Date September 1937
Author George (?) Haas
Title Tax Revision Studies: Estate and Gift Taxes
Description Staff memo, Division of Tax Research, Treasury Department
Location Box 63; Tax Reform Programs and Studies; Records of the Office of Tax Analysis/Division of Tax Research; General Records of the Department of the Treasury, Record Group 56; National Archives, College Park, MD.
 
Table of Contents

TAX REVISION STUDIES, 1937 -- ESTATE AND GIFT TAXES

Summary of Findings and Recommendations

Part I: Structural Revision of the Federal Estate Tax
Part II: Coordination of the Federal Estate and the Federal Gift Tax
Part III: Coordination of Federal and State Taxes on Property
          Transfers

Part I: Structural Revision Of The Federal Estate Tax

     A. Introduction

          1. Legislative history
          2. Revenue significance
          3. The case for Federal death taxes

     B. Structural revisions of the Federal estate tax

I. Various estate tax exemptions

     1. Specific exemptions
     2. Exemptions varying in accordance with number of
        beneficiaries, and their relationship to the decedent
     3. Constant, conditional, and vanishing exemptions
     4. Manner of taking and manner of providing exemption
     5. Insurance exemption
     6. Insurance for the payment of estate taxes
     7. Property previously taxed
     8. Charitable bequests

II. Rate structure

     1. Totality vs. bracket rates
     2. Upward revision of the rate structure
     3. Prior wealth of the beneficiary as third variable in the
        rate structure

III. Valuation for tax purposes

     1. Date of valuation
     2. Community property problem

IV. Compensatory tax on accumulated capital gains

V. Complementary revisions in the Federal gift tax

Part II: Coordination Of The Federal Estate And The Federal Gift Tax

     A. Introduction
     B. The existing lack of coordination
     C. Proposal for the coordination of the Federal estate and gift
        tax
     D. Operation of the proposed method of coordination
     E. Consideration of possible objections to proposed method of
        coordination
     F. Advantages of the proposed plan
     G. Gift tax annual exemption

Part III: Coordination Of Federal And Estate Taxes On Property
Transfers

     1. Introduction
     2. The existing Federal-State conflict in death taxation
     3. Interstate variations in death taxation

          A. Types of death taxes
          B. Definition of gross estate
          C. Definition of net estate
          D. Treatment of life insurance
          E. Amount of specific exemptions
          F. The rate structure
          G. Tax burdens
          H. Dual tax administration
          I. Further interstate variations

     4. Proposals for the coordination of Federal and State taxes on
        property transfers

          A. Separation of sources
          B. Modification of creating device
          C. Federal-State integration

     5. Recommended procedure for the coordination of Federal and
        State death taxes

Table 1 -- Federal estate tax: Changes in rates and exemptions

Table 2 -- Federal and State death and gift tax collections,
           1915-1938

Table 3 -- The Federal state tax: Summary data showing number of
           taxable returns, gross and net estate, and tax liability

Table 4 -- Specific exemptions afforded by State death taxes

Table 5 -- Death tax exemptions in foreign countries

Table 6 -- State death taxes: Method of taking exemptions

Table 7 -- Estate tax returns: Value of deductions on account
           of insurance -- 1931-35

Table 8 -- Estate tax returns: Value charitable, public and similar
           bequests -- 1931-35

Table 9 -- Number of taxable estate tax returns filed, by net
           estate classes, for years 1927 to 1935

TO       Mr. Magill
FROM     Mr. Haas
Subject: TAX REVISION STUDIES, 1937 -- ESTATE AND GIFT TAXES

Summary Of Findings And Recommendations

Part I: Structural Revision Of The Federal Estate Tax

The accompanying memorandum examines in some detail those features of the Federal estate tax which may be deemed worthy of revision in the interest of maximum equity and greater productivity. The more significant of the conclusions are as follows:

1. The specific exemption of $40,000 may well be reduced to $20,000. While no particular case can be developed for precisely that figure as opposed to one slightly higher or lower, evidence is abundant that the present figure is too high. A reduction of the specific exemption to $20,000 would make the estate tax more effective on smaller estates and thus increase revenue. It would, in addition, bring Federal exemption into better conformity with the exemptions provided by State laws, thus eliminating one potent field of interstate variation, yet leaving it at a level above that generally recognized as adequate to provide a tax-free subsistence fund to the decedent's dependents.

