Of Public Interest

Volume 3, Number 3
March, 2001

Richard E. Wagner

Just a few weeks ago, the estate tax seemed close to becoming a relic. Congress voted to abolish the tax last year, and only President Clinton’s veto saved it. With President Bush proposing to abolish the estate tax during his campaign, the prospect for abolition seemed even stronger this year. Or at least it did until a new player entered the tax reform game. This new player is a group of ultra-rich folks who formed the organization Responsible Wealth <www.responsiblewealth.org>.

One of Responsible Wealth’s main claims is that the estate tax is good for philanthropy. In its "A Call to Preserve the Estate Tax," which it presented in the 18 February 2001 issue of the New York Times, Responsible Wealth asserts that the "estate tax exerts a powerful and positive effect on charitable giving. Repeal would have a devastating impact on public charities ranging from institutions of higher education and land conservancies to organizations that assist the poor and disadvantaged."

No one can deny the huge importance of philanthropy to American civic life. A vast array of museums, hospitals, schools, clinics, and foundations comprise but some of the instances where philanthropy has contributed much to our society. If abolition of the estate tax were truly a threat to philanthropy, the tax might well perform a valuable service.

The trouble with Responsible Wealth’s claim is that it is false. Both history and reason show the contrary. Think back to some of the main industrialists of the 19th century, which include names like Rockefeller, Ford, Vanderbilt, Carnegie, du Pont, Mellon, and Whitney, to name but a few. These industrialists founded philanthropies of all types that even today play a major role in America. They did this even though there was no estate tax, nor even an income tax. The claim that the estate tax is necessary to induce significant philanthropy is falsified by our own history.

Many supporters of the estate tax argue that the tax operates as a subsidy to philanthropy. It is easy enough to seek how this mistaken notion could arise. As the tax goes up, it takes ever more wealth to leave any given amount of wealth to heirs. With no tax, it requires but $1 million to leave $1 million to heirs. If the tax is 20 percent, it requires $1.25 million to do so. With a 50 percent tax, it requires $2 million. The estate tax increases the cost of leaving wealth to heirs. Indeed, it is this increased cost that is the reason why the estate tax retards the creation of wealth in the first place.

Some people assert that the non-taxation of charitable bequests is a kind of subsidy. Consider someone who leaves $2 million to philanthropy, when the alternative would have been to leave the estate in taxable bequests. If the tax rate is 20 percent, the charitable bequest reduces taxes by $400,000, which is 20 percent of the bequest. Should the tax rate be 50 percent, the charitable bequest would reduce taxes by $1 million, which is 50 percent of the bequest. Some people have described this tax reduction as a subsidy to philanthropy.

It is perhaps a virtual or imaginary subsidy, but it is not a real subsidy. With a real subsidy, doing something costs you less because someone else pays part of the cost. It is only sensible that a business would spend more on equipment if government subsidized such spending through tax credits. With a real subsidy, you buy more because the provider of the subsidy has lowered the cost you must pay.

The estate tax creates no subsidy for philanthropy. How much does it cost someone to transfer $1 million to philanthropy? The answer is $1 million, regardless of the rate of tax. If there were no tax, which was the situation our 19th century industrialists faced, it would require $1 million to transfer $1 million to philanthropy. Nothing changes by imposing a tax on estates. Whether the tax rate is 20 percent, 50 percent, or anything else, it still requires $1 million to transfer $1 million to philanthropy.

The estate tax does not lower the cost of making philanthropic bequests. It increases the cost of accumulating wealth and making personal bequests. If the tax were 100 percent, personal bequests would be prohibitively costly. Only philanthropic bequests would be possible. This situation, however, would not be good for philanthropy. Our situation in the 19th century would have been much better.

There is plenty of evidence that as personal wealth increases, people direct an increasing share of their wealth to philanthropy. Economists describe this situation as one where charitable bequests are "wealth elastic." Through its ability to reduce personal wealth, the estate tax hits philanthropy particularly heavily. By discouraging the creation of wealth, the estate tax undermines the very foundation of philanthropy, private wealth. Responsible Wealth is wrong: the estate tax is bad for philanthropy.

Richard E. Wagner is Senior Fellow at the Public Interest Institute and Holbert Harris Professor of Economics at George Mason University.

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