America Can't Afford the Death Tax

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The death tax is an economic and financial disaster, not only for the nation as a whole, but also for the federal government. In fact, if you owned the federal government, and you got to keep all of the revenue that federal taxes bring in, you would eliminate the death tax. This is because the death tax costs far more in reduced economic growth than it is worth as a source of tax revenues.

Based upon the latest* long-term projections by the Congressional Budget Office (CBO), the present value (PV)** of America's real GDP (RGDP) is $7,908 trillion. The CBO expects a long-term federal "tax take" of 18.5%, which makes the PV of real federal revenues $1,463 trillion. Of this, only $6 billion, or less than one half of one percent, is accounted for by the death tax.

Unfortunately, while the death tax adds 0.076 percentage points to the federal tax take, it depresses economic growth by forcing the liquidation of existing assets, and by discouraging investment in new assets. A conservative estimate (discussed below) is that eliminating the death tax would increase RGDP growth by 0.1 percentage points.

This may not sound like much, but this 4.35% increase in the economic growth rate would increase the PV of America's RGDP by 45.4%, or $3,589 trillion. Despite the slightly lower tax take, the PV of federal revenues would increase by $655 trillion, or 44.8%.

Think about it. Simply eliminating the death tax would offset the national debt held by the public ($13.1 trillion) and the unfunded liabilities of Social Security and Medicare (an estimated $100 trillion) almost six times over. And, don't forget that, in the process, the PV of the income flowing to the states, local governments, and "We, the People" would go up by $2,934 trillion, or 45.5%.

These numbers highlight the insanity afflicting Washington right now. Everyone is talking about tax increases, spending cuts, and "inequality," and no one is paying attention to the only thing that really matters, which is economic growth. Even if taxes could be raised without harming RGDP growth (which they cannot), it would take a 45% across-the-board increase in federal tax rates to produce as much benefit for the federal government as eliminating the death tax.

OK, now let's look at how the numbers presented above were derived.

Our experience of the present is heavily influenced by the future that we expect. This is why people are willing to invest in projects that pay off over time. As a reflection of this, the financial markets value assets based upon the present values of their expected future cash flows.

Because the federal government can borrow as well as tax, what determines its available financial resources is not this year's tax revenue, but the present value of all future tax revenues, discounted at the interest rate at which the federal government can borrow money.

As it happens, under the CBO's current assumptions, the present value of RGDP (and, therefore, the present value of federal revenues) is extraordinarily sensitive to changes in the rate of economic growth. For example, increasing the RGDP growth rate by 0.1 percentage points (which is the smallest increment that the Bureau of Economic Analysis-the BEA-measures) would increase the present value of RGDP by 45.4%. On the other hand, reducing economic growth by 0.1 percentage points would cut the present value of RGDP by 26.5%.

This extreme sensitivity has profound implications. In purely financial terms, it would worthwhile for the federal government to cut tax rates across the board by up to 31.2% (i.e., cut the federal tax take to 12.72%, from 18.50%) in order to boost RGDP growth by 0.1 percentage points (i.e., to 2.4%, from 2.3%). This makes eliminating the death tax, which brings in less than 0.5% of federal tax revenues, an incredible bargain.

As a corollary, under the CBO's assumptions, the federal government cannot afford taxes that have even the slightest negative impact upon the rate of economic growth. For example, in 2013, the death tax brought in a paltry $12.7 billion, or 0.076% of GDP. This amounted to less than one half of one percent of total federal revenues. To produce any net financial benefit to the federal government at all, the death tax could not reduce America's rate of RGDP growth by more than 0.0012 percentage points. This number is almost 100 times smaller than what the BEA can measure.

Given the numbers, those favoring the death tax are forced to argue that this tax doesn't reduce economic growth at all. This is nonsense. In fact, in terms of its impact upon RGDP growth, the death tax is the very worst tax that we have.

There is a reason that we refer to our economic system as "capitalism." Quantitatively, here is how America's economy works***:

$280,000 nonresidential assets yields $123,000/year GDP yields 1 average ($48,000/year) job

In other words, economic growth is driven by the accumulation of nonresidential assets, which produce an annual 43.9% GDP return for the economy as a whole. This number provides another way to look at the death tax.

For the nation as a whole, the death tax amounts to taking money out of an account paying 43.9% interest in order to put it in an account paying 2.5% interest. From the federal government's point of view, the tax takes money out of an account paying 8.1% interest and stuffs it into an account paying 2.5% interest. Neither of these can be considered to be a brilliant financial move.

The death tax is a pure tax on capital. It forces the private sector to liquidate assets, and to hand the proceeds over to the federal government. If the death tax doesn't do that, it doesn't do anything. However, the death tax does far more damage than to merely reduce nonresidential assets by the amount of the taxes collected ($12.7 billion in 2013).

The death tax rate is 40%. No farm or business has 40% of its assets sitting around in the form of idle, unneeded cash. The firm must be liquidated in some manner to pay the death tax. This liquidation process is inherently disruptive, and disruption has a cost.

The death tax is also something that people have a strong incentive to try to avoid. Looked at in the simplest terms, the death tax is a tax on not blowing all of your money before you die. There is also a huge industry (accountants and lawyers) that is devoted to helping people avoid the death tax.

Taking all factors into account, America would be fortunate if the death tax had the effect of reducing the accumulation of nonresidential assets by only three times the amount of the death taxes paid. Three times the death taxes paid of 0.076% of GDP equals 0.227% of GDP. Reducing net nonresidential capital investment by 0.227% of GDP will decrease RGDP growth by 0.100 percentage points. As noted above, this has an enormous impact upon the present values of both RGDP and federal revenues.

America can't afford the death tax. It's time to eliminate it.

*2.3% real GDP (RGDP) growth; 2.5% real interest rate for federal borrowing, and a federal "tax take" of 18.5% of GDP.

**Based upon the Social Security Trustees' "to the infinite horizon" methodology

***Based upon BEA "Produced Assets" data for 2012.



Louis Woodhill (, an engineer and software entrepreneur, and a RealClearMarkets contributor.  


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