The Unseen Battle Over Estate Taxes

While the press and the blogosphere fixate on the legislative jockeying over income tax rates, a much more lasting issue is being decided in the Capitol’s deepest recesses: Can so-called “death taxes” be laid to rest?

The federal estate tax has been on hiatus in 2010, but it is due to return with a vengeance on New Year’s Day. The tussle over income taxes has given opponents of the estate tax a surprisingly good chance to kill it. We can safely assume that, far from the limelight, some wealthy families and lobbyists for business and farm groups are doing everything they can think of to see that this happens.

The political stars seem to have aligned in their favor. Democrats, including President Obama, urgently want to see the Bush-era tax cuts extended for middle-class families, which they define as individuals with income up to $200,000 and couples with income up to $250,000. They also want Congress to extend federal unemployment benefits for long-term unemployed individuals who have exhausted their state benefits.

And, most importantly, the Democrats desperately want all this to happen before the end of this year. The world would not end if the income tax cuts expired at the end of this month. Nobody will file 2011 tax returns until early 2012, so the cuts could be restored retroactively. But workers would see an immediate drop in their take-home pay as higher tax withholdings kick in. For political and economic reasons, the Democrats are very motivated not to let that happen.

Nearly all congressional Republicans, and a few Democrats, want to see the lower Bush-era income tax rates extended for all taxpayers, including those with high incomes. But they are not as fixated on the end-of-the-year deadline. The Republicans are perfectly content, if necessary, to wait until next year, when they will control the House of Representatives and have more power in the Senate, to send a bill to Obama. They are in a good bargaining position.

The income tax deal is nearly a foregone conclusion. After some posturing, both sides seem willing to extend the Bush income tax rates for all taxpayers for a year, or maybe two or three. Republicans also seem prepared to throw in the extended unemployment benefits.

But what happens to the estate tax?

If Congress does nothing, the tax will come back next month at 55 percent for estates larger than $1 million. This would be a return to where the law stood in 2001, before the Bush tax legislation. No Republicans, and only the leftmost part of the Democratic caucus, want this to happen. When homes, retirement plans and life insurance are included, an estate tax at this level would hit quite a few families that do not consider themselves wealthy – and a fair number of those families tend to vote for Democrats.

Most Democrats, and probably some Republicans, would be happy to bring the estate tax back to where it was in 2009. At that level, the tax would be 45 percent on estates greater than $3.5 million. I am willing to bet that Democrats are arguing for a return to this level of estate tax to accompany a temporary extension of the Bush-era income tax rates.

But many, and probably most, Republicans favor either a less-onerous estate tax or no estate tax at all. Why should they go along with the Democrats on this? They can argue that the temporary extension of the Bush tax law should include all of the Bush tax law, including the current absence of any estate tax.

If Republicans get their way, we won’t just have a one-year interruption of the estate tax; the gap will be something between 2 years and 4 years. The interruption could be even longer if we just repeat this process a few years from now. If the tax is gone for that long, will it ever come back?

I think there is a good chance the answer is “no,” and I imagine a lot of players in this game see things the same way. They are urging Republicans to hold out for a continued estate tax hiatus, even at the price of letting all of the Bush cuts expire in January, pending some retroactive legislation.

If Democrats, who still have their big pre-election congressional majorities, had the power to get what they wanted, the law would already have been passed. But they did not have the votes to keep the estate tax from expiring a year ago, and it does not look like they have the votes to bring it back right now. It looks like the Republicans can hold their ground and win this fight.

I could be wrong about all this, but so far I haven’t been. It isn’t that I’m all that smart or clairvoyant. It’s just that in the decade-long debate over the future of the estate tax, I have learned to ignore what legislators say and pay attention to what they do. And what they have done has gotten us a year without an estate tax.

Since 1998, when I predicted that the estate tax would disappear by 2010, I have been arguing (even though estate tax planning is a good business for my firm) that this would be an excellent result. Circumstances seem to have given the GOP the necessary leverage to deliver it.

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