2. The suggestion that the specific exemption provided by the estate tax recognize the number of beneficiaries and their relationship to the decedent, is not considered desirable for immediate adoption. That either an inheritance tax or an estate tax which recognizes the number of beneficiaries and their relationship to the decedent would make for greater equity, can be readily conceded. However, the accompanying administrative difficulties are believed to outweigh the net addition to equity which could thus be obtained.

3. With respect to the three types of specific exemptions (constant, conditional, and vanishing) now in use in various countries, the vanishing type of exemption is singled out as the one most desirable. The constant exemption ignores the very argument to which it presumably owes its existence, namely, the discrimination in favor of the relatively small estates by granting the privilege of bequeathing a tax-free fund for the maintenance of the decedent's dependents. On the contrary, it bestows a tax advantage which grows larger rather than smaller with the increase in the size of the estate. The conditional exemption, on the other hand, is too arbitrary for it fails to provide a gradual transition from non-taxability to taxability. The vanishing exemption is considered most desirable. It recognizes the necessity of granting tax-free bequests for the support of dependents in the case of small estates, and does not, like the constant exemption, perpetuate the same advantage in the case of large estates, and hence does not impair the productivity of the tax.

4. In connection with manner of taking exemptions, it is observed that if the vanishing exemption is adopted, the necessity for specifying that the exemption be taken from the lowest bracket will be eliminated. In the event, however, that the constant exemption is retained, it will be desirable either to specify that the exemption be deducted from the lowest bracket or to replace the present exemption -- expressed as a deduction from the otherwise taxable base -- by an exemption expressed in terms of a constant tax credit. While it is recognized that an exemption in terms of tax credit is psychologically undesirable because it seems smaller to the taxpayer than a corresponding exemption deductible from a tax base, considerations in the interests of equity and productivity are judged to be more significant. The elimination of the tax advantage inuring to large as opposed to small estates from a constant exemption deductible from the top bracket and the consequent destructive effects upon estate tax revenues, are vital considerations.

5. An examination of the treatment of insurance leads to the conclusion that the present exclusion from the taxable base of $40,000 of insurance payable to named beneficiaries should be eliminated. While the practice of providing a liquid fund for one's family is socially desirable, no valid reason can be presented why that form of asset should be singled out for the taxable base serves to double the size of the specific exemption and thus affords a greater tax advantage to the larger as opposed to the smaller estates, and in addition, of course, results in an impairment of the productivity of the tax.

6. The proposal that insurance for the payment of estate taxes be rendered tax free is not recommended. The contention that estate taxes may subject an estate to forced liquidation is recognized; the Government's obligation to prevent such liquidation, however, is not conceded. The facts that the exclusion of such insurance would defeat progression, impair revenues and deprive the Government of one of its relatively few opportunities to employ the principle of ability to pay as a criterion of taxation, are sufficient justification for including all insurance in the taxable estate.

7. The present treatment of property previously taxed (excluding such property from taxation when the two successive deaths occur within five years) strives for the elimination of multiple taxation, one of the existing inequities in the estate tax. However, the present provision limiting the period of grace to precisely five years is conducive to inequity and should be replaced by a graduated scale ranging from a complete exemption of property previously taxed in cases where the two deaths occurred within one year to exemptions of 20 percent in those cases where the interval between the two deaths is more than four but not more than five years.

8. With respect to the present policy of granting full exemption to charitable bequests, stress is laid upon the inequity resulting from the fact that the tax reduction injuring to estates of different size from a given bequest is widely different, ranging from zero to as much as two-thirds of the entire bequest. While the entire elimination of this form of exemption is deemed undesirable, it is proposed that the present full exemption of charitable bequests be eliminated and in its place a tax credit substituted, such tax credit to bear that ratio to the total tax liability which 50 percent of the charitable bequest bears to the net estate. This procedure would not unduly discourage charitable bequests and would, in a moderate manner, equalize the tax benefits accruing from the exemption to estates of various size, increasing at the same time tax revenue.

