Estate Tax Repeal: Historical Data Indicate Philanthropy May Suffer
Summary
Complete repeal of the federal estate tax is scheduled to take effect for a one year window during 2010. But what if the estate tax is repealed permanently? What effect would that have on testamentary charitable gifts from those who are no longer subject to the tax? Some planners suggest that with more to give, people might give more. Others argue that in the absence of a tax incentive, people will give less. In this article, Chapman University law professor Frank J. Doti examines the historical data to suggest an answer.
By Frank J. Doti
Frank J. Doti is a professor of law and the William P. Foley, II Chair in Corporate and Taxation Law at Chapman University School of Law in Orange, California. He directs the law school's Tax Law Emphasis program and is certified as a Tax Law Specialist by the California Board of Legal Specialization. He is grateful to Chapman law student Marc Thompson for his invaluable research assistance. Professor Doti can be reached at fdoti@chapman.edu
President George W. Bush has been an ardent supporter of permanent repeal of our federal estate tax. Due to congressional budget rules, the best his administration has been able to achieve to date is the 2001 tax act's absurd one-year repeal in 2010.1 After a gradual increase in the unified credit exemption amount from $600,000 under prior law to $3.5 million in 2009 pursuant to the 2001 tax act, no estate tax is imposed on the estates of decedents who die in 2010. Estates of decedents who die in 2011 and subsequent years are again subjected to estate tax with the exemption amount decreased to $1 million.2
Further attempts at permanent repeal are apparently now on the administration's back burner due to the preoccupation with terrorists, the war in Iraq, the crisis in North Korea, and the faltering economy. Although the President's budget proposal contains a provision on permanent repeal, it does not appear to be the major focus of attention as it was in the past.3 Efforts are now directed to stimulating the economy and the stock market as evidenced by the call for excluding corporate dividends from income tax. Nevertheless, the President and a strong contingency in the Congress still favor permanent repeal. With both houses now controlled by the Republicans, albeit by a small majority in the Senate, efforts to repeal the federal estate tax may resurface when the budget deficit becomes more manageable.
Articles have been written and empirical studies published about the impact of permanent estate tax repeal on charitable giving. The debaters are about evenly divided between those who are concerned that repeal will adversely affect charitable giving4 and those who claim that repeal will actually increase charitable giving.5 Many of the authors' conclusions are based on anecdotal evidence of how wealthy individuals will react if there is no estate tax. Just a few of the scholars have applied empirical evidence in reaching their conclusions.
None of the studies have analyzed what may be valuable empirical evidence on what would happen to charitable giving in the absence of an estate tax. When the modern era estate tax was first imposed in 1917, Congress did not provide for a deduction against the gross estate for charitable bequests.6 A few years later, in the Revenue Act of 1921, the apparent oversight was corrected, and an unrestricted charitable bequest deduction became a permanent feature of the estate tax law.7 Interestingly, the charitable bequest deduction was made retroactive to the estates of decedents who died in 1918 and subsequent years.8 So 1917 was the only year in which charitable bequests could not be deducted from the gross estate.
With this history, the post-1917 period seemed to offer a unique opportunity for study about charitable bequests. Of particular interest was the impact on charitable bequests in 1921 and later years when presumably wealthy individuals first became aware of the estate tax advantage of charitable bequests. One might expect that a dramatic increase in charitable bequests in 1921 could indicate a possible link between the ability to deduct charitable bequests from the gross estate and enhanced charitable giving.
The Treasury Department's archives contained relevant data. For persons dying in 1917, the first year the estate tax was imposed, 8,284 estate tax returns were filed with combined gross estates of $1.8 billion.9 Charitable bequests totaled only $2.2 million. For persons dying in 1921, when the charitable bequest deduction was initially enacted, 11,671 returns were filed with combined gross estates of $2.2 billion. Charitable bequests shot up to $77.8 million.10
Between 1917 and 1921 the total amount of gross estates increased 25 percent. During this same period charitable bequests increased 3,419 percent, which is more than 34 times the charitable bequests reported in 1917.11
Looking at the statistics another way, in 1917 charitable bequests represented a negligible 0.121 percent of total gross estates. In 1921 charitable bequests increased dramatically to 3.043 percent of total gross estates. Between 1918 and 1945 charitable bequests annually averaged 4.82 percent of gross estates. Unfortunately, comparable statistics are not available from the Treasury for the period 1946-1988. Between 1989 and 2000 charitable bequests averaged 7.284 percent of gross estates.12
Interestingly, there has been a fairly significant increase in the proportion of gross estates left to charities in the years up to 2001 compared to the 1918-1945 period.13 The trend toward greater philanthropy in recent years may be attributable to a combination of factors:
(2) More sophisticated estate planning with greater use of charitable remainder trusts and similar devices,
(3) Greater awareness of charitable needs from the media, especially in late 2001 as a consequence of the September 11 attacks, and
(4) The unlimited marital deduction in more recent times, which may account for part of the statistically lower charitable bequests in 1918-1945. When estate taxes were payable at each spouse's death, charitable bequests may have been more evenly divided between the husband's and wife's estates. With an unlimited marital deduction, large charitable bequests tend to be delayed until the surviving spouse dies.14
Whatever the reasons, it is clear from the statistics that charitable giving increased dramatically after the charitable estate tax deduction was formally enacted into law in early 1921. Since then, charitable bequests as a percentage of gross estates have remained fairly constant with an upward trend through 2000.15
Was the very significant increase in charitable bequests between 1917 and 1921 attributable to the fact that charitable giving became deductible? Did wealthy individuals all of a sudden become more philanthropic because the federal government "subsidized" their bequests to charities? Given the constellation of variables, these data may not entirely answer that question.
