Continuing on the theme of my recent post on the difficulty of understanding scope of large numbers, a friend of mine published a compelling demonstration of the size of a Trillion Dollars:

• With the latest round of Washington bailout money approaching a trillion dollars, here’s a way to visualize large sums of money assuming that the average dollar bill is 4 mils (0.004 inches) thick:
• One million dollars is one million $1 bills. Lay them edge-to-edge and they would cover 2.57 acres of land.
• One billion dollars would be the same as above but with a 4-inch tall stacks of dollar bills replacing each individual dollar bill.
• One trillion dollars: Use the same 2.57 acres of land, but the stacks of one dollar bills would now be 333-feet tall.

This illustration is courtesy of the CGC Communicator
published by Robert F. Gonsett for California Broadcasters

Nothing is as true as Ben Franklin’s quote. We will all die, and the government will have its pound of flesh. Estate taxes involve the confluence of both.

The founding fathers instituted this tax because it inhibits the formation of American aristocracies.  If large estates are attenuated by taxes when generations change, then each generation is responsible for replenishing the family fortune – the desired result.  If estate taxes destroy family businesses and leave children of the wealthy without the resources to continue their life plan, it is not conserving the American dream.

Conservatives despise the “Death Tax” because it extracts its toll from those seen to be the producers of value in society. In the USA only the 2% of the wealthiest pay estate taxes. This tax effects the conservative constituency heavily because it drains the wealth that can be transferred from generation to generation.  Of course, there is no assurance that the beneficiaries of an estate will have the skills, drive and effectiveness of the person who generated the wealth.

The way estate taxes are levied today is troublesome because they are calculated upon the value of the estate, not on the amount received by each beneficiary. It doesn’t matter whether there are fifteen heirs or only one. It doesn’t matter whether the estate is composed of cash and stocks or the family business or farm. (upon which the beneficiaries may depend for their jobs).

As people live longer, there generations overlap more.  Lets take the case where Granddad built a business, and left it to his son at age 80. The son, 25 years younger at 55 dies two years later, leaving the business to the grandson of 30.  The tax hit from two rounds of estate taxes within two years is unsustainable.  If the business was a farm, the farm would be lost, if it was a factory, family control would be lost, and the grandson would be reduced to a simple employee.  Even with optimal estate planning, a family business worth $50 Million would be lost.

I suggest an alternative scheme for generational taxes.  This plan would protects family businesses and farms, assures a generous “stake” for the children of wealthy, and seems more rational.

First, make the proceeds of an estate taxable to the recipient, with an exemption.  If an individual dies with an estate of ten million dollars and has to split it between eight children, each getting a 1/8^th share it should not be taxed at the same rate as the same estate divided among two.  Under my system, each child in both cases would be assured of receiving a million dollars or so without taxation.  Under present rules the estate would be as heavily taxed in case of eight beneficiaries as when there are only two latter, meaning that each of the eight children would receive well less than a million dollars from the estate. Children and student recipients should have an increased exemption to cover costs of education.

Second, when the estate consists of productive assets (such as land, businesses, patents, copyrights, etc., but not publicly traded securities)  the taxes due on the net value of those assets would automatically be payable over time.  If the period were twenty years, for example, any well managed business can readily finance the tax under these terms.  If the property is sold, the outstanding amount becomes due.  If the person receiving the asset dies before the taxes are paid, the remaining taxes are forgiven.  The goal is that inheritance taxes on productive assets never compound when a generation is less than twenty years.

Reforming estate taxes into inheritance taxes makes a lot of sense.  Actuarially, it is easy to make this proposal “revenue neutral”.  It will resolve claims of unfairness that are the fodder for calls to abolish estate taxes entirely.  It will preserve family businesses and farms, yet still serve the founding father’s goal of averting American aristocracy.