9. It is suggested that the present bracketed rate structure be replaced by one on a totality basis. The contentions that the Federal Government has never employed a totality rate schedule and that the bracket rate structure permits a smoother degree of progression are significant, to be sure. They are secondary, however, in light of the considerations that a totality rate structure allows for an increase in the effective rate of taxation without any apparent increase in the statutory rate schedule and reflects the weight of the tax burden more correctly. Top bracket rates, which under the bracket system appear confiscatory may, when considered in relation to the tax burden on the total estate, be moderate and can be expressed as such in a totality rate schedule. It is considered good public policy to recognize the general public's lack of understanding of bracket rates through the use of totality rates with adequate equalizing provisions at the break-over points.

10. With reference to the level of estate tax rates, it is suggested that the 1935 rate schedule be replaced with a new rate schedule on the totality basis ranging from 1 percent on net estates above a $20,000 vanishing exemption to 75 percent on net estates of $100,000,000 and over. It is readily defended on the ground that an upward revision of the rate structure, with a view to enhancing the effectiveness of the tax on small and medium size estates, is imperative in the interests of productivity and essential in the interests of equity. The rate structure proposed would produce a substantial increase in revenue with a minimum of administrative difficulty and public opposition. It would add a justifiable addition to the tax burden falling upon middle size estates without interfering with the desire of the individual to provide his heirs with the necessities of subsistence.

11. It has been urged that the tax burden imposed on transfers of property at death recognize the prior wealth of the beneficiary. Although such procedure would be theoretically desirable in the interest of equity, the innovation involves a refinement of a finer order than that commensurate with other features of the present tax system and threatens to involve legal and administrative difficulties, some arising in connection with the determination of prior wealth and others from the necessity of taking due cognizance of the ultimate beneficiaries. It is concluded that present efforts at revision could more profitably be directed in other channels.

12. It is suggested that the practice of affording the executor of an estate an option between valuation for tax purposes as of date of death or one year hence be eliminated. Since the estate tax is a tax on transfer of property at death, no logical justification grounded in economic reasoning can be found for the recognition of property values as of any subsequent date. While in periods of rapidly declining values it may be deemed expedient to temporarily alleviate injustice by shifting the date of valuation one year hence, the practice on the whole is undesirable. At all events, now that the downward trend of security values has reversed itself, the plea of expediency has lost its force and the option can produce only administrative difficulty.

13. With respect to community property, it is urged that the Federal Government take a definite position. It is recognized that in the interest of greater productivity it may be desirable to sterilize the community property principle, in which case a utilization of the "right of management and control" concept may prove fruitful.

14. At present when property which has enhanced in value is transferred by inheritance, the capital gains escape income taxation. The constitutional concept of income precludes the taxing of such capital gains under the income tax. To eliminate this inequity, it is proposed to impose a compensatory tax in the form of an additional estate tax on capital gains that have accrued to real estate, stocks and bonds, in the following manner: A tentative tax is to be computed at the regular estate tax rates on the entire amount of the gross estate without the allowance of any deductions whatsoever. Against this tentative tax there is to be permitted a tax credit, computed at the regular estate tax rates on an amount which will be the sum of the adjusted bases for real estate, stocks, and bonds, and the current market of all other gross estate assets. The difference between the tentative tax and the tax credit thus determined will be the capital gains transfer tax or the "initial estate tax" liability which is to be allowed as a deduction for the purpose of computing the basic estate tax.

15. In view of the corollary relationship of the estate and the gift tax it follows that the adoption of any of the above proposals with respect to the estate tax should be accompanied by parallel revisions of the gift tax.

Part II: Coordination Of The Federal Estate And The Federal Gift Tax

In this section there is examined the lack of coordination between the existing Federal estate and the Federal gift tax and there is outlined the procedure whereby the two taxes can properly be integrated. The more significant of the conclusions are as follows:

1. The gift and the estate taxes are complementary constituents of the tax system. As such, they should be properly coordinated. Coordination, however, does not require that the tax burdens imposed upon two complementary tax bases be identical. All that it requires is that the differential in the tax burdens imposed upon either of the two complementary tax bases express the preferential treatment the Government desires to accord the one as compared with the other and that the extent of that preferential treatment available to different individuals bear a rational relationship to the amount of their property transfers.