Nevertheless, it is interesting that testamentary charitable giving increased dramatically after Congress allowed the deduction. If indeed the historical data mean that decedents were influenced before death to change their estate plans to provide more to charitable groups, will a repeal of the estate tax have the opposite result? We will not know the true impact unless permanent repeal becomes a reality.
The data may prove that irreparable financial harm would befall charitable organizations if there were permanent repeal. Further, because a large proportion of charitable bequests are funded by appreciated equities, the unfavorable consequences are exacerbated by the recent, severe stock market decline.
===================================================================== Estate Tax Returns Filed for Decedents Dying 1917-1945 and 1989-2000 Amounts in 000s Total Gross Estate Charitable Bequests ---------------------- --------------------------- Year of Death Number Amount Number Amount % --------------------------------------------------------------------- 1917 8,284 $1,834,281 47 $2,213 0.121 1918 9,781 2,207,719 397 81,584 3.695 1919 11,126 2,628,125 1,394 142,641 5.427 1920 12,492 2,728,574 1,583 64,271 2.355 1921 11,671 2,288,174 1,667 77,870 3.403 1922 12,421 2,637,807 1,871 72,981 2.767 1923 12,898 2,646,743 2,049 78,177 2.954 1924 13,299 2,817,099 2,126 103,539 3.675 1925 13,770 3,201,865 2,200 190,134 5.938 1926 9,049 3,131,523 1,768 119,749 3.824 1927 7,666 3,310,905 1,683 200,124 6.044 1928 8,312 3,651,216 1,881 138,887 3.804 1929 8,830 4,110,174 1,939 217,161 5.283 1930 8,210 3,958,747 1,903 208,695 5.272 1931 7,206 2,879,322 1,733 185,397 6.439 1932 8,193 1,968,457 1,660 106,157 5.393 1933 10,575 2,212,894 1,799 108,435 4.900 1934 10,954 2,308,316 1,888 103,710 4.493 1935 12,467 2,517,444 2,321 134,609 5.347 1936 15,882 3,063,731 2,756 144,635 4.721 1937 16,560 2,822,626 2,906 184,486 6.536 1938 15,781 2,670,669 2,836 150,891 5.650 1939 16,634 2,703,924 2,906 145,889 5.395 1940 17,279 2,681,504 3,032 123,377 4.601 1941 18,013 2,767,501 3,085 140,217 5.067 1942 16,938 2,638,547 2,939 180,943 6.858 1943 16,141 3,052,854 2,709 139,092 4.556 1944 17,699 3,525,827 2,909 192,183 5.451 1945 20,117 3,959,316 3,210 160,152 4.045 1989 50,376 87,171,506 9,792 5,765,620 6.614 1990 50,367 87,116,955 9,709 5,527,490 6.345 1991 53,479 79,112,250 10,160 6,246,781 7.896 1992 59,176 98,850,462 11,053 6,785,352 6.864 1993 60,207 103,692,092 11,119 7,292,066 7.032 1994 68,595 117,025,524 11,869 9,329,704 7.972 1995 69,772 117,735,156 13,063 8,706,603 7.395 1996 79,346 137,435,395 14,233 10,213,252 7.431 1997 90,006 162,250,712 15,575 14,266,433 8.793 1998 97,868 173,817,135 16,983 10,861,331 6.249 1999 103,993 196,436,307 17,559 14,575,316 7.420 2000 108,322 217,402,426 18,011 16,092,353 7.402 --------------------------------------------------------------------- Source: Internal Revenue Service Statistics of Income (date on file with author). =====================================================================
The Center for Philanthropy at Indiana University maintains a "philanthropic giving index" based on survey responses from 150 fund-raising managers. The Wall Street Journal recently reported that Eugene Temple, executive director of the center, announced that the index for 2002 has fallen to its lowest level in the five years that the center has tracked the data.16 Also, the Barna Research Group for Epsilon estimates that the percentage of adults who donate to charities fell from 80 percent in 2001 to 69 percent in 2002,17 the lowest level in 40 years.18 Possible explanations for the decrease in charitable giving may be the economic recession and severe stock market losses. In my view, another possible explanation not identified by the media is a reaction by the wealthy to the 2001 tax act and the perception that there will be permanent repeal of the estate tax. Estate planning practitioners have told me that uncertainty created by the 2001 tax act has caused many of their wealthy clients to hold off on charitable remainder trusts and related testamentary tax vehicles that benefit philanthropic organizations. Historically low interest rates may have also exacerbated the decline in establishing charitable remainder trusts.19
The crucial issue is whether it is desirable to take the chance that wealthy individuals will react to repeal by significantly reducing their philanthropy -- especially if the negative reaction is anywhere near as dramatic as the positive response was between 1917 and 1921.
