Perverse Government Incentives

In 2001, President Bush decided to lower the estate tax as part of his tax cuts and stimulus after 9/11. The death tax, as some call it, is a tax on people’s estates valued over a certain amount. In 2001, the limit was $675,000 and anything over that amount was taxed at 55%. The Bush Administration’s plan was to phase out the estate tax by 2010 by both raising the amount that was protected and lowering the tax rate. The yearly table from wikipedia shows that 2009 estate tax limits are $3.5m in assets, above which anything will be taxed at 45%.

In 2010, the estate tax is completely repealed. The Bush Administration’s plan ends in 2010, meaning that in 2011, the estate tax will go back to $1m and 55%, unless Congress passes another bill to change it, which is doubtful with this economy and the Democrats in power. Whether you think the estate tax is a good idea or not, the current situation sets up some perverse incentives that could save or cost people millions.

Imagine a person with a father who has $10m in assets who is sickly and may die in 2009. If the father were to die in 2009, $6.5m of the money would be taxed at 45%, or close to $3m, but if the father were to live until Jan 1, 2010, the person would save all of that money. The government’s monetary incentive is to keep older, sick people alive, even if it against the person’s best interest. The father might even try to hold on longer than he normally would, just to save the extra money.

Now fast forward to December 2010. The same person from the example above would not have to pay any taxes if their father were to die before the end of the year. If the father were to live until 2011, $9m of the $10m estate would be taxed at 55% or almost $5m. People would have the incentive to make sure that their parents died before the tax rate changed. Now imagine super rich people who have billions. The difference is real money.

Now I don’t think that most people will be influenced by these incentives, as most people care more about their family than money, but I can see situations where someone might (Mom, if you read this, don’t worry!). The estate tax changes are just another example of government policies creating unintended incentives and consequences. Hopefully nobody tries to “take advantage” of these changes.