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54–663—PDF 2008

S. HRG. 110–1017

ALTERNATIVES TO THE CURRENT

FEDERAL ESTATE TAX SYSTEM

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

MARCH 12, 2008

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

DEBBIE STABENOW, Michigan

MARIA CANTWELL, Washington

KEN SALAZAR, Colorado

CHUCK GRASSLEY, Iowa

ORRIN G. HATCH, Utah

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

PAT ROBERTS, Kansas

JOHN ENSIGN, Nevada

JOHN E. SUNUNU, New Hampshire

RUSSELL SULLIVAN, Staff Director

KOLAN DAVIS, Republican Staff Director and Chief Counsel

(II)

(III)

C O N T E N T S

OPENING STATEMENTS

Page

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee

on Finance ............................................................................................................ 1

Grassley, Hon. Chuck, a U.S. Senator from Iowa ................................................. 7

WITNESSES

Batchelder, Lily, professor, New York University, School of Law, New York,

NY ......................................................................................................................... 2

Dodge, Joseph, professor, Florida State University, College of Law, Tallahassee, FL ................................................................................................................... 4

Duff, David, professor, University of Toronto, Faculty of Law, Toronto, Ontario, Canada ........................................................................................................ 5

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Batchelder, Lily:

Testimony .......................................................................................................... 2

Prepared statement .......................................................................................... 25

Responses to questions from committee members ......................................... 46

Baucus, Hon. Max:

Opening statement ........................................................................................... 1

Bunning, Hon. Jim:

Prepared statement .......................................................................................... 74

Cantwell, Hon. Maria:

Prepared statement .......................................................................................... 75

Dodge, Joseph:

Testimony .......................................................................................................... 4

Prepared statement .......................................................................................... 76

Responses to questions from committee members ......................................... 87

Duff, David:

Testimony .......................................................................................................... 5

Prepared statement with attachment ............................................................. 97

Grassley, Hon. Chuck:

Opening statement ........................................................................................... 7

Mahoney, Hon. Tim:

Prepared statement .......................................................................................... 161

Roberts, Hon. Pat:

Prepared statement .......................................................................................... 163

COMMUNICATIONS

American Family Business Institute ..................................................................... 165

American Farm Bureau Federation ....................................................................... 172

Anthony Timberlands .............................................................................................. 175

Blum, Warren I. ....................................................................................................... 177

National Cattlemen’s Beef Association .................................................................. 180

RATA Associates, LLC ............................................................................................ 182

Schumaker Trucking and Excavating .................................................................... 184

Simkins-Hallin ......................................................................................................... 186

Small Business Council of America ........................................................................ 188

(1)

ALTERNATIVES TO THE CURRENT

FEDERAL ESTATE TAX SYSTEM

WEDNESDAY, MARCH 12, 2008

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC.

The hearing was convened, pursuant to notice, at 10:06 a.m., in

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus

(chairman of the committee) presiding.

Present: Senators Lincoln, Salazar, Grassley, Kyl, and Bunning.

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. The hearing will come to order.

Edmund Burke once criticized his opponents by saying, ‘‘They defend their errors as if they were defending their inheritance.’’ We

are here today to examine the estate tax. We are here today to consider whether taxing estates is an error, and we are here today to

examine whether there are other ways to address inheritance.

This is a second hearing in a series of hearings focusing on estate

tax reform. We hold a third when we return in April. Now usually,

when people talk about estate tax, they focus on the current system. They talk about a little change here, a little change there.

They talk about turning one dial a quarter to the left, turning another dial a quarter to the right. They work on the issue as though

they were tuning a radio.

In this hearing, we put the old radio aside. Today we are going

to take a look at other concepts, other ways to deal with inheritance outside of the box. Under current law, the estate tax changes

every year through 2011. Every year, the law changes. The law

phases out completely and then it springs back to its original high

rate and low exemption level.

Our estate tax law is complicated. It is intimidating to small

businesses, ranchers, and farmers. The law lacks certainty for the

American people. We seriously need estate tax reform.

I know that accomplishing an estate tax mark-up this year will

not be easy, but let us work toward that goal. I am committed to

getting estate tax reform done, and I am ready to roll up my

sleeves and work with Senators to get a reform proposal that will

benefit Montana, and the rest of the country.

These Finance Committee hearings will give us a review of some

reform possibilities. These Finance Committee hearings will begin

a good policy debate, and I hope that the debate will lead to a bipartisan estate tax compromise.

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* For more information, see also, ‘‘Description and Analysis of Alternative Wealth Transfer

Tax Systems,’’ Joint Committee on Taxation staff report, March 10, 2008 (JCX–22–08), http:/

/www.jct.gov/publications.html?func=startdown&id=1318.

Today we will hear about taxing the beneficiary rather than the

estate. We will hear about an income exclusion system, and we will

hear about how other countries deal with this issue and the results. Now, I do not endorse any of these proposals, certainly not

at this time. They are very interesting, but they are not ones that

I yet endorse.

What I do want is the committee to have thought widely about

the possibilities for replacing the estate tax, so today we are not

going to defend the tax law’s errors. Today we are going to talk

about fundamental change to the estate tax, and in so doing see

if we can leave a better inheritance for everyone.*

The first witness is Professor Lily Batchelder, professor at New

York University Law School. I am very proud to note that in her

earlier career Professor Batchelder served as a law clerk for the Finance Committee. In fact, I was just talking with Jon Selib in my

office, and how he and Lily were here at the same time as interns,

and he has a very high regard for you, Professor. I know you have

been talking with him since you have come back, but again, he has

very high regard for you.

The second witness is Professor Joseph Dodge, professor at Florida State University College of Law. Also, we have with us Professor David Duff, who is professor from the University of Toronto

in Canada. Thank you all for coming.

It is our practice here that every witness speaks 5 minutes, and

your statements will automatically be included in the record.

Why don’t you go ahead, Professor Batchelder?

STATEMENT OF LILY BATCHELDER, PROFESSOR, NEW YORK

UNIVERSITY, SCHOOL OF LAW, NEW YORK, NY

Prof. BATCHELDER. Thank you. Mr. Chairman, members of the

committee, my name is Lily Batchelder. I am an associate professor

of law and public policy at NYU’s School of Law. Thank you for the

opportunity to testify before you today.

I would like to briefly discuss the distribution of inherited income

and estate tax burdens under current law, and then discuss two reform options. Both of these could be implemented on a revenueneutral basis and I think would make the estate tax system better

targeted on the unearned income that extraordinary inheritances

represent.

As I have outlined in my written testimony, wealth transfers

tend to significantly exacerbate existing economic disparities.

Surachai Khitatrakun and I have estimated that, in 2009, heirs

will inherit about $400 billion. While people of all income levels

often receive relatively small inheritances associated with the family bonds that I think we do, and should, value, a very small number of people at the top receive extraordinarily large inheritances.

For example, Figure 2 in my written testimony shows that, on

average, inherited income of those in the top 1 percent of the inheritance distribution is about 34 times larger than the average inheritance of all others receiving a bequest in a given year.

3

And I think this concentration of inheritances is important because it means that they are exacerbating existing economic disparities. About 40 percent of all household wealth is inherited. I

think it is also important because disparities in inherited income

appear to be the single largest barrier to intergenerational economic mobility.

The current estate tax system is the most important mechanism

by which the fiscal system mitigates the effects of inheritances on

economic mobility. This is the case because, under the estate tax

system, the burden actually generally falls on heirs and not donors.

As Figure 4 in my written testimony shows, on average, the estate

tax only burdens heirs who receive really extraordinarily large inheritances.

To me, this means that it is not really a double tax on the decedent, who may have worked very hard to accumulate this wealth,

but instead it is a tax on a major source of unearned income of

those who are fortunate enough to be born into a family that leaves

them a really extraordinarily large inheritance.