Ironically, some very wealthy people are opposed to estate tax repeal. Two of the richest Americans, William "Bill" Gates Sr. and Warren Buffett, have voiced strong objection to estate tax repeal.20 Buffett has reported that he plans to leave the bulk of his estate to charities.21 Clearly, in supporting the wealth transfer tax regime, he must relish the estate tax incentive for private philanthropy, which has the effect of reducing government coffers.
The debate over the future of the estate tax will certainly continue as Congress and the President decide what to do with our wealth transfer system. I urge our federal administrators and lawmakers to carefully consider the potential impact on charities in light of some very old but potentially compelling statistics.
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Economic Growth and Tax Relief Reconciliation Act of 2001, H.R. 1836, P.L. 107-16. See section 2210(a), as added by the 2001 Act, section 501(a). Section references are to the Internal Revenue Code of 1986, as amended, except as otherwise noted.back
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Section 2010(c), as amended by the 2001 tax act, section 521(a).back
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General Explanation of the Administration's Fiscal Year 2004 Revenue Proposals (Blue Book), available at http://www.treas.gov (Feb. 3, 2003).back
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See, e.g., Rick Cohen, "NCRP Fact Sheet on the Charitable Implications of the Estate Tax," National Committee for Responsive Philanthropy, available at http://ombwatch.org/npadv/ estatetax/ncrpfacts.html (May 3, 2001); David Joulfaian, The Federal Estate and Gift Tax: Description, Profile of Taxpayers, and Economic Consequences, U.S. Dep't of the Treasury, OTA Paper 80 (December 1998). At the time of publication, David Joulfaian was a financial economist with the Office of Tax Analysis for the United States Department of the Treasury. See also David Joulfaian, "Charitable Bequests and Estate Taxes," 44 Nat'l Tax J. 169 (1991).back
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See, e.g., Bruce Bartlett, "Estate Tax Repeal Won't Affect Giving Much," National Center for Policy Analysis, available at http://www.ncpa.org/pi/taxes/pd062600a.html (June 26, 2000); Jim Saxton and Mac Thornberry, Joint Economic Committee, 105th Cong., Study on the Economics of the Estate Tax (December 1998).back
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Revenue Act of 1917.back
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Revenue Act of 1921. The deduction is now found in section 2055.back
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Id.back
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Internal Revenue Service, Statistics of Income, Estate Tax Returns Filed for Decedents Dying 1917-1945 (on file with author). Assistance in compiling these figures was provided by Barry Johnson of the Internal Revenue Service, Statistics of Income Special Projects Division.back
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Id.back
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Id. Charitable bequests also increased dramatically in the years immediately after 1917. Charitable bequests increased in 1918 to 3.695 percent of total gross estates. The Revenue Act of 1921 did make the charitable bequest deduction retroactive to 1918 and subsequent years. Nevertheless, we have not been able to determine if decedents were aware of Congress's intent to make the deduction retroactive. If they were, the significant increase after 1917 may be attributable to changes in estate plans to take advantage of the charitable deduction. We do not have evidence, however, that the retroactive nature of the law was known before enactment of the Revenue Act of 1921 in January 1921.back
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Internal Revenue Service, Statistics of Income, Estate Tax Returns Filed for Decedents Dying 1989-2000.back
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Id.back
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The marital deduction was first enacted in 1948 and was expanded to an unlimited deduction in section 2056, as amended by the Economic Recovery Tax Act of 1981.back
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Statistics of Income, supra note 12.back
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Tom Herman and David Bank, Wall Street Journal, December 26, 2002, at D1-D2.back
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The Orange County Register, December 8, 2002, at 1.back
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Id.back
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Section 664(e) requires that the noncharitable interest of a charitable remainder trust be valued at no less than 5 percent of the fair market value of trust assets. Thus, donors receive a relatively lower charitable deduction for the remainder interest compared to the current lower rate of investment return that the assets can actually earn for the noncharitable beneficiaries.back
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Carl Hulse, "Battle on Estate Tax: How Two Well-Organized Lobbies Sprang Into Action," N.Y. Times, June 13, 2002. William H. Gates Sr. and Chuck Collins, Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes (Beacon Press, 2003).back
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William F. Buckley Jr., "Capitalist Unction," National Review Online, at http://www.nationalreview.com/buckley/buckley021601.shtml (Feb. 16, 2001).back
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