Inheritance Tax Reform
Testimony of Nathan A. Benefield, Director of Policy Analysis, Commonwealth Foundation for Public Policy Alternatives, Pennsylvania House Finance Committee
Good morning. I am Nathan Benefield, Director of Policy Analysis for the Commonwealth Foundation. The Commonwealth Foundation crafts free-market policies, convinces Pennsylvanians of their benefits, and counters attacks on liberty. I would like to thank Chairman Benninghoff and the members of this committee for the opportunity to testify on the issue of the estate tax.
I am joined today by David Logan, an economist with the Tax Foundation. I will be brief in my remarks before turning it over to Mr. Logan to talk about his research and analysis of estate and inheritances taxes across the nation, but I wanted to preface his testimony with a few comments.
I want to note, particularly for those watching at home who may be less familiar with this issue, that unlike the federal estate tax which exempts all but the largest estates, Pennsylvania’s inheritance tax applies to the first dollar of every estate. Heirs of even the smallest estates must pay the tax. While spouse and children under age 21 are exempt from the inheritance tax, adult children, siblings, and other heirs are taxed at a rate between 4.5% and 15% of the property value.
The inheritance tax is a burden not only in terms of taxes collected, but in compliance cost. Estate planning necessary to ensure inheritance tax compliance is an additional burden to all families. Further, the inheritance tax represents the retaxing of property already taxed, first by income taxes, then by property taxes.
The state death tax hampers many, but is especially detrimental to small businesses and family farms. By requiring heirs to pay a tax on the property inherited, the inheritance tax effectively requires those without significant income or cash to sell part of their inheritance to pay their tax bill. This may lead to the breakup of family businesses, as well as the sale of farmland for other uses. In 2005, the Commonwealth Foundation suggested that eliminating the inheritance tax would be better for preserving farmland than Growing Greener II. With Growing Greener bond funds nearly exhausted, and many clamoring for new revenues for that program, I would reiterate that eliminating the state inheritance tax would do as much, if not more, to preserve farmland than government spending for that purpose.
Last year, Pennsylvania residents (and nonresident heirs) paid $800 million in the state inheritance tax. This is no small sum of money to be sure, but its impact on the taxpayers forced to give up a share of their inheritance is far greater than its impact on the state budget. To put $800 million in perspective, here is another figure: 4.5 days. That is how long it takes state government to spend $800 million, given the total operating budget of $66 billion.
I also want to note that there are many proposals on the table today—immediate elimination of the inheritance tax, a phase out over several years, lowering the rates for some or all categories, exempting estates under a certain value, exempting farm properties, and exempting domestic partners. While all of these proposals have merit, we believe the best approach is the outright elimination of the inheritance tax.
A lower rate reduces, but does not eliminate, the economic damage caused by the inheritance tax. Additional exemptions, while lowering the overall tax burden, don’t reduce the cost of compliance (and may even make tax compliance more complex). Phasing out the tax over several years would likely be politically easier, given the current difficulties in balancing the budget; but given the phaseout of the Capital Stock and Franchise Tax, I’m skeptical a phaseout would proceed on schedule.
I thank you for the opportunity to share our thoughts. I will now turn it over to Mr. Logan who can speak more fully to many of these issues on the inheritance tax, particularly in the national context, and I will be happy to answer any questions I can following his remarks.