The estate tax system is a blunt instrument, though. In my view,

its biggest weakness is that this relationship between, on one hand,

the heir’s financial circumstances, and on the other hand, the estate tax burden, is relatively imprecise. Some people receiving relatively modest bequests may bear a substantial tax burden if they

are inheriting from an extremely large estate, and some people receiving really extraordinarily large inheritances may bear no estate

tax burden if they are receiving from one or more estates that are

just below the lifetime exemption. This basically happens because,

under the current system, the tax rate depends on the amount

transferred and not the amount inherited.

There is an opportunity for reform in 2009 because of the unthinkable, in my view, incentives created by a 1-year repeal of the

estate tax. I think we should use this opportunity not to repeal the

estate tax, but to reform it so that it is really better targeted on

extraordinary amounts of inherited income.

The option I would like to discuss first, which in my view is the

best alternative, would be to replace the current system with a

comprehensive inheritance tax. Under this alternative, an individual inheriting an extraordinary amount over their lifetime

would pay income tax and a flat 15-percent tax on a portion, and

only a portion, of that inheritance. So in effect, extraordinary inheritances would then be taxed at the same rate that earned income is now taxed under the income and payroll tax.

We have estimated that this reform could be implemented on a

revenue-neutral basis relative to 2009 law if about the first $2 million in inheritances were tax-exempt. To state the obvious, $2 million is a big inheritance. If an heir inherits this amount at age 18,

he and his spouse can live off the inheritance for the rest of their

lives without ever working and their annual household income will

be higher than that of 9 out of 10 American families.

If this proposal were adopted, it would have important effects.

The distribution of burdens among heirs under the estate tax

would stay relatively similar on average, but Figure 8 of my written testimony shows that the burdens would be allocated very differently at an individual level. It shows that about 60 percent of

4

heirs burdened by the estate tax would bear no tax burden under

this inheritance tax, and, among those who are burdened by both

taxes, their rate would often be very different.

I think these differences illustrate how this reform would improve the equity of the wealth transfer tax system because it would

base the tax rate on the person that actually bears the burden of

the tax, the heir, and it would make it better targeted on the unfair advantages that exceptionally large inheritances create. It

would also have some other advantages. It could simplify current

law. It would only burden about 3 heirs in 1,000.

But I do want to mention a second alternative because this is

very ambitious, which would be to simplify current law.

The CHAIRMAN. If you could, very briefly.

Prof. BATCHELDER. Sure. There are a bunch of simplification options that one could apply to current law. For example, allowing

carry-overs of the lifetime exemption for spouses, narrowing the

differences between the tax rates on gifts and bequests, reforming

the treatment of illiquid assets, including family businesses. I

think all of these options are worth considering as well and could

be implemented on a revenue-neutral and distributionally neutral

basis.

Thank you.

The CHAIRMAN. Thank you, Professor, very much. That is very

interesting.

[The prepared statement of Professor Batchelder appears in the

appendix.]

The CHAIRMAN. Professor Dodge?

STATEMENT OF JOSEPH DODGE, PROFESSOR, FLORIDA STATE

UNIVERSITY, COLLEGE OF LAW, TALLAHASSEE, FL

Prof. DODGE. Thank you, Chairman Baucus, Senator Grassley,

committee members.

Well, I think the existing system is seriously flawed. It is quite

easy to plan around. It does not really serve directly a purpose, as

Professor Batchelder explained. It sort of creates incentives for

wealth to either be destroyed or to be hidden. So now you have a

great opportunity, since the estate tax is scheduled to expire soon,

to in a sense start over again and come up with a better system.

But there are basically two different tracks that can be followed

here, as I see it. One is reforming the income tax system, which

sort of has a gap with respect to gifts and bequests. The other has

to do with a better wealth transfer tax system which serves a different purpose. I would say the purpose is to mitigate undue disparities of unearned wealth, to further the dispersal of wealth. As

a general matter, I do not think the income tax and the transfer

taxes should be blended. I do not think features of a transfer tax

should be imported into the income tax.

So in general, I do favor transferee-oriented taxes. I really do not

have anything significant to add to that, except taxes on transferee

directly tie in to goals of preventing undue accumulation of unearned wealth, furthering equality of opportunity, and encouraging

the dispersion of wealth.

So apart from the accessions tax, the other transferee-oriented

system that I want to talk about is what I call the income inclusion

5

approach, which involves treating gifts and bequests as income to

the transferee without a deduction to the transferor. If this system

were adopted, then another income tax alternative, which would be

to tax gains and losses at death or gift, would not be necessary.

Of course, that system of taxing gains and losses at transfer is

a system that Canada now has. That is fine standing alone, but it

should not be combined with including gifts and bequests as income. Basically, receipts of gratuitous transfers are income. If the

statutory exclusions were repealed, they would be included as income.

Well, I see time is flying. So I want to mention, briefly, some of

the features of the income inclusion proposal as I see it. There

would be no lifetime exemption, as such. However, support received

would be excluded, as under present law. Third party payment of

bills would be excluded. That is like tuition and health care. Gifts

of consumable items should be excluded, the general idea being

that things that look like support would be excluded from the tax

base. Even bequests could be excluded under certain circumstances, like bequests received by persons under 25. They could be

annuitized and treated as support. There could also be an exclusion, within reason, for tangible personal property because that basically represents a consumption decision by somebody else.

Next, the income tax has a realization principle so that gifts and

bequests received in kind would not necessarily have to be taxed

upon receipt, but instead they could be taxed later on. Now, probably marketable, publicly traded, highly liquid assets should be included, but hard-to-value assets, which would include, of course,

closely held business interests and some real estate, would not be

income upon receipt, but instead the income would be deferred

through a zero-basis mechanism. So either you would have a

stepped-up basis if an item were included, or you would have zero

basis, but historical basis would be erased.

Well, there are other features. I see my time is up. But basically

the system would be integrated with the existing income tax system, including subchapter J dealing with the taxation of trusts and

beneficiaries.

Thank you.

The CHAIRMAN. Thank you, Professor, very much.

[The prepared statement of Professor Dodge appears in the appendix.]

The CHAIRMAN. Professor Duff?

STATEMENT OF DAVID DUFF, PROFESSOR, UNIVERSITY OF

TORONTO, FACULTY OF LAW, TORONTO, ONTARIO, CANADA

Prof. DUFF. Thank you, Mr. Chairman. And thanks to the committee for giving me the opportunity to speak with you today.

My name is David Duff, and I am a professor of tax law and policy at the University of Toronto, Faculty of Law, where I have

taught since 1996.

My testimony today is based on two articles that I have written

on wealth transfer taxation, and they are appended to my written

testimony.

The first argues for a wealth transfer tax in the form of an accessions tax, which would apply to the cumulative amount of gifts and

6

inheritances that are received by individuals over the course of

their lifetimes rather than aggregate amounts given by donors over

the course of their lifetimes, as is the case with the current Federal

wealth transfer tax system in the U.S.

The second article attempts to explain the apparent political

unpopularity of wealth transfer taxes and the abolition of these

taxes in Canada, Australia, and New Zealand, which repealed their

estate and gift taxes in the 1970s, 1980s, and 1990s.

Beginning with the first article, let me briefly explain why I

think that a society should tax transfers of wealth and why an accessions tax is a better tax for this purpose than the current Federal wealth transfer tax system in the United States.

As a philosophical matter, I believe that it is both legitimate and

desirable for a society to moderate extreme inequalities in the distribution of wealth and in the opportunities that wealth provides

by taxing substantial gifts and inheritances above a generous exemption.

While I believe that a society should value and encourage the

family bonds that are associated with the transfer of assets from

one generation to another—and I think that is particularly the case

with family heirlooms, family enterprises, family farms—I believe

that this value needs to be balanced against the negative social and

political consequences for a democratic society that can result from

the transfer of large dynastic fortunes from one generation to the

next.

