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Research & Commentary: New California Estate Tax Would Be Huge Burden on an Already Overtaxed State

April 15, 2019

In this Research & Commentary, Matthew Glans examines a proposed revival of California’s estate tax.

More than the residents of most states, Californians face a barrage of taxes that impede economic growth and investment. California has the highest top marginal income tax rate, at 13.3 percent, the second highest gasoline tax, and the highest state sales tax, at 7.3 percent.

One of the few areas of California’s tax system that gives taxpayers a break, relative to other states, is its lack of an estate tax, which was banned in 1982 by voters through two ballot measures. Estate taxes, commonly called “death taxes,” are levies on property transferred from a deceased person’s estate to relatives or other parties.

A proposal has emerged in the California State Legislature that would create a new state estate tax based on the current federal estate tax. According to a press release from the sponsor of Senate Bill 378, state Sen. Scott Wiener (D-San Francisco), the proposed estate tax would impose a 40 percent tax (the same as the federal rate) on estates ranging from $3.5 million to $11.4 million for individuals or $7 million to $22.8 million for married couples. These thresholds would not be adjusted for inflation. The bill contains exemptions for transfers to a surviving spouse and for family farms. If passed, the new tax would have to be ratified by voters in the November 2020 statewide election.

The revenue generated by the estate tax would be used to fund programs with the goal of promoting “socioeconomic equality” in California. These include programs for low-income families and children. Although helping the poor is an admirable goal, it is clear the estate tax is primarily designed to redistribute income. The estate tax is particularly immoral because it applies a tax to property that has already been taxed.

Supporters of the bill estimate the new tax could generate anywhere from $500 million to $1 billion each year. These estimates are likely too generous, however. State estate taxes have proven to be problematic for state budgets, because it is easy for taxpayers to move from a state with a high estate tax state to another with a lower rate. One hypothetical example offered by The Heritage Foundation reveals how a “successful New York business owner with $50 million of lifetime savings can move his family and company to Florida, Georgia, Texas, or 28 other states and cut his death-tax liability by more than $7 million.”

Increasing the estate tax can also affect other tax revenues as well. Economists Jon Bakija and Joel Slemrod calculated the departure of wealthy retirees due to high state inheritance and estate tax rates can result in reduced income, sales, and property tax revenues lost during the last years of a resident’s life. Bakija and Slemrod estimate a state’s revenue losses could be “as much as 1.73 times as large as the tax revenues that might have been collected from that person’s estate.”

Bakija and Slemrod also found that a “1 percentage point increase in a state’s average estate or inheritance tax rate is associated with a 1.4 to 2.7 percent decline in the number of federal estate tax returns filed in a given state.” This effect was magnified with larger estates, those worth more than $5 million. In those instance, the number of federal estate tax returns declined by 4 percent in response to a 1 percentage point rate increase. These results suggest that reviving California’s estate tax would lead many residents to relocate to avoid the high estate tax rate. In some instances, state domicile laws allow residency to be established elsewhere without requiring yearlong residence.

Although proponents of the death tax say it is a way to bring equality to the tax system and target the wealthy, death taxes more frequently burden small businesses. Often, small businesses do not have the liquid assets to pay the tax and are forced to reduce business investment, cut employees, close down, or accept a buyout.

Estate taxes are double taxation and stifle investment and entrepreneurship, reduce economic growth, discourage savings, increase the cost of capital, raise interest rates, and bring in little revenue. Californians made the correct choice when they ended the estate tax nearly four decades ago; lawmakers should reject a new estate tax and avoid repeating past mistakes.

The following documents examine estate taxes, their effects on the economy and investment, and current proposals for reform from multiple perspectives.
 

State Inheritance and Estate Taxes: Rates, Economic Implications, and the Return of Interstate Competition
https://taxfoundation.org/state-inheritance-estate-taxes-economic-implications/
In this Special Report, Jared Walczak of the Tax Foundation examines the various characteristics of state inheritance and estate taxes, sets out their current rates and structures, explores the history of estate and inheritance taxation in the United States, and reviews the academic literature on the effects of these taxes on economic activity, migration, and revenue.

Do the Rich Flee from High State Taxes? Evidence from Federal Estate Tax Returns
https://www.heartland.org/publications-resources/publications/do-the-rich-flee-from-high-state-taxes-evidence-from-federal-estate-tax-returns-1
Jon Bakija and Joel Slemrod examine in this paper how “changes in state tax policy affect the number of federal estate tax returns filed in each state, utilizing data on federal estate tax return filings by state and wealth class for 18 years between 1965 and 1998.”

The Moral Case against the Death Tax
http://heartland.org/policy-documents/moral-case-against-death-tax
This Cato Policy Analysis by Edward McCaffery is a primer on the basics of the death tax. It says the tax fails to achieve most – and quite possibly any – of the objectives its supporters promote.

Interstate Competition and State Death Taxes: A Modern Crisis in Historical Perspective
http://heartland.org/policy-documents/interstate-competition-and-state-death-taxes-modern-crisis-historical-perspective
Jeffery Cooper of the Quinnipiac University School of Law argues the current decline of state death taxes is not an isolated modern event but rather another step in a decades-long interstate battle to attract and retain wealthy citizens.

The Federal Estate Tax: History, Law, and Economics
http://heartland.org/policy-documents/federal-estate-tax-history-law-and-economics
David Joulfaian of the U.S. Department of the Treasury traces in this manuscript the evolution of the estate tax since its enactment. He provides a brief legislative history and description of the structure and features of the tax, and then reviews the fiscal contribution of each of the estate and gift taxes. In addition, Joulfaian provides data on the number of individuals and households touched by the tax as reflected by the number of returns filed over time, and he gives a comprehensive review of the behavioral effects of the tax.

Straight Talk About the ‘Death’ Tax: Politics, Economics, and Morality
http://heartland.org/policy-documents/straight-talk-about-death-tax-politics-economics-and-morality
Dennis J. Ventry, Jr. of the University of California-Davis criticizes the political, economic, and moral cases against wealth-transfer taxes. Ventry argues the rhetoric surrounding the effort to repeal estate and gift taxes – particularly the charge it destroys family farms and closely held businesses – is misleading and even disingenuous. He also argues estate and gift taxes do not threaten aggregate savings, labor supply, or economic growth as its critics maintain.

The Economics of the Estate Tax: An Update
http://heartland.org/policy-documents/economics-estate-tax-update
Daniel Miller of the Joint Economic Committee argues the federal estate tax generates costs to taxpayers, the economy, and the environment that far exceed any potential benefits it might arguably produce. The paper updates a previous Joint Economic Committee report on the federal estate tax.

The Economic Case against the Death Tax
http://heartland.org/policy-documents/economic-case-against-death-tax
In this Heritage Foundation Backgrounder, Curtis Dubay details a replacement for the death tax and explains why Congress must kill the death tax—now.

How the Death Tax Kills Small Businesses, Communities—and Civil Society
http://heartland.org/policy-documents/how-death-tax-kills-small-businesses-communities-and-civil-society
Writing for the Heritage Foundation Backgrounder series, Patrick Fagan argues the death tax makes a direct assault on a community’s economy by undermining small business, a primary source of sustenance for communities.

 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.

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Article Tags
Taxes
Sub-topic
Taxes: Estate Tax
Author
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance. In 2012, Glans was named senior policy analyst.
mglans@heartland.org @HeartlandGR