Kill the Death Tax, and In Return Kill the Muni Deduction

Kill the Death Tax, and In Return Kill the Muni Deduction
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Who says politicians aren’t an innovative bunch? Just take a look at the federal budget, and one discovers considerable innovation in dreaming up ways to take and spend other people’s money.

Among the many destructive tax measures imagined and imposed by government officials over the decades – well, actually, over the centuries – the death tax (or estate tax) stands out as a particularly egregious levy.

After paying assorted and substantial taxes and fees to various levels of government over a lifetime, the tax man shows up at death to claim a percentage of the deceased’s assets. The current federal estate tax rate is 40 percent, with a 2017 exemption level of $5.5 million (adjusted annually for inflation). While we hear many dubious complaints about a so-called lack of fairness in life, a tax on total assets at death truly ranks as unfair. For good measure, the death tax discourages investment, shifts resources from the productive private sector to wasteful government, and takes a heavy toll on many family businesses, including some enterprises having to be sold or simply being closed up.

Assorted studies have shown the ill economic effects of the death tax. For example, a report from the Joint Economic Committee of the U.S. Congress noted that the estate tax has reduced the capital stock of the nation, and the levy serves as “an overwhelming cause of the dissolution of family businesses” and “a significant hindrance to entrepreneurial activity because many family businesses lack sufficient liquid assets to pay estate tax liabilities.” A 2014 Heritage Foundation study found that killing the death tax “would boost U.S. economic growth by more than $46 billion over the next 10 years and generate an average of 18,000 private-sector jobs annually. Eliminating the federal death tax would create economic opportunities for American families and free up financial assets for private-sector investment and income growth.”

So, while the death tax discourages productive economic activity, another feature in the U.S. tax code subsidizes spending driven and guided by politics. Interest on public purpose state and local government bonds is not subject to the federal income tax. While there certainly are legitimate undertakings for which state and local governments should float bonds, given the incentives at work in government, it’s often difficult to figure out which projects are based on true need, political preferences or grandstanding, or special-interest influence. Plus, there’s the question of whether government should be doing the work, or is it better left to the private sector.

But no matter the answers to such important questions, in the end, why should there be an effective federal subsidy for state and local government projects? Arguably, such a subsidy further incentivizes spending more money than government otherwise would.

So, here’s a thought: Let’s make a trade that will clearly benefit the economy as part of federal tax reform. Kill the death tax and kill the deductibility of interest on state and local government bonds.

In the static world of federal budgeteers, this would basically be a straight-up trade. According to estimates from the Treasury Department, federal deductibility of interest on state and local government bonds will “cost” the federal government an estimated $31.9 billion in fiscal year 2018. Meanwhile, OMB figures that federal estate and gift taxes will rake in $31.5 billion.

While there are many tough issues to be wrestled with in trying to advance tax reform, eliminating both the death tax and the federal tax subsidy on state and local government bonds is an easy-peasy trade.

Ray Keating is an economist and a novelist.  His latest thriller is Wine Into Water: A Pastor Stephen Grant Novel.  

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