Editorial

Mark it down as the first tax increase of the new Democratic era. The Journal reported yesterday that President-elect Obama and Congressional leaders intend to maintain the estate tax rather than let it expire on schedule in 2010.

They will do so even though their economic stimulus plan is supposed to be about creating millions of new jobs in a hurry. The death tax strikes most heavily at small- and medium-sized family-owned businesses that generate the majority of new American jobs. So hitting these family businesses with a multimillion dollar tax bill when the owner dies won’t help job creation.

Republicans are partly to blame here for making this easy for Democrats, thanks to their mistakes in the 2001 tax bill. Rather than repeal the tax immediately, Republicans got bamboozled into agreeing to a 10-year phase-out that eliminates the tax only for a single year. Then the rate goes all the way back in 2011 to the confiscatory 55% rate of the Clinton era, with a mere $1 million exclusion. Republicans never did fix the tax revenue estimating process on Capitol Hill, and this is one price for that failure.

Mr. Obama wants to make the current death tax rate of 45% permanent, along with an exclusion of $3.5 million ($7 million for couples). One issue to watch is whether this exclusion is indexed for inflation, or else over time it will hit more and more average earners who build up a small nest egg over a lifetime. Think Alternative Minimum Tax.

The death tax is supposed to be an easy way to extract revenue from the likes of Warren Buffett and Bill Gates, who support the tax. It won’t. The super wealthy have foundations and other tax dodges to shield themselves from much of the tax. A 2006 Joint Economic Committee (JEC) study found that death tax “liabilities depend on the skill of the estate planner, rather than on capacity to pay.” So much for tax fairness.

By contrast, “family-run firms and farms particularly feel the pinch of the estate tax, because they are less likely to have the liquid resources needed to meet their estate tax liabilities.” The latest JEC estimate is that the death tax has reduced the stock of capital in the economy by about $847 billion. So let’s get this straight: We are said to need an economic stimulus plan that will borrow and spend roughly the same amount of money to replace the capital stock that the estate tax has wiped out. Go figure.

This lost capital reinvestment translates into fewer workers on business payrolls. Douglas Holtz-Eakin, the former Congressional Budget Office director, estimates in a new study that the economy would create roughly 1.3 million more small business jobs with no death tax rather than with a 45% rate. Foreign governments understand this relationship, which is why they have been slashing their estate taxes in recent years. According to the American Council for Capital Formation, the U.S. has the third highest estate tax in the developed world — 49% if you add the federal rate and average state rate, just below 50% in Japan and South Korea.

Republicans alone won’t have much chance to stop this Obama estate-tax plan, so its fate will hang on Senate Democrats. For years many of those Democrats — especially in swing states like Arkansas and Montana — campaigned on the promise to lower or eliminate the estate tax. We’ll now find out if they meant it.

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