2. The Federal estate and gift taxes are in pressing need of coordination because: (a) The gift tax has greatly reduced the effectiveness of the estate tax by affording substantial opportunity for reducing tax liability incident to property transfers; (b) the opportunity for reducing tax liability in this manner is not uniformly available to all individuals but accelerates more than in proportion to their transferable wealth; (c) the reduction in the tax liability incident to property transfers available through inter vivos gifts is greater than that required by public policy; and (d) the distribution of estates through inter vivos gifts encouraged by the preferential treatment accorded it for tax purposes and the consequent reduction of property transfers subject to the estate tax has reduced the amount of inheritance and estate tax revenue available to the States.

3. Partly as a result of the lack of coordination between the estate tax and the gift tax, transfer taxes occupy a relatively minor role in the American revenue structure, notwithstanding the fact that they comprise one of the two main constituents of the tax structure capable of the application of the ability to pay principle.

4. The advantages accruing from the use of inter vivos gifts are no doubt greater than those contemplated by Congress. The legislature did desire to encourage the distribution of estates during the lifetime of their owners, but not to the extent and in the disproportionate manner actually provided by the present law.

5. A coordination of the estate and the gift tax can be achieved by viewing inter vivos gifts as installments of property transfers and viewing the taxes on such gifts as payments on account of transfer taxes. The two taxes are mutually interdependent. They derive from identical origins and fall upon interchangeable transactions and, therefore, barring legal consideration to the contrary, should be combined.

6. Such coordination can be achieved by the following administratively relatively simple device: (a) Retain the 25 percent differential inherent in the existing gift tax and the estate tax rate structure; (b) change the existing net gift tax base to a gross base, comparable to that used in the taxation of estates; (c) consider the taxes paid on inter vivos gifts as installment payments on account of final estate taxes; (d) include in the taxable base at the time of death not only the residual estate remaining after gifts, but also the value of property previously reported for gift tax purposes; (e) compute a tentative estate tax liability upon all of the property disposed of by the decedent both during his lifetime and at his death; (f) credit against this tentative tax liability (l) gift taxes paid and (2) such a premium upon such gift taxes as suffices to express the tax advantage it is desired to afford inter vivos gifts.

7. The device herein proposed for the coordination of the Federal estate and the gift tax may possibly be subject to the following objections: (a) That it is impractical for it implies a stationary estate tax and gift tax rate structure and that in the event of future rate changes, tax liability would have to be recalculated retroactively to the first gift; and (b) that the accumulation of gifts for ultimate inclusion in the residual estate for gift tax purposes may be unlawful because title to the property distributed through inter vivos gifts is not held by the decedent at the time of his death. The first of these criticisms is considered to have little force; the appraisal of the second must await Judicial review.

8. The proposed coordinating device has numerous advantages: (a) It would present no additional administrative problems for a record of inter vivos gifts is already being maintained currently for gift tax purposes; (b) it will increase revenue from the estate and the gift tax by increasing the effective transfer tax rate, without an alteration of the existing rate structure; (c) the Federal Government will be enabled to accord precisely that encouragement to inter vivos gifts which is required by public policy, and which at the same time will be uniformly available to all individuals, and not vary more than in proportion to their wealth; (d) the proposed treatment of property transfers will be a logical corollary of the cumulative tax base and cumulative tax credit concept already employed in connection with gift taxes; (e) it will make the bases of the estate tax and gift tax identical; (f) it will eliminate the double use of exemptions and the double use of lower brackets in connection with property transfer taxes; (g) it will provide the machinery for eliminating the inequitable effect of gift taxes upon the estate and inheritance tax revenues of State governments without any reduction of Federal revenues; (h) it will forestall the present movement toward independent State gift taxes and thus will stifle a new and potent conflict which is arising between the Federal Government and the States.