In addition, to the extent that recipients have not earned the

gifts and inheritances that they receive largely because of the luck

of their birth, I do not believe that they can legitimately complain

about a tax that requires them to share some of their good fortune

with others who have not been so lucky. From this perspective, it

is clear why an accessions tax would be a better tax than the current Federal wealth transfer tax system in the United States.

While the current gift and estate tax applies to aggregate

amounts transferred by donors over the course of their lifetimes

and at death—regardless of how this wealth is distributed among

recipients—an accessions tax would apply to the cumulative value

of gifts and inheritances that are received by beneficiaries over the

course of their lifetimes, which are, after all, the amounts that actually contribute toward inequalities in wealth and opportunities.

As well, the current gift and estate tax sends exactly the wrong

message about a wealth transfer tax by taxing successful, hardworking and generous donors who have accumulated wealth out of

income on which they have often already paid tax.

In contrast, an accessions tax sends a very different—and I believe justifiable—message, by taxing the beneficiaries of substantial

gifts and inheritances on amounts that they themselves have not

earned and on which they themselves have not paid any tax. Why

then do wealth transfer taxes seem to be so politically unpopular,

and why were they abolished in Canada, Australia, and New Zealand?

Although I do not have time to go into all the details here, it is

important to note that the wealth transfer taxes in each of these

countries were estate and gift taxes, much like the current wealth

transfer taxes in the United States. For this reason they were vulVerDate 11-MAY-2000 14:25 Mar 09, 2010 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 54663.000 SFIN1 PsN: SFIN1
7

nerable to the same kinds of criticisms that have been rightly directed at the Federal estate and gift taxes in the United States:

that they impose a second tax on donors who have accumulated

wealth out of income on which they have already paid tax, and that

they punish their success, hard work, and generosity.

As well, since affluent retirees can avoid donor-based wealth

transfer taxes by moving to jurisdictions without these taxes, estate and gift taxes like those that existed in Canada, Australia, and

New Zealand are also vulnerable to competition from jurisdictions

that do not collect these taxes. This is probably not as big a concern in a large country like the United States, but was a significant

concern in Australia, New Zealand, and Canada.

In contrast, since recipient-based wealth transfer taxes, like an

accessions tax, apply to gifts and inheritances that are received by

younger and less geographically mobile recipients, they are much,

much less vulnerable to this kind of tax competition. As a result,

when one surveys wealth transfer taxes around the world, it is not

surprising that it is recipient-based taxes that have been far more

resilient than donor-based taxes, and in fact in several countries

account for a larger share of total tax revenue and Gross Domestic

Product today than they did 30 years ago.

In conclusion, therefore, I believe that questions of principle, as

well as practical politics, support replacing the current Federal

wealth transfer tax system in the United States with an accessions

tax that would apply to the amount of gifts and inheritances received by individuals over the course of their lifetimes.

The CHAIRMAN. Thank you, Professor. That was very interesting.

[The prepared statement of Professor Duff appears in the appendix.]

The CHAIRMAN. Senator Grassley, do you have a statement?

Senator GRASSLEY. Yes, if I could, please.

The CHAIRMAN. Sure.

Senator GRASSLEY. Just a short one.

OPENING STATEMENT OF HON. CHUCK GRASSLEY,

A U.S. SENATOR FROM IOWA

Senator GRASSLEY. I apologize for being a little bit late. First of

all, it is very important that we deal with this issue, because 2010

and 2011 are just around the corner and it is something we should

have dealt with if we wanted to make estate planning easier for

everybody. I bear some responsibility for that because I was chairman of this committee for a while as well. Because of these dates,

it has become imminently necessary to discuss, and hopefully to determine, the fate of the estate tax.

As I have stated before, I believe that the death tax is fundamentally unfair from both a philosophical and technical perspective. I

do not believe that it is appropriate for government to come in following the death of an individual and tax the money that a person

has legally earned and saved during his lifetime.

Additionally, since the estate tax has to be paid 9 months after

the death of an individual, many small business people and farmers have had to sell off their business assets simply to pay the

death tax arising solely because of the death of a prior owner. To

me, this situation is fundamentally wrong because death should

8

not be a taxable event and government should not be profiting from

death.

While my personal view of repeal is firm, I understand that other

alternatives need to be explored in order to come to a fiscally appropriate compromise prior to the sunset of the 2001 reforms and

the return of exorbitant rate schedules for 2011, with a 1-year repeal in 2010. I am going to be working towards that compromise.

Many of my colleagues have discussed changes to the current

rate and exemption schedules, and their suggestions are well received. However, beyond these suggestions, both the chairman and

I believe that it would be helpful and informative, as we are hearing today from academics and experts who have written extensively

in this area, for the committee to have another hearing to address

other issues in the current estate tax system if it remains unchanged following the expiration of the 2001 reforms.

Finally, the chairman and I believe that it is important to draw

on the experiences of other countries, and we have heard about

that.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator.

A question comes to my mind. These are all very interesting

ideas. That is, transition rules. Say we were to move toward an accession type of system, inheritance rather than tax to the transferor. What kind of transition rules do you contemplate? Professor

Batchelder?

Prof. BATCHELDER. Yes. I think there are a couple of alternatives.

I would actually suggest——

The CHAIRMAN. And I would say, because people plan. They plan

their estates.

Prof. BATCHELDER. Yes.

The CHAIRMAN. A lot goes into planning by a lot of people, and

then, lo and behold, it becomes a totally different system. Just your

thoughts on transition.

Prof. BATCHELDER. Yes. Yes. Well, there is one country that, to

my knowledge, has transferred from an estate tax to an inheritance

tax, which was Ireland. What they did was have the transition

occur prior to enactment. One of the issues is, if you enact an inheritance tax and have it go into effect right after the bill passes,

many people, knowing that the bill will pass, will max out their

lifetime gift tax exemption.

So in order to prevent that kind of gaming, I would recommend

having the transition occur maybe back to the date of introduction

or some prior date.

You could give credit for prior taxes paid, but I actually think

that would give relatively small benefits, because most people who

receive a substantial inheritance just receive one. In some of the

data that I have looked at with my co-author, we find that, of people who inherit $1.7 million or more, that tends to represent, if

they inherit that in 1 year, 94 percent of their lifetime inheritances. So giving them credit for prior taxes paid may not be necessary, but it certainly is an option.

The CHAIRMAN. Again, in Ireland, why the change? Do you know

much about what happened in Ireland?

9

Prof. BATCHELDER. As far as I know, it has been very successful.

It has been in place for about 30 years, and it is sort of similar to

the accessions tax that Professor Duff was describing in terms of

aggregating your inheritances over time and applying a tax rate to

the amount received.

The CHAIRMAN. But is the amount of income taxes or the revenue

gain saved by the government about the same, or not?

Prof. BATCHELDER. Yes. I do not have this in my written testimony, but the percentage of tax revenues raised from most transfer

taxes cross-nationally is generally around 1 or 2 percent, and actually, inheritance taxes are much, much more common than estate

taxes.

The CHAIRMAN. But even those countries that have inheritance

tax, it is about 1 percent?

Prof. BATCHELDER. One to 2 percent. Some go up to 6 percent.

It varies to some degree.

The CHAIRMAN. All right.

Mr. Duff, transition?

Prof. DUFF. Well, it is not an area I have actually done work in

because, of course, in my context we abolished these things, so the

transition would be starting from scratch.

The CHAIRMAN. Right. Right.

Prof. DUFF. And that poses much more significant issues than in

the U.S., where the incentives obviously would not be as significant

to game the system as if you are starting from scratch. I think, actually, Professor Batchelder has written about some of this. I think

the transition issues where you already have an estate tax are not

so serious because you already have something in place.

I think one thing that could be considered is a credit for prior

estate taxes paid, but I think, as Professor Batchelder points out,

it is not a huge issue because, for the most part, you get an inheritance once and you do not receive these small amounts over a period

of time.

