Prescott on the Estate Tax
I am puzzled by those who say that the repeal of the estate tax will hurt charitable giving. Repeal has two opposing effects: a substitution effect (it raises the relative price of giving to your favorite charity rather than to your heirs) and an income effect (you have more to give). Critics of repeal seem to assume that the substitution effect dominates the income effect. I am not convinced that is right.
Since an estate tax is really just another name for a tax on capital income, then there is certainly no justification for such a tax. I, and others, have written before in these pages about the inefficiency of capital income taxes, and there's no need to revive those arguments here, except to say that we can only grip the neck of our vibrant economic goose so tightly before it eventually dies and quits laying those golden eggs....
Yet what about all the money that is left in bequests to fund university alumni buildings, art museum wings and public broadcasting? If we abolish the death tax, won't charitable organizations be hurt? I admit to a soft spot for this argument, but the fact is that people will still give to charity. In 2003, charitable contributions reported on 1040 income tax forms totaled $145 billion, which is roughly 10 times the $14.6 billion charitable contributions reported on the estate tax forms.
Imagine a wealthy Harvard alum. His will says, "Give each of my 10 heirs $10 million after taxes, then the rest to Harvard." If he faces an estate tax rate of 50 percent, then funding the heirs will cost an extra $100 million, which will all come at Harvard's expense. Isn't something along these lines plausible?
If commentators know of relevant evidence about the size of income and substitution effects regarding charitable giving at death, please share it with us.
Update: I am alerted to a relevant CBO study of the topic. The CBO's bottom line:
The analysis finds that permanently raising the amount of wealth exempt from the estate tax to either $2 million or $3.5 million would reduce charitable giving by less than 3 percent, as increased giving by the wealthiest donors would partly offset lower giving by donors with wealth below those cutoffs. However, permanently repealing the estate tax would cause a larger decline in charitable giving—of 6 percent to 12 percent. For the federal government, reduced giving would directly raise income tax revenues by lowering the amounts claimed as itemized deductions for charitable contributions. That revenue gain would partially offset the loss in revenue caused by repealing the estate tax.