The Death Tax

Impact on Investment, Employment, and Entrepreneurs

This Special Report is excerpted from a study prepared for the Center, “The Death Tax: Investments, Employment, and Entrepreneurs.”


Over the past 25 years, the ACCF Center for Policy Research has sponsored groundbreaking research on tax policies to encourage capital formation and economic growth. As the U.S. Congress and the Administration prepare to debate the Taxpayer Relief and Refund Act of 1999 (which includes a phased-in death tax repeal), the Center offers this Special Report to focus the discussion and explore the economic impact of the death tax.

Professor Holtz-Eakin’s study observes that there are large and important behavioral responses to the estate tax. It also suggests that the estate tax disproportionately affects a scarce economic resource: entrepreneurs. His analysis of the empirical evidence indicates that the estate tax imposes a significant deadweight cost on the economy, fails to raise sufficient revenue to be considered a tool for income-distribution goals, and engenders considerable administrative and compliance costs. In short, the evidence suggests that the estate tax should be eliminated from the Federal revenue system.


The U.S. estate tax (sometimes referred to as the death tax) is simply a wealth tax assessed on the value of wealth at death. As discussed further below, the estate tax is sometimes characterized as a tax on transfers. However, the tax base is wealth itself and it is easiest to evaluate the tax in this way.

Although the history of the estate tax in the United States dates to over 200 years ago, the current features of the tax were put in place by the Tax Reform Act of 1976. Since that time, the United States has employed three taxes-the estate tax, the gift tax, and the generation skipping transfer tax (GSTT)-which comprise the Unified Transfer Tax. The logic of the tax system is straightforward. The value of the estate is taxed at increasing marginal tax rates ranging from 18 percent (for a taxable estate of zero to $10,000) to 55 percent (for a taxable estate value of $3 million or more).1 An important feature of the tax, however, is the “unified credit.” In effect, this provides a credit against the tax liability associated with the first $650,000 of taxable estate. This has two effects: the first $650,000 of estate is exempt from tax and the effective marginal tax rate schedule begins at 37 percent. Because all interspousal transfers are exempt from tax, each spouse, in effect, takes the unified credit in succession, leading to a total exemption of $1.3 million of estate value.

While the tax raises little revenue (in 1999 it is projected to generate about $24 billion from the 49,200 estates that are subject to the tax2 ), it generates considerable criticism. Proponents of the tax argue that it is too easy to avoid and insufficiently aggressive in redistributing resources, while critics highlight its sizeable marginal tax rates, economic distortions, and potentially perverse distributional consequences.3 In short, the debate suggests little satisfaction with the status quo. The time is ripe for a reassessment of the estate tax.

Evaluating the Estate Tax

Impact on Return to Savings

The estate tax is a tax on capital accumulation, with the tax base as the individual’s accumulated wealth (after appropriate deductions and exemptions). Accordingly, the greater the individual’s accumulation, the larger the tax liability. By implication, the estate tax lowers the return to saving. An individual who starts with $25,000 and earns an average return of 15 percent over 30 years will accumulate in excess of $1.6 million. A simple 50 percent estate tax reduces the net accumulation to just over $800,000, which is equivalent to lowering the annual return to 12.4 percent. For this reason, the impact of the estate tax is conceptually similar to the impact of all taxes levied on capital income. In this example, it is tantamount to an additional tax of just under 20 percent on the annual return to capital.

Impact on Investment

Taxes on the return to capital make capital markets less efficient (and thus slow investment spending) by placing a “wedge” between the return offered by profitable business opportunities and the return received by suppliers of funds. To continue the example, if the return to capital is taxed at a rate of 33 percent, firms may offer a 15 percent return, but suppliers of funds will receiveonly a 10 percent return after tax. The presence of the capital income tax interferes with the smooth matching of saving and investment.

Another way to view the cost of capital income taxes such as the estate tax is that it forces firms to use a higher internal hurdle rate (15 percent instead of 10 percent) in order to meet the market rate of return. Accordingly, it forces firms to pass up otherwise profitable investments-i.e., the tax reduces the accumulation of business assets of all types.

Sole proprietors and other entrepreneurs are especially exposed to the effects of the estate tax. Moreover, a pair of recent papers (Carroll, Holtz-Eakin, Rider, and Rosen [forthcoming], and Carroll, Holtz-Eakin, Rider, and Rosen [1997], referred to below as CHRR) indicate that sole proprietors are unusually sensitive to the personal tax situations when making their businessdecisions.