The CHAIRMAN. So what is wrong with this idea? I mean, there

is always the other side of the coin. What are the down sides of

an inheritance as opposed to estate tax?

Prof. DUFF. I actually find it difficult to see what the down side

is. I am surprised that the world has not moved in this direction.

I think if the U.S. were to do this, it would be a leader in this and

a lot of other countries would follow.

The CHAIRMAN. If you had to think of a down side, what would

it be?

Prof. BATCHELDER. I can offer a down side.

The CHAIRMAN. All right.

Prof. BATCHELDER. It sort of depends on your perspective. It does

change incentives for giving. I tend to see this as a bit of an up

side, that it creates an incentive for very wealthy households to distribute their wealth more broadly. But people may not like that.

It also would shift, to some degree, the incentives regarding charitable contributions, so in general, because charities are taxexempt, they would not be subject to an inheritance tax, because

when they receive inherited income that is not income. It might

change the charities eligible for that exemption. Right now, my understanding is that certain charities, including 501(c)(4)s, are not

10

eligible for the estate and gift tax exemption. They presumably

would be for an inheritance tax exemption.

The CHAIRMAN. Professor Dodge?

Prof. DODGE. Well, the charitable community might not like it

because they might actually prefer that wealth be highly concentrated so that the tax incentives for giving to charity would be

maximized.

The CHAIRMAN. What about the countries you mentioned, Professor Duff? I am now addressing charitable giving. Is there as

much, less, say in those countries compared with the U.S., and

does it have any effect? Does the form of wealth transfer in those

countries have an effect?

Prof. DUFF. I think there have been studies that suggest there

is less charitable giving in Canada than in the U.S., but of course

we do not have any kind of wealth transfer tax system that creates

those incentive at all. So, if you get rid of the taxes altogether, I

think the evidence is that there is actually less of an incentive for

charitable giving. But that is an argument for some kind of wealth

transfer tax system, not an argument for a particular kind, necessarily.

The CHAIRMAN. Senator Grassley? Thank you very much. Very

interesting.

Senator GRASSLEY. Yes. I am going to start with Ms. Batchelder.

One of our concerns with your program is the potential that a family farm or small business, whose assets by their nature are illiquid, will have to sell the assets of their business in order to pay

off the inheritance tax. I know you address this issue in your paper

by suggesting that an heir can defer payment of the inheritance tax

based on illiquidity, while requiring the heir to pay a market rate

of interest on the amount that was deferred.

What argument could you make that this market rate of interest

requirement would not ultimately be more punitive in nature to

the small business owner/farmer who may not even have the cash

on hand to pay this amount of interest on the business or farm that

they have inherited?

Prof. BATCHELDER. Thank you. Well, I guess one response I

would have is, I think you could defer the interest as well. So the

general idea was that, if you inherit a business and you do not inherit liquid assets sufficient to pay the associated tax liability, that

you would be able to defer those taxes due with interest. I would

be fine with deferring the interest payments until you actually sell

that business. Frequently, with family businesses, heirs do choose

to sell them just because they do not wish to continue operating

them.

There are a number of provisions within current law to address

family businesses. To my knowledge—but you may very well know

of people who have been forced to sell their business—there has not

been a family farm that has been forced to be sold under the current provisions, but I do think it is worth trying to establish the

rules that make that not even a theoretical possibility, which is, I

think, what this proposal could do.

Senator GRASSLEY. Mr. Duff, was it the experience of Canada,

New Zealand, and Australia that the estate tax was replaced by a

less divisive tax, like sales tax or value added tax, to replace the

11

revenue which was lost based on the estate tax repeal, or was the

revenue simply lost? The reason I ask this is because it would be

instructional to know what tax had to ultimately rise in order to

replace the revenue lost from the repeal of the estate tax or whether it simply went away with nothing to take its place.

Prof. DUFF. Right. Well, to answer that, one has to understand

the nature of taxes that are based on the English model. Historically, neither Canada, nor Australia, nor New Zealand taxed capital gains at all, so capital gains in Canada were not taxable until

1972, in Australia, not until sometime in the 1980s, and New Zealand, not until the 1990s. So, in fact, what ended up happening in

all of these countries is the wealth transfer taxes were repealed

and capital gains taxes were introduced.

In Canada, actually the way it fell out politically is, it happened

at the very same time in 1972, and partly it was because, in Canada, a decision was made to tax capital gains at death and there

was a sense that the Federal Government had that, well, they

should reduce the level of combined taxes on death from a deemed

realization at death and the wealth transfer taxes. Their policy was

not to eliminate wealth transfer taxes completely because provinces

had collected wealth transfer taxes.

The Federal Government in Canada said, we will get out of the

area and leave it to provinces to collect their share, but, of course,

then what ended up happening is inter-jurisdictional tax competition took over. Once one province was out of the game, others also

got out of the game and it all unraveled.

A similar phenomenon happened in Australia. In Australia and

New Zealand, the wealth transfer taxes were repealed before capital gains tax was introduced, but once the transfer taxes were repealed it became a stronger argument for having capital gains tax.

In Australia, there is a carry-over basis at death, not a deemed

realization at death. So, if one were to say what replaced them, it

certainly was not value added tax. In Canada, that did not come

until much, much later. It would be capital gains tax, which of

course the U.S. has had right from the outset of its income tax.

Senator GRASSLEY. Do you want to comment, Mr. Dodge?

Prof. DODGE. I wanted to comment on Professor Batchelder’s

comment. I actually disagree with her on this point. I do not think

an interest charge would need to be imposed on deferral because

the tax base would grow, because the future tax base would include

income and appreciation; therefore, there is no real revenue loss

from deferral. In fact, there would be possibly a revenue gain if the

greater amount were taxed in higher brackets. So, therefore, I do

not think you need an interest charge on deferral.

Senator GRASSLEY. All right.

Do you want to react to that?

Prof. BATCHELDER. Yes. I actually do think it would be important. I think the general philosophy should be to try to not create

incentives or disincentives to hold illiquid assets, so not to penalize

family-owned businesses, also not to make them especially preferred.

In that case, it would be important to have the tax liability be

assessed at the time of the transfer with interest, because otherwise you could have people withdraw a lot of the cash from the

12

family business, sort of depreciate the value, and then when they

ultimately pay tax, pay a much smaller tax burden, but they effectively would have received a huge amount of inheritance just by

spending the cash of the business.

Senator GRASSLEY. All right.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator.

Senator Salazar?

Senator SALAZAR. Thank you very much, Chairman Baucus and

Ranking Member Grassley, for holding this hearing on this important issue.

I think, at least for me as I approach this issue, one of the big

concerns we have had as we look at reform is, how do we deal with

the reality of paying the bills of the government? The pay-go rules

that we have adopted in this Congress are very important to me,

and at least to some members of this committee.

So to you, Ms. Batchelder, I would ask this question. On your reform option one, you say you would impose a 15-percent tax on extraordinary bequests that would be beyond the inheritance and you

would create some kind of a $2-million exemption. Can you elaborate on your proposal and what the consequence of that would be

in terms of the fiscal consequence sent to the government?

Prof. BATCHELDER. Sure. So the roughly $2-million exemption

would be revenue-neutral relative to 2009 estate tax law, which is

a $7-million per-couple exemption, $3.5 million per donor. The idea

would be that you would include amounts above that $2 million in

income and there would be a 15-percent flat tax, so that means

that I could inherit $2 million tax-free. If I inherit $3 million, I

would include $1 million in income, so it would be subject to the

income tax and it would be subject to a 15-percent flat tax, so the

marginal tax rate would start off at 15 percent.

Senator SALAZAR. So the $2 million, we are taxing the heir. We

are taxing the inheritance, we are not taxing the estate, under your

concept. That $2-million exemption is a lifetime exemption. It

would be similar to, say, a household’s primary residence, the lifetime exemption that we have under tax law. Is that the kind of

concept that you would be pushing here under that proposal?