9. The present practice of exempting $5,000 gifts made in any one year to any number of individuals is considered excessive. Its replacement by a maximum donor's annual exemption of $5,000, irrespective of the number of donees, ie recommended.

Part III: Coordination Of Federal And State Taxes On Property, Transfers

In this section there is examined the lack of coordination between the existing Federal and State taxes on property transfers and there is outlined a procedure whereby the transfer taxes of these two jurisdictions can be properly coordinated. The more significant of the conclusions are as follows:

1. The taxation of identical tax bases by two separate and sovereign jurisdictions requires coordinate action. The absence of coordination is certain to produce undesirable economic and social consequences. That coordination is lacking in the field of property transfer taxation and has of necessity produced undesirable consequences requires no demonstration.

2. While the problem of eliminating conflicting Federal and State taxation is of more vital significance to the States than to the Federal Government, the latter cannot continue ignoring the problem, partly because the States themselves are unable to solve it but primarily because the Federal Government itself is earnestly interested in sound fiscal practice by all governmental units.

3. The adoption of the crediting device in 1924 and its expansion in 1926 signified a willingness on the part of the Federal Government to share its transfer tax revenue with the States, first in the ratio of 3 to 1 and later in the ratio of 1 to 4. Immediately following 1924 and 1926 the States attempted to conform their transfer tax systems to this Federally dictated pattern by imposing tax burdens approximately equal to 80 percent of the 1926 Federal estate tax rate schedule; the Federal Government, however, gradually annihilated the effectiveness of its own program by reducing the relative quantitative importance of the State tax credit.

4. The 1932, 1934 and 1935 Federal Revenue revisions served to dwarf the role of the States in the transfer tax field. In their efforts to counteract Federal action, the States resorted to the enactment of additional death taxes and the imposition of gift taxes, thereby adding to Federal-State conflict.

5. The failure of the Federal Government to attempt an elimination of the conflict before now is probably due to the fact that the extent of existing conflict is generally underestimated and the remedial effects of the crediting device are exaggerated.

6. The extent to which the crediting provision has failed to eliminate interstate variation in property transfer taxation is remarkable. Not only does the need for dual administration and dual taxpayers' compliance remain but in many respects there is probably as wide a diversity in State death duties as prior to the adoption of the crediting provision of 1924. Information obtained through a questionnaire submitted by the Division of Research and Statistics of the Treasury Department to the death tax administrators of the several States and an analysis of the several death tax laws reveals that variations with respect to (a) the type of taxes employed, (b) definition of gross estate, (c) valuation practice, (d) definition of net estate, (e) treatment of insurance, (f) size of specific exemption, (g) manner of taking the exemption, (h) rate structures, and (i) the tax burden imposed, collectively produce a heterogeneous State-by-State property transfer tax pattern.

7. As a result of these variations (a) the ratio of credits claimed for taxes paid to States against Federal estate tax liability to State inheritance and estate tax collections ranges from 0 to 92 percent; (b) the differential estate taxes passed by the various States in order to take advantage of the available Federal credit are limited in effectiveness because the taxes imposed by the States are in many cases in excess of the maximum Federal credit; and (c) the significance of the death taxes in the revenue structures of the various States ranges from 0 in one State to more than a fifth in another. In other words, interstate variations permeate all aspects of State death taxes leading to the unmistakable conclusion that the crediting provision in itself is not adequate for the elimination of interstate competition and Federal-State conflict in death taxation.

8. The proposals which have been advanced for the elimination of conflict in Federal-State taxation of property transfers fall into three general categories: (a) Separation of revenue sources, (b) modification of the crediting device and (c) Federal-State integration.

9. The relative merits of these proposals must be appraised in light of the following objectives: (a) That any change in Federal-State relations does not unduly reduce Federal revenues, (b) that it increases substantially or at least moderately State revenues, (c) that it not be coercive upon the States, (d) that it be of a type which can go into effect gradually and not be conditional upon the enactment of specific kind of legislation in all of the States, (e) that it disturb as little as possible the death tax legislation now on the books of the States, inspired in part by the Federal Government's crediting device, and (f) that it minimize as far as possible the need for dual administration and dual tax compliance.