Consider first the decision of an entrepreneur to employ others in the business. CHRR find that there are large and statistically significant impacts of personal taxes on the employment decision. Specifically, they find that for sole proprietors, the elasticity of the probability of having a wage bill (i.e., having some employees at all) with respect to the “tax price” (one minus the tax rate) is 1.21, indicating a substantial response to taxation in making employment decisions. In the same way, for those sole proprietors who already have employees in place, the corresponding elasticity of the total wage bill with respect to the tax price is 0.37.

What does this imply for the estate tax? An analysis by Massachusetts Institute of Technology Professor James Poterba (1997) estimated that the estate tax raises the tax rate on capital income by 0.3 percentage points, although for older individuals the effect could be as large as 3 percentage points. As an illustration, consider an entrepreneur in the 50 percent income tax bracket. For this person, a 1 percentage point increase in the tax rate due to the estate tax constitutes a 2 (=.01/.5) percent decrease in the tax price. Using the CHRR estimates, there are two effects. First, the increase in the tax rate implies a 2.42 percent decrease in the probability of doing any hiring at all. That is, the existence of the estate tax reduces the fraction of sole proprietors who expand by over 2 percent. At the same time, it signals a 0.74 percent decrease in the wage bill of sole proprietors that already have employees. The latter effect could take the form of either lower (than otherwise) wages for current employees or a diminished number of new employees. In short, taken together, the estate tax is tantamount to an annual 3 percent reduction in desired hiring by sole proprietors. Since sole proprietors are only one portion of the small business community, one can only speculate on the overall impact.

Turning to the demand for business investment, CHRR find that a 5 percentage point increase in tax rates lowers investment by sole proprietors by 9.9 percent. Again, one can translate the estate tax into these terms by using Professor Poterba’s range of impacts for the estate tax. For illustration, using the range of 1 percent to 3 percent as the estate-tax-equivalent income tax rate suggests that the estate tax lowers annual investment by about 2 percent to 6 percent. To give a sense of the magnitudes involved, in 1997 there was roughly $125.1 billion in investment by sole proprietors, suggesting a decline of between $2.5 billion and $7.5 billion in this narrow category of small business alone.

Impact on Wages

These results suggest a substantial response. That is, the mere presence of the estate tax later in life distorts current business decisions (fewer employees; less capital). These shifts are the heart of a critique of the distortions introduced by the estate tax.

At the same time, they also have an impact on the perceived fairness of the estate tax. Although the total dollars collected by the estate tax are not substantial enough to have a tangible effect on the income distribution, the estimated responses imply that estate tax is shifted-forward in time to the business operation and onto factors of production (capital and labor). Most economists concur that, regardless of who sends in the tax payment, the true cost of labor taxes is born by employees in the form of lower wages. Similarly, the impact of taxes on capital also gets shifted to labor through slower capital accumulation that hurts productivity and real wage growth. In this way, these responses suggest that the estate tax is borne at least in part by workers.

Impact on Employment

The estate tax’s impact on labor and entrepreneurs is documented in new research regarding the estate tax and employment growth in family-owned businesses. The research is based on the data collected in a mail survey sent to businesses in upstate New York and collected during March and April of 1999.4 The survey includes the responses of a large number of family-owned businesses with a small number of employees, as well as a relative few comparatively larger family-owned and -operated businesses in upstate New York. As a result of the variation in the survey (both large and small firms; both family-owned and publicly traded firms), it is possible to investigate the specific effects of the estate tax, which is likely to apply only to those family-owed firms of sufficient size.

The results are summarized in Tables 1, 2, and 3 which show, respectively, the distribution of firms by employment size, regression results regarding the growth rate of employment over the past five years, and regression results regarding the anticipated growth of employment over the next five years (each measured as a percent of current employment). Focus for a moment on Tables 2 and 3, which examine directly the relationship between past employment growth and planned future growth and the estate tax. In each of the analyses, the explanatory variables are Estate Tax (=1 if market value exceeds $650,000 and business is family-owned) indicating that the firm’s owner will be liable for an estate tax, Family Owned (=1 if family owned), and Size of Firm (=number of employees). To examine the robustness of the results, each table also shows variables including Female Head (business headed by a female), and Minority Head (business headed by minority).

Table 1 Distribution of Firm Sizes in Survey
All Firms Family-Owned Firms
Employees Number Percentage Number Percentage
Less than 20 177 39.9 145 40.1
20 to 100 162 36.5 133 36.7
100 to 500 84 18.9 72 19.9
Over 500 21 4.7 12 3.3
Total 444 100.0 362 100.0


Table 2 The Estate Tax and Past Employment Growth
1 2 3 4
Estate tax -2.32 -1.88 -3.34 -2.87
(1.01) (1.04) (1.24) (1.28)
Family-owned 2.48 2.11 3.48 3.13
(1.25) (1.26) (1.51) (1.52)
Size of firm 0.0199 0.0364 0.0228 0.0392
(0.204) (0.203) (0.231) (0.230)
Female head 2.61 2.80
(1.12) (1.26)
Minority head -0.651 -0.992
(1.55) (1.74)
Constant 0.280 0.00754 0.339 0.00749
(0.858) (0.875) (0.995) (1.02)
Number of firms 417 417 365 365
Notes: Standard errors shown in parentheses. Columns (1) and (2) use entire sample; columns (3) and (4) restricted to those firms with non-zero growth.