Prof. BATCHELDER. It would be lifetime inheritances received.

And one thing I should note is, the $2-million revenue-neutral

threshold is sort of arbitrary relative to 2009 law. In my written

testimony I did include our estimates of what the revenue-neutral

threshold would be relative to 2008 law, to 2011 law, a few different permutations. So it would depend on what revenue baseline

Congress would like to set in order to achieve the targeted level of

deficit reduction.

Senator SALAZAR. Mr. Duff, I will ask you as well. You talk about

the importance of—I think you said, if we do the accessions tax,

philosophically where you approach this issue from, I think your

words were that it is all right, a good thing for society to moderate

extreme inequalities in wealth. Then you continued on and you

said that it is also important to protect certain heirlooms, family

farms, family businesses, and the like.

How, under your concept of the accessions tax or your reform

package number one, would you deal with that issue of those speVerDate 11-MAY-2000 14:25 Mar 09, 2010 Jkt 000000 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 54663.000 SFIN1 PsN: SFIN1
13

cial properties? I think Senator Baucus, myself, and others on this

committee are very concerned about ranchers and farmers, and the

fact that we have many estates out there that have a high value

but very low cash. One of the things we want to make sure we do

is to prevent having farmers and ranchers from having basically to

give up the family farm or ranch to pay some kind of an estate tax.

That is one of my key interests in dealing with this issue. So how

would you deal with that issue under your concepts?

Prof. DUFF. Well, I think there are two responses. One, with a

significant-enough exemption, it is generally not a problem. The

statistics I have seen in the U.S. suggest that, as the exemption in

the U.S., the estate tax has gotten high enough. Most of the estates

that have these illiquid assets generally have very liquid assets as

well. I think the evidence is pretty clear on that.

But I agree with Professor Batchelder that, even if in theory

there is a problem with illiquid assets, then it should be addressed.

As I said, my arguments suggest that there should be a balance between the values of transferring these kinds of family assets and

the tax.

Senator SALAZAR. So would you create an exemption then for

those illiquid assets under your proposal?

Prof. DUFF. I think my preference would be not an exemption,

because of course that creates strong incentives for people to transfer assets like that and then, of course, liquidate them. So I think

a deferral approach, as Professor Batchelder suggests, is probably

the best kind of approach to deal with those concerns.

Senator SALAZAR. All right.

Yes, go ahead.

Prof. DODGE. Yes. I guess I also think that deferral is a solution,

but I think I might differ from the others. I would defer the taxable

event until either sale or cessation of qualified use, as opposed to

imposing a tax and then deferring the tax with interest. So I would

defer the taxable event and that would also avoid valuation issues.

You just wait and see what happens.

Senator SALAZAR. Thank you very much. My time is up.

The CHAIRMAN. Thank you, Senator.

Senator Bunning?

Senator BUNNING. Thank you, Mr. Chairman.

Professor Batchelder, in your testimony you referred to inheritance income as unearned. But that term is more than a little misleading. It is not only earned income, it is earned and previously

taxed. If a donor earns $100 of ordinary income and pays 40 percent in Federal and State income tax, he or she is left with $60.

If the donor dies the next day and decides to leave it to his grown

child or children, under your proposal it would be taxed at 54.6

percent in 2011, that is 39.6 plus your 15-percent flat tax. That

leaves $27.24 before State death tax, sales tax, and other tax imposed on the child. I understand you are proposing a $2-million exemption, but that

may not be enough if the donor is trying to transfer a farm or a

small business. What possible incentive would donors have to build

a nest egg to provide for the safety and security of their children

and grandchildren if more than 73 percent will be taxed away? I

understand your zeal to level our income, but what will you do to

14

the incentive structure that for centuries has motivated Americans

to build businesses and create jobs?

Prof. BATCHELDER. Well, I would like to make two points. First,

with respect to it being a tax on unearned income, I agree that the

donor, when we work and we save, we are taxed on that income.

They then have a choice about how to spend it. When an heir receives a windfall, which I would view extraordinarily large inheritances to be, that is another person getting to choose how to spend

that income.

Senator BUNNING. What if the first person spent everything?

Prof. BATCHELDER. Then they would be taxed on it.

Senator BUNNING. Yes. Then they would not be able to provide

that second, or first, or fifth, or ninth child with one cent of inheritance.

Prof. BATCHELDER. Well, I sometimes find double taxes to be a

bit of a misnomer, because I think we should have one tax on each

person. So if the donor spends it on some jewelry, then the jeweler

will pay tax.

Senator BUNNING. Why does the government have a right to that

money? That is what I want to get at.

Prof. BATCHELDER. I do not think it is about a right so much as

how we should allocate tax burdens. If someone has inherited more

than $2 million over their lifetime, I think they do have a better

ability to pay taxes than someone who has not inherited anything

and has worked to earn $2 million over their lifetime. So in terms

of figuring out——

Senator BUNNING. Well, the same thing would go with that sec- ond person then that went out and earned that $2 million, or $4

million, or whatever it might be. You are going to confiscate their

inheritance for their children the same way. So what is the incentive?

Prof. BATCHELDER. The burden, as I mentioned in my testimony,

will be borne by the heir. So I think that, in allocating the tax burdens between people who inherit extraordinary amounts in society

and those who do not, we should be taking into account extraordinary amounts of inheritances. For normal inheritances, I fully

agree that we should be supporting and encouraging those kinds of

family bonds. But once we get above $2 million, that to me

becomes——

Senator BUNNING. I have an example. Somebody said that you do

not lose family farms. I am going to give you a perfect example how

a $12-million estate, in 4 years, disappeared to the tax collector. A

$12-million estate. No will by the owner, no will by the spouse. The

owner dies, spouse is due for the estate tax. The spouse dies. Now

the children inherit the $12 million. Now they have to pay $4 million in estate tax. This is just as recently as 10 years ago. They

cannot pay it. They do not have the liquid assets.

So they hock the farm to a bank, and the farm is a horse farm

that has to produce so much income to pay off the principal and

the interest that they borrowed. Well, the horse business went

south and it did not produce the principal and interest enough to

pay off that liability. The bank, 4 years later, took the whole estate,

$12 million. This man worked 60 years to build this estate of $12

million, and in 4 years the Federal Government leveled it, totally

15

and completely. It is my daughter-in-law and son, if you really

want to know about it. So the Federal Government has a tax

event—I am sorry, Mr. Chairman, but this gets a little personal because my family was involved.

The CHAIRMAN. You go right ahead.

Senator BUNNING. And so the tax consequences of dying should

not be accompanied with the transfer of that money to the Federal

Government.

Prof. BATCHELDER. If I could, I am very sorry about that.

Senator BUNNING. So am I.

Prof. BATCHELDER. Under the proposal I would be advocating for

treating family farms and other illiquid assets, there would be no

tax due when the transfer occurred. So long as your daughter and

son-in-law were operating the farm, that tax liability would just be

deferred indefinitely. It would be due only if they decided, we do

not want to run it any more, we want the cash, then the tax would

be paid and due. But prior to that, there would be no tax due.

Senator BUNNING. And what happens if they run it and transfer

it to their children?

Prof. BATCHELDER. The tax liability would continue to accrue and

it would be deferred indefinitely.

Senator BUNNING. Deferred as long as a member of the family

ran the farm?

Prof. BATCHELDER. As long as it is not sold, it stays within the

family and is being run by the family, it would not. It would just

defer with interest.

Senator BUNNING. All right.

Thank you very much, Mr. Chairman.

The CHAIRMAN. Thank you.

Are you ready, Senator Lincoln? All right. Fine. Senator Lincoln.

Senator LINCOLN. Thank you, Mr. Chairman. And thanks for

pulling us together here to have another discussion.