10. In the light of the above enumerated criteria, none of the three general categories of proposals hitherto advanced for the elimination of Federal-State conflict in death taxation is acceptable.

11. Existing Federal-State conflict in the field of death taxation can be eliminated by combination of two previously proposed methods. Specifically, it is recommended that the Federal Government provide the States with an option as follows: Those States which continue to levy their own death taxes may continue to take advantage of the 80 percent credit allowed against Federal estate taxes under the 1926 Act. Those States, on the other hand, which will abolish their own death taxes will receive in lieu of this State tax credit a fixed proportion of Federal estate and gift tax collections in their respective States.

12. This option arrangement has numerous advantages: (a) It provides a gradual transition from the existing situation and can, therefore, go into operation immediately and need not be postponed until such a time as appropriate legislative action has been taken by all of the States; (b) the arrangement is in no sense coercive upon the States but will obviously be attractive to them; (c) it will eliminate the necessity for separate State administration and dual estate tax compliance; (d) it will not necessitate new State legislation either in the estate or gift taxation, but rather, will produce the gradual repeal of existing legislation; (e) it will contribute to the solution of the problem of State jurisdiction with respect to death taxation; (f) it will provide for a gradual simplification of the Federal estate tax structure itself by gradually eliminating the use of the 1926 rate schedule; and finally, (g) it will enhance general acceptability of the structural revisions of the estate and gift taxes themselves by providing for the gradual elimination of State taxes upon the same tax bases.

13. From point of view of the Federal Government, the disadvantage of the proposal lies in the fact that it will serve to transfer some revenue to the States which otherwise could be retained for Federal purposes. This, however, is no real disadvantage because the proposed structural revisions of the estate and gift tax will more than provide sufficient revenue to bridge the difference between the amounts which would have to be diverted to the States and the amount of the credits now allowed for taxes paid to States.

14. The proposed device will be acceptable to the States because it will obviate the necessity for dual administration and dual taxpayers' compliance at the same time that it eliminates interstate competition and increases State transfer tax revenues.

15. Finally, too much emphasis cannot be placed upon the necessity of making a start in the direction of Federal-State tax coordination. Death taxes offer a good starting point, particularly because of their wide use as sources of State revenue but primarily because they present an opportunity for adding substantially to State revenues without corresponding loss of Federal revenue. The resulting good will is certain to contribute immeasurably to the solution of Federal-State conflict in other fields of taxation.


TO       Mr. Magill
FROM     Mr. Haas
Subject: TAX REVISION STUDIES, 1937 -- ESTATE AND GIFT TAXES

Part I: Structural Revision Of The Federal Estate Tax

A. Introduction

A study of the Federal estate tax and its companion, the gift tax, has been made, as a result of which there are presented herein several suggestions for improvement. Some are desirable in the interest of equity and others are significant from the point of view of greater productivity. The recommended revisions fall into three categories: (a) structural revision of the Federal estate tax; (b) coordination of the Federal estate tax and the Federal gift tax from the point of view of enhancing their separate and collective effectiveness; and (c) coordination of the Federal estate and gift taxes with STATE death and gift taxes, with a view to eliminating tax conflict. These three categories of revisions, though interrelated, will be discussed separately in the order indicated.

I. Legislative history

The estate tax has been a continous element in the Federal tax system since September 9, 1916, when the first Federal estate tax (Title II, Revenue Act of 1916) went into operation under pressure of war finance. Prior to 1916 death taxes appeared only intermittently in the Federal tax system, usually in the form of inheritance rather than estate taxes. Significantly, some of these earlier death taxes also owed their existence to the exigencies of wars.

Since its adoption in 1916, the rates of the Federal estate tax have been changed eight times (Table I). In the 1926 Act the rates were reduced, leaving a rate schedule ranging from 1 percent on the first $50,000 to 20 percent on the part of the net estate in excess of $10,000,000. This Act continues in force today but is supplemented by an additional levy prescribed by Title II of the Revenue Act of 1935, /1/ with a rate structure ranging from 2 percent on the first $10,000 to 70 percent on the part of the net estate in excess of $50,000,000.

