Boomers Beware
The Estate Tax Is Now Not Just for the Rich

By Norman J. Ornstein
April 23, 1997

American Enterprise Insititute

The estate tax currently touches only one bequest in fifty, but unless the law is changed, in coming decades the tax will affect the legacies of a significant percentage of middle-class Americans.

My father was a traveling salesman. He did not make a lot of money in his lifetime, but did manage to accumulate a small nest egg that he was proud to bequeath to his three children when he died a decade ago. It was an amount for each about equivalent to the purchase price of a small economy car. At that time, for him and most of his generation, the notion of an estate was a notable accomplishment; the idea that there might be personal estate taxes was almost laughable. Estate taxes were for the super-rich, not for the average middle class guy.

The estate tax concept, as one of society's major ways to target the rich, has been a venerable one in America. It has resonated with most voters; after all, the current estate tax kicks in only at the $600,000 level, or $1.2 million for a couple, and takes its biggest bite at the rarefied level of $3 million and above. Add in additional breaks for capital gains and it would seem to target only the Rolls-Royce set.

But the world has changed for the generation that followed my dad's. And as a result, the current drive to reduce estate taxes has struck a chord with more constituencies than a few wealthy conservative Republicans. To be sure, the Clinton administration is resisting change, arguing that it would simply be a windfall for the rich. But lawmakers who resist it, including Democrats, will do so at their peril.

The root of the change in political climate comes from the dramatically different economic circumstances of baby boomers, including those in their 40s who are in their peak earning years and those in their 50s planning for retirement, and from the perverse cumulative effect of several taxes, including those on retirement income, that can make the tax on a lifetime of savings approach 90 percent or more.

The fact is that a large swath of middle-age, middle-class people own their own homes, have savings building in pension plans like 401(k)s and IRAs, and in many cases have small businesses or professional offices. But you don't have to be a doctor, lawyer, or entrepreneur to have accumulated a sizable nest egg in contemporary America. Many mid-level homes purchased for a song in the 60s are worth several hundreds of thousands of dollars now. People with pension plans invested in the stock market--including, say, a lot of college teachers under their TIAA/CREF, the nation's largest pension plan--have ridden the boom and built up impressive retirement nest eggs.

While just under 2 percent of estates pay taxes now, when baby boomers start to retire, their savings will total in the many trillions, and $600,000 estates will be almost commonplace. If the current system stays in place, a lot more people than the Rockefellers and Mellons will feel the heavy bite.

The major element of that bite is the estate tax itself, which moves quickly up over 50 percent. But consider two additional lesser-known effects. In most pension plans--such as 401(k)s or Keoghs--contributions are in pre-taxed dollars and earnings accumulate untaxed until retirement, and are then taxed as income as one withdraws them to live on. But what happens to the assets in the retirement plan that are still there when the retiree dies? They are taxed at income tax rates--but with much of the tax burden added on to the estate tax if the estate is over the $600,000 level!

That's not all. If too much money has accumulated and not been spent in retirement, the IRS can levy an additional 15 percent "excess accumulation" tax on them--making the combined tax 90 percent or even more! In fact, Stanford University economist John Shoven and his Harvard colleague David Wise have shown that in some circumstances, in high-tax states such as New York and California, the tax can equal more than 99 percent, essentially confiscating everything that has accumulated.

Of course, we are still talking about a minority of Americans; most people will not come close to building assets of $600,000 or more in their lifetimes. But neither are we dealing only with the Forbes 400. The numbers of people with assets large enough to be affected by estate taxes will certainly swell into the millions over the next decade or two.

That means a slew of politically active middle-class voters, proud that they have built up assets by saving and investing, will be faced with the prospect that all they have sacrificed to accumulate may be virtually confiscated. They heeded the rules and norms--saving, not spending. Their reward is to have it snatched away before their kids can touch it. These are not people who consider themselves rich. They will not be happy that politicians have labeled them as such.

Beyond the changing politics of wealth accumulation, estate taxes need rethinking for other reasons. The fact is that they have not done what they were intended to do: prevent the handful of superwealthy from concentrating their gains even more in a small elite. The very wealthy have found many ways to reduce or avoid confiscatory estate taxes, often by spending instead of investing, or investing in less productive areas just to avoid the taxes. The estate tax has been as big a boon for estate-tax lawyers as the pre-1986 loophole-filled income tax code was to crafty accountants.

Many Western countries are doing away with estate taxes altogether, a course advocated by Speaker Newt Gingrich. America won't do that; an estate tax at least makes a statement about our values and our desire to prevent too much concentration of wealth and power. But we surely can change a set of levies that ends up punishing savings and investment and will soon punish middle-class success. Politicians who resist that logic might find voters who usually don't mind hitting the rich joining the barricades against them.

Norman J. Ornstein is a resident scholar at the American Enterprise Institute.