Estate taxes discourages small business ventures and is net worse for all social classes.

Our estimates indicate that the growth in EIG (estate, inheritance, and gift) taxes per decedent is negatively related to the growth in the number of firms, especially small firms. This result is consistent with the asymmetric liquidity effect – the claim that EIG taxes have a stronger negative effect on small businesses because of the difficulty small business owners face in raising the funds needed to pay the estate tax bill. Consequently, the dissolution incentive falls more heavily on small businesses. Our estimates suggest that, holding everything else constant, the phase out of the Federal estate tax after the enactment of EGTRRA in 2001 has lead to a higher growth in the number of firms, especially small ones.

Contrary to the popular belief that the estate tax impacts only the rich, our estimates suggest that EIG taxes may affect numerous other individuals. By increasing the dissolution rate of businesses, higher EIG taxes may increase unemployment and create efficiency losses in the form of decreased competition. Higher EIG taxes may also discourage entrepreneurs from starting new businesses or increasing their value. As a result, higher EIG taxes may decrease capital accumulation, thereby lowering labor productivity, wages, and economic growth (Stiglitz, 1978). All members of society, rich or poor, share the detrimental consequences of lower economic growth.

If higher EIG taxes increase business dissolutions, then the gains in EIG tax revenues could be partially offset by losses in income, property, and sales tax revenues. The dissolved businesses would have generated various non-EIG tax revenues over multiple years if not for the one-time EIG tax bill. Relying on EIG taxes as a revenue source may come at a high opportunity cost in terms of lost revenues from other taxes. For this reason, the estate tax may be a rather costly revenue-generating tool (Bernheim, 1987; Wagner, 1996; Feldstein, 2000; Miller, 2006).

Another potential concern with the estate tax is bracket creep. If the estate tax exclusion amount is not adjusted to inflation it will apply to an increasing number of taxpayers over time analogously to the alternative minimum tax (AMT). As of 2004, only 1.2 percent of estates had values high enough to trigger the estate tax (McIntyre, 2006). However, if Congress does not continually adjust the exclusion amount on the estate tax, an increasing number of smaller estates will be subject to the estate tax because the net worth of retirees’ households has been growing at twice the rate of inflation from 1983 to 2007 (these calculations apply to the median net worth of households headed by someone age 65 or older). If this trend continues, more and more households will find themselves being subjected to the EIG tax, even though it was ostensibly intended only for the very wealthy.