The gift tax was first enacted in 1924 for the principal purpose of preventing evasion of the estate tax through the making of inter vivos gifts. This tax was repealed two years later, as a result of concerted opposition by the several States. It was enacted anew in 1932 with rates at about 75 percent of those of the existing estate tax and with upward changes in the rate structure made in 1934 and 1935, has remained in force to date.

2. Revenue significance

During the fiscal year 1936 the Federal estate tax yielded $219,000,000 and the gift tax an additional $160,000,000. For the current fiscal year the yield from these two taxes is estimated at $249,000,000 and $25,000,000 respectively (Table 2). Since its enactment in 1916, the estate tax, together with the gift tax, have produced approximately $2,100,000,000. Beginning with a modest $6,000,000 in 1917, the yield of the estate tax had increased to $154,000,000 by 1921, but declined thereafter, reaching the low point in 1933 with a yield of only $34,000,000. The decline in Federal estate tax revenue which became particularly conspicuous after 1924, was due (1) to the operation of the crediting device for taxes paid to States, (2) to the increase in exemptions and decrease in rates, and (3) to the decline in security and other property values. Partly because of enactment of increased rates and partly because of rising property values, the yield from this tax has been on the upward swing.

These collections, even when added to the $100,000,000 collected annually by State governments, comprise a relatively small proportion of total tax and customs revenue raised in the United States. It will be seen from the table below that death taxes generally are more significant in the revenue structure of the other States, especially non-Federal States, than in that of the United States.

Approximate proportion of total revenues derived from death taxes in certain (mainly federal) states


         State                                      Percent

    Australia                                          4%
     Canada                                              3
     Great Britain                                       7
     New Zealand                                        10
     Union of South Africa                               5
     United States                                       2

Source: Interstate Commission on Conflicting Taxation, 1935 Progress Report.

The explanation of the relatively minor significance of death taxes in our revenue structure lies neither in the fewness of large estates nor in the lowness of maximum rates, but rather in hill exemptions and low rates on small and middle size estates.

3. The case for Federal death taxes

In spite of its relatively minor revenue significance the Federal estate tax has Been the subject of much controversy. With the passage of time, however, the traditional legal argument that death duties should be levied exclusively by the States has gradually given way before the onslaughts of economic necessity and interstate competition. Those arguing against the imposition of Federal death duties have maintained that the power to regulate transfers of property at death rests with the States, who are therefore the logical agents for imposing and collecting such transfer taxes; that the Federal Government has encroached upon a field preempted by the States; that under normal conditions the States' need for death tax revenues is greater than that of the Federal Government; that the necessity of probating estates in State courts makes State administration simpler, particularly with reference to the problem of valuation; that Federal death duties impose a geographical discrimination, placing the bulk of the Federal tax burden upon half a dozen States; and finally, that historically there has never been a permanent Federal estate tax, since the Federal Government has entered the field only in times of emergencies.

The proponents of Federal death taxation counter these arguments by the assertions that the legalistic argument in reference to property transfers falls to the ground from the decision of the courts that the Federal Government may constitutionally levy death duties; that it has been necessary for the Federal Government to encroach upon State territory in many fields which, however, is not necessarily undesirable but merely calls for active coordination; that the States' need for revenue is better served with Federal participation since it eliminates interstate competition and makes the effective imposition of State death duties actually possible; that the logic of the State administrative unit is not conclusive for, while State administrators and executors can compromise as to valuation disputes with reference to estates located within one State, they are powerless with respect to estates divided between two or more States; that some of the States have openly recognized the superiority of the Federal administration by accepting the Federal agents' valuation of the estate for State tax purposes; that the collection of the bulk of the Federal revenue from six States is not of necessity geographical discrimination since it is due solely to the fact that these States claim as residents the wealthiest people of the country whose fortunes are built, not upon a local basis but upon a nation-wide foundation, logically calling for taxation on a national basis; that the imposition of Federal death duties is gradually acquiring a permanent character, now particularly vital since the Federal Government is in no position to abandon sources of revenue and should at all events retain such administrative machinery and experience as has been acquired.