Professor Batchelder, Professor Dodge, and Professor Duff, we

thank you for taking time to be here today to discuss an issue that

is of tremendous importance to me particularly on behalf of my

constituency, to reform the estate tax system.

I have been working with my colleagues here on the Senate Finance Committee for more than 5 years, at a minimum, I guess,

since 2003, to really try to address the uncertainty that is created.

The unknown for any of us is dangerous and creates a tremendous

amount of fear, but here in the estate tax system we created that

uncertainty with the 2001 law in terms of the cliff that we are

going to hit after 2009, people not understanding or being able to

plan ahead, and particularly with something that is as precious to

them as something that they have spent their life creating, whether it is a business or their family’s inheritance or a family farm

that has been in the family for generations, or a business that has

been in the family for generations.

So it is something very tangible and certainly something that I

think represents a tremendous amount of who we are as Americans, that you could work hard all your life to be able to build

something, to pass it on to your children, and then unfortunately

find yourself in a situation where, because of the tax system we

16

have created, you would have to sell all of that in order to be able

to pay those taxes.

But for 5 years, Senator Kyl, Senator Grassley, Chairman Baucus, and I, and others have been studying this issue. We have been

meeting with experts at the Joint Committee on Taxation. We have

been discussing the possible solutions that would bring about relief

for our family-owned farms and businesses. Here we are again

today, continuing that discussion about this very issue, with another discussion expected sometime, I think, in the next work period. We are going to continue to do that.

And certainly I do appreciate the chairman’s dedication to this

issue, because he truly has been dedicated to it, and the committee’s continuing desire to study the issue—and no one can deny

that today’s hearing, with three professors on our witness panel, is

a good way to examine the topic from an academic perspective.

But I think, particularly from the perspective of my constituency,

it is time for less talk and less study and more in terms of action,

in terms of what we can do to provide more predictability and more

assurances to families who are working hard every day to build

that family business, the opportunity to be able to hand it off to

their children, which is what they want more than anything.

We have heard from our professors here today who say we

should think about other alternative systems. I have to say, with

all due respect, I am sorry, but my family-owned businesses in Arkansas could really care less whether it is called an estate tax, an

inheritance tax, or take-the-money-and-run tax, or whatever we are

going to call it. Whatever name we want to put on it and whatever

system that you use to collect it, it is all the same for our familyowned businesses and farms that have to pay it.

Maybe you have a difference of opinion, and I would certainly be

glad to hear that. But whether it is a farmer or a farmer’s son that

will inherit the business and keep it running, whether it is a meatpacking business, whether it is a small equipment business, whatever, one of them has to pay the tax and neither of them has the

liquidity to be able to deal with that, the liquid capital that they

need in order to be able to do that. So changing the method of collection is not, in my opinion, going to make that problem go away

for a family-owned business.

Maybe there are tweaks or bells or whistles that you all have

come up with, or ideas—I apologize for being late—that you may

have expressed, and we are certainly glad to listen to those. But

I do strongly believe that now is the time for action. Two thousand

nine is our last year under the 2001 changes before we eliminate

the estate tax, and certainly in 2011, we go right back to where we

started.

I believe that we have the capacity and the capability to reflect

our American values in our tax system in a way that is going to

be balanced, fair, and is going to help us continue these kind of

businesses that are the generators of the good jobs that exist out

there in America, not to mention the investment that it makes in

this country. So I look forward to working with my colleagues who

care about this issue in the weeks and the months ahead to take

some real action to address the issue, and I look forward to, again,

your perspectives and suggestions.

17

Maybe, Professor Dodge, you would like to start. You were shaking your head ‘‘no,’’ that somebody is not going to have to pay that

tax if it is an inheritance.

Prof. DODGE. Well, it is a fundamentally different tax. It is not

the same tax with a different name. Under the current system, the

taxable event is the time of the gift or the date of death, and you

just have to have that be the taxable event and you have to value

the property at that time.

But under either the accessions tax or the income inclusion proposal, or even under the deemed realization system, the taxable

event can be whenever you decide, because they are transfereeoriented systems.

So in the case of family farms and closely held business interests,

I would propose an inherent or integral part of the transfereeoriented tax—which, by the way, is similar to the realization principle of the income tax, that the receipt of an interest in a trust

or a family business or an illiquid asset is just not a taxable event.

Senator LINCOLN. Well, if revenue is coming in, somebody is paying it.

Prof. DODGE. What?

Senator LINCOLN. If revenue is coming in, someone is paying it.

Prof. DODGE. Well, there are other aspects of the tax. This would

only be a part of it. Deferral, if these businesses are successful, the

tax base will be larger at such time later on that it is taxed. If they

are unsuccessful—as in Senator Bunning’s case, you will not have

a tax liability that is greater than the value of the business.

Senator LINCOLN. So you are suggesting that it be deferred to see

if the business is going to be successful?

Prof. DODGE. No. It has nothing to do with—that is just random.

But it would be deferred until such time as the business is either

sold or it ceases its qualified use.

Senator LINCOLN. What about prepayment?

Prof. DODGE. Well, people could elect to prepay, possibly.

Senator LINCOLN. For a lower rate.

Prof. DODGE. You could build an election. Sometimes people

would find it advantageous to accelerate the taxable event. I see no

reason not to have that option built into the system.

Senator LINCOLN. Professor Batchelder?

Prof. BATCHELDER. Yes. First, in terms of the difference between

an inheritance tax and an estate tax, I would be happy to sort of

explain why I think it actually would matter, practically, at the

level of who is burdened by the tax. But in terms of illiquid assets

in family farms and family-owned businesses, it seems like there

are several different approaches we could take. One would be to

stick with the sort of patchwork of rules that we have.

There was a quote in a book on estate tax repeal that found that

both the American Farm Bureau and the New York Times had

never identified a single family farm that had been sold to pay the

estate tax. We just heard a story of one that had been, so I think

it certainly may exist and is a theoretical possibility under the existing rules.

And two other possibilities have been discussed. Professor Dodge

has discussed the possibility of just not imposing the tax at all

18

until the business is sold, and then imposing it on the value of the

business at that time.

I would actually prefer an approach where you would determine

the tax liability at the time of the transfer, but then defer it indefinitely with interest until it was sold. So as long as it is not sold,

there would be no tax liability.

Senator LINCOLN. But there would be tax liability eventually,

with interest, which puts the pressure on the business that is moving from one entity to another in terms of management. I mean,

if we use the example of Wall Street and publicly traded companies, when the CEO dies, there is no shift there. The liquidity is

there in order for those businesses to continue.

When you take a shift here from one generation to the next in

a family-owned business, a farming operation, or a ranching operation, I mean, all of a sudden you have to come up with the liquidity to pay a tax, as well as assuming the management risk and

other things like that. How can they be competitive in that scenario?

Prof. BATCHELDER. Well, the concept would be that they would

not owe any tax at that time, so there would be no need for liquidity because you would owe no tax. It would be deferred until, if the

heirs eventually decide they want to cash out, they do not want to

run the family business. Then they would be taxed on their inheritance to the extent that it exceeds a really high exemption, but if

they do not take the cash out they would not be taxed.

Senator LINCOLN. Does it make a difference who they sell it to?

Prof. BATCHELDER. No, I do not think it necessarily should.

Senator LINCOLN. No. We have lost tremendous family-owned

businesses, which people here in Washington love to talk about

how important family-owned businesses are. We have seen tremendous sales of family-owned businesses to major corporations because they cannot survive under the kind of pressures that both

these types of tax systems and regulations have on them as small

businesses without the capital to be able to survive.

I mean, I do not know. If our objective here in this country is

to not only create, but perpetuate the American dream that you

can build a family-owned business, how are we providing the fertile

environment in order for that to continue? If we continue to put the

kind of restrictive, both tax laws, but also the same kind of regulatory burdens that exist for small businesses, I do not know.

