Diagnosis Murder: The Death of State Death Taxes

Since 1976, more than 30 states have eliminated their "death" taxes and many others have reduced them. This unexplored case of interstate tax competition presents a unique opportunity to develop a new, more satisfying definition of competitor based on historical elderly migration patterns. Using data from 1967 onward, we outline the recent history of state death tax competition and present a spatial econometric analysis. Interstate tax competition is evident and grows stronger when using migration-based definitions of competitors. The article concludes with still more evidence of interstate tax competition the recent movement by states to effectively revive their death taxes. (JEL H7, D7) I. INTRODUCTION The federal estate tax has received wide attention especially because its elimination has been a centerpiece of President George W. Bush's tax proposals. (1) Largely overlooked, however, is the quiet revolution that has been taking place at the state level. Since 1976, 31 of the 48 contiguous states have repealed their "death" or estate, inheritance, and gift (EIG) taxes, instead relying only on the pick-up tax whereby states capture a portion of the federal estate tax liability but do not increase the overall liability of the estate. (2) Of the remaining 12 states that still have EIG taxes, 2 have enacted legislation that will eliminate them by 2005 and others are considering doing so. Beyond the outright elimination of EIG taxes, many states have also acted to reduce them in a variety of ways, such as exempting certain beneficiaries, such as the spouse. This trend is noteworthy for several reasons. Foremost, it appears to us a prime example of intense interstate tax competition due to the growing size and political influence of the elderly population. There is additional political pressure because states may worry that high EIG taxes will drive the high-income elderly to move to bordering states or retirement havens. The stakes may be substantial. For example, Longino and Crown (1989) estimate that Florida had a net gain of $5 billion in income from the elderly migrants it received between 1985 and 1990, and Sastry (1992, 73) estimates that one new job is created for every 2.5 elderly migrants it receives. State EIG tax competition also provides us with a unique opportunity to explore alternative definitions of competitor states beyond simple geography because the movements of the tax base--the elderly--are fairly easy to track via historical migration data. Yet no research to our knowledge has explored interstate EIG tax competition. Furthermore, these widespread changes in state EIG taxes provide substantial cross-sectional and time-series variation that has been mostly overlooked by researchers interested in the behavioral effects of estate taxes. (3) State EIG tax policy is also still in flux. Current and proposed changes in the federal estate tax have substantial revenue consequences for states, effectively eliminating EIG tax revenues for those that rely solely on the pick-up tax. How will the states react to this change? At present, several states have enacted or are considering legislation that would effectively decouple their EIG taxes from the federal estate tax and so would preserve the revenue source. Indeed, as the federal estate tax is slowly eliminated, EIG taxes in states that continue to use them may be the only remaining taxes on bequests. Yet little is known about them. Our research seeks to fill this void. Using state-level data from 1967 to the present, we first describe the brief history and geographical pattern of these widespread reductions in state EIG taxes. To our knowledge, ours is the first research to document in a systematic way this phenomenon. We begin with a chronology of the states that eliminated completely their EIG taxes (thereby choosing to rely instead only on the pick-up tax). However, there are many other ways that the states may reduce their EIG taxes, such as increasing exemptions or reducing tax rates. …