Washington finally declared a truce on the death tax this year, with estates now taxed at 40% with an exemption of $5 million. President Obama insisted on preserving this tax to spread the wealth, though it raises less than 2% of federal revenue and discourages lifetime savings, as even a 1981 study by Mr. Obama's former chief economist Larry Summers showed.
Now the death-tax debate has shifted to state capitals, with mixed results depending on which party runs the state. Prior to 2001, states could impose an estate tax of up to 16% with no extra burden on their residents because a federal tax credit offset state estate taxes. That policy has ended and now state death levies are paid out of the assets of the deceased.
Four states—Indiana, North Carolina, Ohio and Tennessee—have reacted wisely by eliminating or phasing out their estate taxes. This leaves 18 states plus the District of Columbia that still impose a gift or estate levy. (See the nearby list.) Most of them still apply a 16% rate—as if federal rules haven't changed.
The grand prize for self-abuse goes to Minnesota, which this year enacted a new 10% gift tax with a $1 million exemption. A gift tax is a levy on money given away while still alive. This tax is in addition to Minnesota's 16% estate tax. The new law is all the more punitive because it applies the 16% estate tax (6% on top of the earlier 10% gift tax) to any gift within three years of death.
This is essentially a clawback tax, or more taxation without respiration. Democratic Governor Mark Dayton, who signed the law, is the heir to a department store fortune and knows a lot about inheriting wealth but not much about creating it.
Studies by Mr. Summers and many others conclude that successful people who have built up wealth continue to invest in the enterprise and save money in their later years in order to leave a legacy to their heirs. This accounts for the trillions of dollars of wealth passed from one generation to the next. The higher the tax rate the more this incentive for wealth creation is reduced. The combined federal and state death tax rate now approaches 50% in many states (after accounting for deductions). This explains why estate tax planning and avoidance is a booming industry.
State death taxes are especially futile because residents subject to the tax can avoid it by fleeing before they die. No less an ardent liberal than the late Senator Howard Metzenbaum moved to Florida from Ohio to avoid estate taxes after he retired from politics. A successful New York business owner with, say, $50 million of lifetime savings can move his family and company to Florida, Georgia, Texas or 29 other states and cut his death-tax liability by up to $8 million.
Thousands of Minnesota snow birds move to Florida during the winter months already, and so the new tax adds an extra financial incentive not to return. The Center for the American Experiment, a Minnesota research group, found that $3 billion of income has been lost to the state since 1995 after Minnesotans relocated to Florida and Arizona.
The think tank's conclusion should be required reading for policy makers in every state still imposing a death tax: "If enough people move away and stop paying Minnesota taxes, then Minnesota will experience a net revenue loss due to the estate and gift tax." This will mean that people making less than $1 million a year will be left paying the tab. So much for spreading the wealth.
A version of this article appeared August 20, 2013, on page A14 in the U.S. edition of The Wall Street Journal, with the headline: The Die Harder States.
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