Table 3 The Estate Tax and Planned Employment Growth
1 2 3 4
Estate tax -4.87 -4.01 -6.01 -5.83
(1.54) (1.60) (1.73) (1.95)
Family-owned 4.92 4.34 6.05 6.18
(1.91) (1.93) (2.10) (2.31)
Size of firm -0.0126 0.0123 0.0135 0.0108
(0.329) (0.329) (0.339) (0.348)
Female head 2.47 2.51
(1.65) (1.84)
Minority head 3.38 -3.19
(2.43) (2.71)
Constant 0.421 -0.192 0.447 -0.202
(1.31) (1.34) (1.39) (1.52)
Number of firms 407 407 361 361
Notes: Standard errors shown in parentheses. Columns (1) and (2) use entire sample; columns (3) and (4) restricted to those firms with non-zero growth.


The regressions in Tables 2 and 3 uniformly show a strong negative relationship between anticipated liability for an estate tax and the growth of employment. The results hold even more strongly for those firms that are growing (i.e., discarding the zeros).5 Specifically, consider the entry of -2.32 in the first row and column of Table 2. The entry indicates a large negative relationship between the number of jobs created in the past five years (as a percentage of employment) and future liability for the estate tax. Moreover, the impact is nearly large enough to offset the faster growth displayed by family-owned firms (2.48), other things being equal. (In both cases, the precision of the estimated coefficients-as measured by the standard error-is sufficiently high to place considerable confidence in estimates.)

This finding is not limited to just the specification and sample in column 1, or even to past employment growth. Instead, the finding appears robust to changes in both the sample and the specification of the regression model. Using the survey data, but alternative techniques, PPINYS (1999) estimates a loss of 15,000 jobs in the state of New York alone over five years due to the estate tax.

Likewise, an examination of Table 3 indicates that there is similar strong negative relationship between the estate tax and planned (percentage) growth over the next five years. While one might place greater confidence in the relationship between past growth and estate taxes (because one might believe more what firms do than what they say they will do), the overall pattern is quite strong.

Another empirical analysis utilizing data on almost 14,000 households from the Health and Retirement Study (HRS; Juster and Suzman 1995) and the Asset and Health Dynamics Among the Oldest Old Survey (AHEAD; Soldo et al. 1997) also shows that the estate tax reduces the amount of labor supplied by older workers. The analysis shows that 5.2 million workers chose not to work at a cost of $106 billion in GDP in 1998.

Impact on Entrepreneurs

The final piece of new evidence regarding the estate tax is based on the combined HRS/AHEAD sample and focuses on the role of entrepreneurs in the estate tax. Specifically, defining an entrepreneur as anyone with at least $5,000 of business assets, one finds that the estate tax has a disproportionate impact on entrepreneurs as opposed to rich portfolio investors.

To begin, entrepreneurs constitute only 8 percent of the total (weighted) sample. Nevertheless, they hold $2.4 billion out of the total (weighted) net worth of $9.9 billion in the sample, or roughly 25 percent. Thus, they are much more exposed to the taxation of wealth accumulation. Put differently, entrepreneurs are three times more likely to be subject to the estate tax than are simple portfolio investors. Or, turning to another perspective, of those liable for the estate tax, 48 percent are entrepreneurs, compared with only 6 percent among those not liable for the estate tax. In short, the estate tax is more likely to tax entrepreneurs and, in doing so, to tax asset accumulation and risk-taking in the economy.

What is the bottom line? To date, the literature contains little empirical evidence directly linking the estate tax with actual business practice. Although this analysis is of only one survey, it represents a step toward buttressing the large, anecdotal literature on the detrimental impact of the estate tax with the type of solid statistical evidence available for other tax policies. Viewed in isolation, they suggest large behavioral effects from the estate tax. Taken in conjunction with the related evidence (above) they begin to build a case for large distortions from the estate tax.

Critique of Recent Death Tax Studies

Two recent studies of the estate tax by Gale and Perozek (1999; GP) and Davenport and Soled (1999; DS) reach far different conclusions about the impact of the tax than the preceding summary.

