminating the tax entirely. Moving forward, the remaining states that still levy the tax should consider taxes that create less of an administrative and economic burden.

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