Sunday, December 04, 2011

Estate, gift taxes are a drag on economy

Published in The Tennessean, Sunday, December 4, 2011

by Richard J. Grant

Some taxes are just not worth the trouble. There are many ways in which a tax can end up costing us more than the revenue it generates. This is especially true when the tax rates are high and the tax base is narrow enough that people can shift to other activities that are less heavily taxed. Resources shift into second-best uses.

Taxes reduce the ability of individuals to accumulate capital. Although some government spending is devoted to long-term capital projects, such as roads and bridges, most of it is shifted into consumption. As social programs become a larger proportion of governmental spending, governments increasingly inhibit our ability to maintain and create capital. With less capital, our future incomes will unfortunately be lower than they would have been.

While this implies a lower future standard of living for individuals, it also implies a lower capacity for the future provision of government services. With less capital and lower incomes than we might otherwise have had, the tax base is lower. Future tax revenues cannot be as high as they would have been.

Perhaps the purpose of the tax is not to raise revenue but to discourage the activity that is being taxed. To discourage officially undesirable activities such as smoking and certain types of industrial pollution, we can estimate the amount of taxation needed to reduce these activities to acceptable levels. We know that when we tax something we tend to get less of it.

This is why a particular tax usually generates less revenue than its governmental sponsors had hoped to receive. People really do work less when they no longer believe that their next dollar of after-tax income is worth the effort. People really do shift their capital away from highly taxed investments. People also move themselves to other countries or states, albeit reluctantly, when the tax savings make it worthwhile.

Such mobility is most feasible for people with higher levels of wealth or income. This is what makes the estate tax one of those not worth the trouble.

Arthur Laffer and Wayne Winegarden of Laffer Associates have recently concluded a study on “The Economic Consequences of Tennessee's Gift and Estate Tax.” Tennessee is one of only 19 states with a separate estate tax and one of only two states with a gift tax. Tennessee has the single lowest exemptions for both its estate tax and its gift tax, which makes them more burdensome.

Gift and estate taxes contribute less than one percent of Tennessee's total tax revenues. They also make Tennessee less attractive to high net-worth people, many of whom would be inclined to invest and build businesses locally. Pennies gained, dollars lost.

Laffer and Winegarden estimate that had Tennessee eliminated its gift and estate taxes 10 years ago, Tennessee's economy would have been over 14 percent larger in 2010 and there would have been more than 200,000 additional jobs in the state. Also, the greater prosperity would have brought state and local governments more than $7 billion in extra tax revenues.

Although Tennessee is a right-to-work state with no income tax (except on interest and dividends), low corporate taxes and a low overall tax burden, its economy has significantly underperformed other states that can boast the same advantages. The difference seems to be Tennessee's gift and estate taxes.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.


Twitter: @RichardJGrant1

Copyright © Richard J Grant 2011