A Citizens Guide to Initiative 920
Repealing the Estate Tax
2006-12
This Policy Note is a summary of A Citizen’s Guide to Initiative 920, published by Washington Policy Center and is available online at www.washingtonpolicy.org
In November, voters will again have the opportunity to repeal the Washington state estate tax by voting on Initiative 920. Initiative 920 would eliminate the state’s version of the estate tax—the federal estate tax would remain unchanged by the initiative.
The estate tax (sometimes referred to as the “death tax” by opponents) has been a politically sensitive issue since its permanent adoption by both the state and federal governments in the early 1900s.
An estate tax is a tax paid on the total value of a deceased person’s estate. This differs from the inheritance tax, which taxes the assets a living person receives through inheritance. It also differs from the transfer tax, which is a tax on gifts of wealth between living people and generation-skipping transfer taxes—a tax between grandchildren or more distant relatives.
Washington state’s first estate tax was implemented in 1901 and in the decades that followed, the various transfer taxes were added as well. There was little change in the estate tax system for most of the first 80 years of its existence.
In 1981, opponents of the estate tax filed Initiative 402. The initiative asked voters to repeal the inheritance and gift taxes to the amount the federal estate tax credit allowed. This meant that only estates liable for the federal estate tax would be subject to tax—the state government would basically receive a credit from the amount due to the federal government. This would not increase the tax liability of those who had to pay the estate tax, but would provide a cut of the federal revenue to the state government.
Voters approved Initiative 402 by a two to one margin, 67% to 33%. Initiative 402 repealed the inheritance tax and the gift tax. The generation-skipping tax and federal estate tax remained.
In 2001, the U.S. Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), which phases out the federal estate tax by the year 2010. It also phased out by 2005 the credit system set up between the individual states and the federal government. After 2005, states could no longer receive credit for the federal estate taxes paid.
The actions of the Congress led to problems of estate tax law in Washington state. Even after the federal government raised the base exemption and lowered tax rates, the Washington state Department of Revenue (DOR) continued to collect the estate tax based on the previous system and rules. Because of the way the law was written and the Department of Revenue’s interpretation, the DOR continued to collect the estate tax as if the Congress had not passed the EGTRRA.
In February 2005, the state Supreme Court unanimously ruled that the DOR should have complied with the EGTRRA and should have lowered tax rates and raised exemption levels in parallel to the federal levels. The Supreme Court ordered a refund be sent to estates that had been inaccurately taxed. The refund amounted to approximately $152 million.
Shortly after the estate tax ruling by the Supreme Court, the state legislature and the governor in 2005 enacted a “stand alone” state estate tax. This new estate tax was independent of the federal tax codes and resulted in a second estate tax upon decedent’s estates in Washington. The same legislation, however, permanently repealed the generation-skipping transfer tax.
A new twist to the newly enacted estate tax was how the revenue from the tax was to be spent. Previously, the estate tax revenue went directly to the state’s general fund and had done so for 100 years. The revenue from the new estate tax is deposited into the education legacy trust account. This account funds the Student Achievement Fund, which was created by the passage of Initiative 728 in November 2000.
According to state law, the education legacy trust account funds are to “be used for deposit into the student achievement fund and for expanding access to higher education through funding for new enrollments and financial aid, and other educational improvements.”
Supporters of the estate tax are quick to point out that the revenue from the estate tax funds smaller class sizes and educational opportunities. Herein lies one of the more controversial issues between the two campaigns, because supporters of the initiative are equally as quick to mention that the tie-in with education funding was implemented only last year. And before 2005, all tax revenue from estate taxes was deposited into the general fund.
The current estate tax includes exemptions so that any estate that falls below the exemption amount is not subject to the tax. When the new estate tax was first enacted, that exemption was $1.5 million. As of January 2006, the exemption was raised to $2 million. Tax rates depend on the size of the estate but range from 10% to 19%.
The impact of the estate tax on Washington citizens is another hot topic. According to Department of Revenue numbers, just over two hundred estates are subject to the tax in 2006, increasing slightly over time. However, the overall impact of the estate tax on the economy is difficult to judge.
A large body of research suggests that the indirect effect of an estate tax does affect entrepreneurial activity because regular income taxes have similar behavioral effects. Family-owned businesses and individuals take steps to avoid paying the estate tax and the costs of avoiding the tax. These strategies, along with the opportunity costs associated with less capital to re-invest in a business suggest that the estate tax does indeed have a negative impact on the economy.
As far as how big an impact the estate tax plays on state revenue collection, the Department of Revenue’s figures show that the estate tax makes up less than one percent of total state revenues.
This small percentage is also reflected on a national scale. The federal estate tax makes up less than one percent of all federal revenues per year.
The debate over the estate tax seems to be coming down to two main issues. First, can small and family-owned businesses financially survive the death of the principle owner? Many small business owners are concerned that the cost and fairness of taxing a death will harm the economy and hinder the expansion of free enterprise. Secondly, proponents of the estate tax argue that funding public education is the state’s paramount duty and that wealthy individuals should pay part of their estates in order to partially fund scholastic “improvements.”
For more information on the estate tax, see WPC’s “Citizen’s Guide to Initiative 920."