I am truly an advocate for family-owned businesses because I see

the productivity in them and I see the job creation that they provide this country. So, I do not know. I do not see where you are

doing anything but putting off the pain.

Prof. BATCHELDER. Well, I think it means that there is no liquidity crunch. I guess the other point I would make is, I would hate

for us to lose sight of the potentially valuable role that making

wealth transfer taxes part of the tax system can create in terms

of ensuring that economic mobility is distributed more evenly. I

would hate for us to be distracted from that by this problem.

Just to cite one statistic, the Tax Policy Center has estimated

that business and farm assets compose more than half of the estate

value for only 2.8 percent of taxable returns, so 97 percent of taxable returns really do not have a problem right now.

19

I think it is important to remember those 97 percent and think

about, do we want this kind of tax within our fiscal system, do we

think it is important to recognize the extent to which inheritances

can affect someone’s ability to pay, just like earning income from

work or savings can affect their ability to pay?

Senator LINCOLN. So are you saying that 97 percent are not affected because they do not reach the amount or is it because they

have planned for it?

Prof. BATCHELDER. It is because——

Senator LINCOLN. There are a lot of resources that, unfortunately, family businesses have to spend and devote to mitigating

their risk in terms of estate taxes and what their families and their

future generations will have to deal with.

Prof. BATCHELDER. Yes. So this statistic was that over half of

taxable estate values are liquid assets. Ninety-seven percent of

them have over half of their estate as liquid assets. So I do not

know what those liquid assets are, but generally one would think

then liquidity is not the issue, that one should be able to pay any

associated tax liability and continue the family business, if you so

choose, without the tax system preventing you from doing so.

The CHAIRMAN. Professor Dodge, you look like you want to get

in here.

Prof. DODGE. Well, it is hard to tell just from the statistics about

liquidity. As Senator Lincoln suggests, there might be pressure to

sell to large corporations or there may be purchases of life insurance. I do not think the tax law should distort economic decisions

such as the purchase of life insurance just to fund the liquidity for

the tax. So it is hard to tell. I would not be able to, I submit.

Besides, this is obviously an issue of intense interest to the committee. I do not think we need to be absolute purists. So again, I

would say that, given the big picture, I think the accessions tax or

the income inclusion system is better than the existing system,

partly because it is a transferee tax. Again, I would say in the case

of illiquid property, that the answer is deferral of the taxable

event.

That would have two ancillary benefits. First, there would not be

any interest charge involved. Second, you would not have to value

a closely held business interest. Under present law, valuing closely

held business interest is where all kind of estate planning gimmicks are, family-limited partnerships and all that sort of thing.

Senator LINCOLN. But would that mean that you would not have

a step up in basis when they pass down within the family? You

would have to, would you not?

Prof. DODGE. Well, if you were going to defer the—no, that is an

income tax issue. So the accessions tax is a separate tax. Income

tax issues are separate.

The CHAIRMAN. Let me just ask a question here. Why not, just

as these three countries, just abolish the wealth transfer tax and

the government just gets the revenue it wants with income tax, or

capital gains, or whatnot, as I suppose Australia, Canada, and New

Zealand do. I do not know what their taxation system is that realizes the income.

Before I ask you two that question, let me ask Professor Duff. So

how do these countries make up for lost revenue?

20

Prof. DUFF. Well, as I said, in these countries capital gains tax

did not exist beforehand, so they introduced capital gains tax and

that really was the——

The CHAIRMAN. Is it higher or lower than the U.S.?

Prof. DUFF. It is slightly different. In Canada, we include half the

gain in income and then subject it to the ordinary rate, so it is effectively half the ordinary rate. Probably comparable to the U.S.,

our capital gains tax rate. Maybe a little bit higher.

The CHAIRMAN. All right.

Prof. DUFF. Our tax rates are a bit higher.

The CHAIRMAN. But again, why not——

Prof. DUFF. Can I actually address that? Because I do not think

those taxes address the key issue, the philosophical issue, about

why I think it is legitimate and desirable to tax these transfers of

wealth. As I said before Senator Lincoln was here, I think there

needs to be balance in a tax system, I think balance in the values

that a society has. One value is the value of building up an enterprise, transferring it to your children, and I think that value is an

incredibly important value that should be respected and encouraged. But it has to be balanced against the concerns about moderating significant disparities in wealth and opportunity.

The CHAIRMAN. Would you advise those countries to redress that

balance? Is there imbalance in those three countries?

Prof. DUFF. I think in terms of the transfer of wealth from one

generation to the next, there is.

The CHAIRMAN. In those three countries. Yes. Well, that might

answer your question then, your answer—both your answers—as to

why not abolish and address it the way these three countries do,

that is, lost revenue.

Prof. BATCHELDER. I would just add that, currently, that income

tax taxes all the receipts that we have, from work, from saving,

from lottery winnings, if you find a fancy painting on the street.

That is all income.

The one major thing that is included is income from gifts and bequests. I think that, if we are going to do that within income tax,

we should be thinking about how to make sure that that kind of

income is still counted in allocating tax burdens, and either an estate tax or an inheritance tax is one way to do that.

I am less concerned about sort of ordinary inheritances. So most people receive inheritances well below, actually, $100,000. Once

you get up to, say, $2 million, that is the top 1 percent of the inheritance distribution and they are receiving these really extraordinarily large inheritances that are not considered at all in allocating income tax burdens.

So, if we were to repeal the estate tax and not replace it with

anything else that looked at inheritances, we would really be giving

a free ride to people who, in my view, are very fortunate to receive

such a large inheritance and be born into a family that can afford

to give it to them. I am not saying we should tax it all away, but

when it really exceeds some extraordinary threshold, we should

have them share their good fortune, as Professor Duff said, with

everyone else.

The CHAIRMAN. So both Professors Dodge and Duff would agree

with that general concept? That is, extraordinary wealth should be

21

taxed, that the transferee should pay some tax on extraordinary bequests.

Prof. DODGE. Yes. But it is ultimately a political question, because the idea of an accessions tax is, in a way, kind of different

from fixing holes in the income tax. You could do both simultaneously. Like, you could have a system that, under the income tax,

taxed gains and losses at gift or death, and on top of that have an

accessions tax with a large exemption. They are just two different

taxes.

The CHAIRMAN. What do European countries do?

Prof. DUFF. Most European countries levy inheritance type taxes.

I am not as familiar with what they do with capital gains at death,

whether they have carry-over basis, whether they have deemed realizations. I think some have one, some have the other.

I think the U.S. is pretty unique in having stepped-up basis

around the world, but most continental European countries have a

recipient-based tax. The donor-based taxes tend to be something

that the English-speaking world has adopted, so England, as I said,

Australia, Canada, New Zealand, had them. The U.S. has that approach. It was probably related somehow to common law systems

versus civil law systems.

The CHAIRMAN. I understand.

Senator LINCOLN. Could I ask just a couple?

The CHAIRMAN. Yes, go ahead.

Senator LINCOLN. So, Professor Dodge and Professor Duff—I’m

assuming, I guess, Professor Batchelder, too—you really think government then should play the role of determining how personal income should be divided? I mean, if you are saying that it is redistribution and those who are fortunate enough to have worked hard

all their life to build something, I mean, the incentive was there

that if we build this business we will be able to hand it off to our

heirs, our children. But then at that point the government decides

whether or not you are going to be able to do that because we are

going to redistribute your personal income, your personal wealth in

a way that we see fit?

Prof. DUFF. As I said, I think there needs to be balance, right?

These values are very important, and so, as we have talked about

this, I think all of us have said that, for closely held enterprises—

farms, certain kinds of family heirlooms—that kind of value is really important and needs to be respected. The best way to, I think,

address that is through either deferring the moment of the tax or

deferring the tax itself. But it has to be balanced against other values that I think democratic societies hold, which are that when

there are extreme inequalities of wealth and opportunities, that is

not a healthy thing for a society.

Senator LINCOLN. Can you not do that by limits?