Aside from the controversial issue of Federal-State priorities in the field of death taxation, the case for the Federal estate tax derives adequate economic merit from its characteristics as a direct tax. Sound fiscal practice requires that insofar as feasible, and barring imposts for regulatory purposes or for the benefit of special groups, the tax burden be distributed in accordance with the ability to pay principle. This requirement of progressiveness in taxation can be fulfilled only by a direct tax for in all other cases the burden ultimately falls upon individuals other than those who pay it in the first instance, rendering its distribution in accordance with preconceived standards of ability to pay a virtual impossibility.

The above statements, together with the open admission of State tax administrators that chaos would result in State death taxation from the abandonment of the field by the Federal Government, seem adequate to establish the propriety of Federal death duties.

B. Structural Revisions Of The Federal Estate Tax

I. Various Estate Tax Exemptions

1. Specific exemptions

The 1932 Federal estate tax, as amended in 1935, provides for a specific exemption of $40,000. In the decade preceding 1926 the specific exemption had been consistently $50,000. In 1926, partly as a concession to those who demanded the Federal Government's withdrawal from the death tax field, the exemption had been increased to $100,000. It remained at that level until 1932 when it was again reduced to $50,000, only to be lowered the following year to $40,000.

Because of the relatively high magnitude of the specific exemptions, death taxation is limited to comparatively few large estates and the effective rate of taxation upon estates is reduced to a very low level. Some indication of the destructive effects of high specific exemptions upon estate tax revenues may be gleaned from Table 3. Out off approximately 1,100,000 adult deaths annually, Federal taxes were paid on 8,655 estates in 1935; 5,104 in 1932; 6,364 in 1931; 7,028 in 1930 and 10,642 in 1925; at best, one return per one hundred adult deaths. In Australia during 1931 approximately 47,000 adult deaths produced 8,000 taxable returns. In Great Britain some 475,000 adult deaths produce annually approximately 150,000 taxable death tax returns.

Recognition should also be given to the fact that the exemptions provided in the tax laws of the American States are generally well below the Federal exemption, this providing a potent field for interstate variation and interstate competition. While the exemptions afforded by the State death tax laws cannot be placed on a comparable basis because of the use of both inheritance and estate tax form, significant comparability can be obtained by relating the exemptions provided in the estate tax laws to those afforded a representative family (assumed to consist of a surviving wife, a minor child and an adult child) by the inheritance tax laws. This comparison is presented in Table 4. It will be observed that in nineteen of the forty-seven States, specific exemptions permitted amount to less than $25,000; in fourteen, they range between $25,000 and $50,000; in three between $50,000 and $75,000; and in only seven are they in excess of $75,000. The remaining four States afford exemptions ranging from $100 to $30,000 which, however, are not continuous in character but diminish or vanish with the increase of the taxable estate above the amount of the exemption.

These, in part, are the considerations responsible for the consensus that a reduction of the size of the specific exemptions would be desirable. Such a reduction, as already implied, is supported by a number of arguments: It would increase the yield of the estate tax; it would increase the effectiveness of the estate tax rate schedule; it would eliminate part of the existing interstate variation; it would be an extension of the principle of ability to pay in death taxation; and finally, it would bring the Federal estate tax into closer conformity with that of foreign countries.

Further support for a lower exemption may be found in the fact that the specific exemptions afforded by other countries are conspicuously less than the $40,000 exemption permitted by the Federal law. In Table 5 the specific exemptions provided in the death tax laws of several foreign countries are presented on a comparable basis. In the case of those countries which use inheritance taxes, the exemption shown is that afforded the surviving spouse. It should be noted that in comparison to the $40,000 exemption provided by the Federal Act, the exemptions provided by all foreign countries other than Australia, Germany and Canada, amount to less than $2,000. In the case of the Commonwealth of Australia the exemption is A$1,000, or $4,000. Great Britain allows only an exemption of A$100. Those permitted by the tax laws of Canada range from $1,000 to $25,000.

In opposition to a reduction of the exemption, it is frequently urged that such diminution of the specific exemption would increase difficulties of administration and would interfere with the individual's rights to provide his heirs with a decent standard of living.

 
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