What leads to the different bottom line? First, GP focus their analysis on motives for transfers and, effectively, give each motive equal standing in their analysis. But the empirical evidence suggests a more-than-equal role for altruistic intergenerational links such as those evidenced by family businesses. Second, GP are concerned exclusively with the effect of the estate tax on the level of saving, a narrower criteria than the standard approach used here that incorporates the full range of economic decisions and tax-related costs. Finally, their focus on saving does not permit analysis of affected business decisions or cost-of-capital effects in general.

DS, in contrast, adopt a seemingly naive assessment of the current estate tax. First, they argue that it is a valuable tool for purposes of income and wealth redistribution, despite the fact that it raises a minuscule amount of revenue. Moreover, no consideration is apparently given to the very real evidence that the estate tax is shifted, at least in part, onto capital (including the pensions of “poor” people) and labor. In similar spirit, the assessment of the costs of the estate tax by DS argues that the only relevant costs are administrative and compliance costs, and that these are small. This misses the most important cost: the distortion imposed on decisions regarding saving, investment, portfolios, business organizational form, labor supply, etc. There is a substantial literature documenting the importance of these costs for other taxes. As a matter of simple introspection they cannot be dismissed for the estate tax, and the discussion above suggests that these distortions may be quite large for the estate tax. Finally, DS argue that estate taxes affect only a small part of the population. But this is very misleading, as estate taxes disproportionately affect entrepreneurs.


The new data presented here suggest that the estate tax is shifted-forward in time to the business operation and onto factors of production (capital and labor). Since most studies suggest that the labor supply bears the incidence of labor taxes and that slower capital accumulation hurts productivity and real wages, this suggests that the estate tax on “rich and dead” small business owners and entrepreneurs may be in part paid by their far-from-rich and very alive employees.


  1. Because the “benefits” of the initial, lower tax rates are phased out, the effective marginal tax rate reaches a maximum of 60 percent.
  2. See Joint Committee on Taxation (1998). Indeed, Bernheim (1987) suggests that the tax is actually a net revenue loser because of the interaction with the charitable deduction of the individual income tax.
  3. McCaffery (1994) is an especially prominent critic.
  4. See “Survey on the Impact of the Federal Estate Tax on Family Business Employment Levels in Upstate New York,” Public Policy Institute of New York State, June 1999.
  5. Although not especially numerous, the presence of zero values for the dependent variable might lead one toward a Tobit estimator. Doing so leaves the basic message of the data unaltered.


  • Bernheim, Douglas. 1987. Does the Estate Tax Raise Revenue? In Tax Policy and the Economy, ed. Lawrence Summers. Cambridge, Mass.: MIT Press, 1:113-138.
  • Carroll, Robert, Douglas Holtz-Eakin, Mark Rider, and Harvey S. Rosen. Forthcoming. Income Taxes and Entrepreneurs’ Use of Labor. Journal of Labor Economics.
  • Carroll, Robert, Douglas Holtz-Eakin, Mark Rider, and Harvey S. Rosen. 1997. Entrepreneurs, Income Taxes, and Investment. Paper presented at conference, Does Atlas Shrug? The Economic Consequences of Taxing the Rich, 24-25 October 1997, at Office of Tax Policy Research, University of Michigan Business School, Ann Arbor, Mich.
  • Gale, William and Maria Perozek. 1999. Do Estate Taxes Reduce Saving? Brookings Institution, Washington, D.C. Mimeo. April.
  • Davenport, Charles and Jay A. Soled. 1999. Enlivening the Death-Tax Death-Talk. Tax Notes 26 July: 591.
  • Joint Committee on Taxation, U.S. Congress. 1998. Present Law and Background Relating to Estate and Gift Taxes. 105th Congress, 2d session. 27 January.
  • Juster, F. Thomas and Richard Suzman. 1995. An Overview of the Health and Retirement Study. Journal of Human Resources 30: S7-S56.
  • McCaffery, Edward J. 1994. The Uneasy Case for Wealth Transfer Taxation.Yale Law Journal 104(2).
  • Poterba, James. 1997. The Estate Tax and After-Tax Investment. NBER Working Paper No. 6337. Cambridge, Mass.: National Bureau of Economic Research. December.
  • Public Policy Institute of New York State (PPINYS). 1999. Survey of the Impact of the Federal Estate Tax on Family Business Employment Levels in Upstate New York. Prepared by Travis Research Associates, Inc.
  • Soldo, Beth J., Michael D. Hurd, Willard L. Rodgers, and Robert B. Wallace. 1997. Asset and Health Dynamics Among the Oldest Old: An Overview of the AHEAD Study. The Journals of Gerontology Series B: Psychological and Social Sciences 52B: S1-S20.