Prof. DUFF. What do you mean by limits? I think that is

what——

Senator LINCOLN. Amounts.

Prof. DUFF. That is what exemptions are about. A basic exemption that says only taxing above very large, substantial gifts and

inheritances is, I think, exactly that: a limit. It does not say, well,

you cannot do beyond that. It is just, there is a price to be paid

beyond that, and the price is to share with the rest of society. You

22

might even say, well, all right, so government requires that sharing. Then, of course, people always say, well, it disappears into government, right? So then make the sharing explicit. Take the revenues and dedicate them to education for people from disadvantaged

backgrounds, things that will give people a leg up who do not have

that leg up otherwise.

Senator LINCOLN. Right. I do not disagree with you, necessarily.

I certainly believe that, as Americans, we all have a huge responsibility to give back to this great country that has given us so much

in terms of opportunities, and those very opportunities to build a

business from nothing or from scratch. But then comes the big

question that we always fall over ourselves about here, and that is,

where are those limits? How do you determine?

I visited with a man who has spent his life building a small business, investing in infrastructure and machinery. He has four sons.

To say he is limited to an exemption of $1.5 million or $3.5 million

does not get him to where he needs to be. He is still going to have

to dissolve. Better yet, he will be bought out by some big major,

huge corporation because he cannot pass it down to his sons without coming up with the liquidity that he needs to do that.

Prof. DUFF. This is one of the advantages, of course, of the inheritance type or accessions approach: four sons, four exemptions, as

opposed to four sons, one exemption under the estate tax. You distribute to your four sons, each of them gets, under Professor

Batchelder’s proposal, a $2-million exemption. That is $8 million of

exemption rather than, the current system is what next year?

Three or something?

Prof. BATCHELDER. Next year would be $3.5 million. Right now, it is $2 million.

Senator LINCOLN. And then back to $1.5 million in 2011, which

would be one.

You mentioned the deferral, Professor Dodge, that you thought

that might be something that would be very helpful. Of course, we

want to create something that not only is going to be, I think, advantageous to making sure that family businesses can continue,

but we also want to simplify as we go. I know the chairman has

worked tirelessly, working on simplification of the tax code.

We do not want to make it any more complicated. But with deferral, I am not aware of all of the administrative burdens, but I do

understand there are some in terms of the IRS reporting requirements and other things like that. Is there any issue there? Have

you done the research in terms of how that can be simplified?

Prof. DODGE. Well, under the accessions tax, that is completely

separate from issues like whether there is a carry-over basis or a

stepped-up basis. So whatever the basis is for income tax purposes,

under accessions tax deferral there would be no valuation at the

time of gift or death.

There would just not be a taxable event until it is basically converted away from the qualified use; that is what you are trying to

protect, keeping the business in the family. So, if they sold it, then

the proceeds of sale would be subject to accessions tax. If it were

a farm and they ceased operating it as a farm and decided to subdivide it and sell off the lots, well, that would be the triggering

event.

23

Senator LINCOLN. What about if it went into conservation?

Prof. DODGE. I do not see any administrative problem. All you

would have to do is identify property out there that is subject to

this system.

Senator LINCOLN. Right. So you do not see any worries about additional reporting or IRS complications or greater need for oversight.

Prof. DODGE. No, that is the problem under the carry-over basis

system, because you have an event that supposedly fixes basis, but

it does not bear fruit for many years later. But I do not see that

as a problem under the accessions tax.

The CHAIRMAN. As I understand it though, with the other systems, with inheritance systems, there could well be a lot of complexity there, too. You do have issues of step-up or carry-over, a

number of exemptions. A lot of people do not like the current system because they do not like paying taxes.

But, second, they do not like paying taxes on something they

build up, as has been discussed here. The third, it is extremely

complex. Estate planning is very, very complex. The question is, if

we were to have a system where wealth was transferred on the

basis of inheritance, would we necessarily have a much less complex system or not? I am just only on complexity at this point.

Prof. DUFF. Professor Batchelder has actually talked about this.

I think there are lots of advantages to a recipient-based tax over

an estate-based tax in terms of simplicity, particularly when you

come to dealing with trusts and the generation-skipping tax that

exists in the U.S. All that complexity comes from trying to tax on

the donor side rather than the recipient side. Actually, I will hand

it over to Professor Batchelder because she has written about this.

Prof. BATCHELDER. Yes. I actually think there are a number of

simplification advantages to an inheritance tax, and also a number

of ways that we could simplify current law. Some of the advantages

of an inheritance tax you can only get within an inheritance tax.

The big issue, I think, is that, whenever you have a tax that is

applied to extraordinarily wealthy people with very sophisticated

tax advisors, you are going to need some complicated rules because

their tax advisors are going to spend a lot of time trying to figure

out how to game them.

The way to prevent that is to treat economically similar transactions alike, so that, even if you restructure a transfer, it is all

going to be taxed the same way and then there is really no way

around it.

An inheritance tax, I think, would allow more of that. A particular area that it would is, there are some very complicated rules

under current law about split and contingent interests—this is

when sort of the ultimate beneficiary is unclear. You create a trust

and maybe a portion of it is going to go to the spouse and be exempt, or a portion will go to a charity and be exempt, and then a

portion is going to go to a taxable beneficiary. We have these very

complicated rules to figure out, all right, we think 53 percent is

going to go to the tax-exempt beneficiary. An inheritance tax would

let you just wait and see, and ultimately whatever goes to the

spouse or charity, that is subject to the exemption. Whatever goes

to the taxable heir——

24

The CHAIRMAN. I am going to have to conclude this hearing,

unless——

Senator LINCOLN. Can I just ask one last question, please?

The CHAIRMAN. Senator Lincoln has one question.

Senator LINCOLN. Thank you, Mr. Chairman.

There are not many times that I wish I was a tax attorney, but

with this issue, I do. Fortunately I am surrounded by some very,

very thoughtful tax attorneys, and grateful for their counsel. But

you are right, they are very smart people and they do figure out

an awful lot on that chessboard in terms of ways to deal with it.

The last thing I would just like to ask is, you all talked consistently about deferral in terms of the payment. One of the issues we

deal with—I mean, family businesses can defer, I think, already in

many instances. But the way we work around here are in 10-year

budgets, so we have to understand what something is going to cost.

The repeal of the estate tax is very costly, in the sense that it is

a lost revenue to the Treasury. If this inheritance tax continues to

be deferred, does this proposal or idea that you are advocating not

score as costly as repeal if all we are doing is deferring that tax?

Prof. BATCHELDER. Well, again, the deferral option that I was describing would only apply if you do not have the liquid assets to

pay the tax. So as I mentioned, 97 percent, at least, of estates do.

Presumably about that many would under an inheritance tax.

Senator LINCOLN. Of course, the nitty-gritty detail there is what

you are describing as liquid. I mean, you can always sell land. It

becomes liquid if it has to.

Prof. BATCHELDER. Right. Right.

Senator LINCOLN. Yes. So I know that certainly the chairman

has been an incredible tutor in terms of figuring out, when there

is a cost with something, it has to be dealt with. Obviously, the cost

of full repeal is tremendous. We realize that that is problematic.

But if we are continually deferring the inheritance tax, then I

think it probably scores enormously costly as well and is something

we have to deal with in terms of figuring out how we change things

and make them better.

So, Mr. Chairman, thank you very much. I do hope that we can

come to a resolution, because the unknown has become enormously

frightening to many of my small businesses, farmers, and ranchers.

I know if we all put our heads together we can come up with something that gives them more certainty in terms of what they can expect, and certainly greater simplification. So I appreciate the chairman’s leadership.

Thank you all.

The CHAIRMAN. I thank you all. This has been a very provocative

hearing. It is kind of mind-bending, in some respects. Thank you

very much.

The hearing is adjourned.

[Whereupon, at 11:30 a.m., the hearing was concluded.]

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