Is Repeal of the Estate Tax a Dead Issue?

Sometime shortly, the Senate is expected to vote on the fate of the estate tax. The House has already voted to repeal the tax; however, several Senators have found it difficult to vote for total repeal. One Senator, Ron Wyden (D-Ore.), who has voted to repeal the estate tax in the past, recently noted, “The deficit picture is different today and the choices are pretty darn hard.”

The budget deficit has been dramatically increased in the past year, with two major hurricanes costing hundreds of billions in recovery costs, and a war in Iraq that continues to demand billions of dollars to prosecute. Further, Congress will be facing votes this fall on measures to institute cuts in a range of domestic programs. The trade-offs associated with repealing or dramatically curtailing the estate tax are becoming more evident than they were in the recent past.

The Senate voted on legislation to repeal the estate tax every year from 1999 through 2002. At the time of each of those votes, the Congressional Budget Office was projecting sizeable surpluses over the coming ten-year budget period. The current fiscal picture is very different. CBO now forecasts large deficits over the next 10 years and beyond.It is particularly telling to compare the present outlook with the outlook at the time that Congress debated the 2001 tax-cut package, which included the measure that repeals the estate tax in 2010. In 2001, CBO was projecting a surplus of $5.6 trillion over the 2002-2011 period. Today, deficits of $3.7 trillion are projected over that period.

The coming estate tax vote also differs from earlier votes in that it is occurring amidst a debate on how to restore long-term solvency to Social Security. Eliminating or dramatically shrinking the estate tax would take “off the table” a source of revenue that could be used to help close the Social Security shortfall. Some Social Security proposals, such as a plan developed by former Social Security Commissioner Robert Ball, would help restore solvency by maintaining a moderate-size estate tax and dedicating the revenues it collects to Social Security. (The Ball plan combines this measure with changes in Social Security benefits and taxes.) Eliminating most or all of the estate tax would eliminate this option, however, and thereby increase the depth of the Social Security benefit cuts or payroll tax increases that ultimately will be needed to restore solvency.

As you are probably aware, the current exemption against estate tax is $1.5 million per person. That exemption, unless the law is changed, will increase to $2 million per person over the next three years, then go to $3.5 million in 2009, disappear entirely in 2010, and drop back to $1 million per person in 2011. It is my personal belief, based on information coming out of Congress, the most likely scenario will be that with increased pressure on Congress to maintain revenue, at least presently, that estate tax repeal is dead in the water for the next few years. Instead, I anticipate that Congress will ultimately raise the exemption to around $4 - $5 million per person and lower the effective tax rate from a top rate of around 50% to something in the 25% range.

The bottom line is that your estate planning should be based on the assumption that the estate tax will not be repealed. Better to plan for the tax and be wrong than to plan for the repeal and be wrong.