TCS Daily

Death Tax Soon to Be Repealed in Hong Kong?

By Veronique de Rugy - March 7, 2005 12:00 AM

In 2001, President Bush signed a bold tax cut package known as the Economic Growth and Tax Relief Reconciliation Act of 2001. The good news is that the bill included the biggest tax cuts since Reagan. The bad news is that the tax cuts are not permanent. Some of the reforms are set to expire while others may not even take effect at all. One change that might not take place is the loudly advertised abolition of the estate tax -- also called the death tax.

The President's tax package designed a gradual repeal of the estate tax. According to the plan, the death tax exemption will increase each year until 2010 when it will be completely repealed. However, this repeal is temporary. For budgetary reasons, the President agreed to the sunset of his tax cuts after 2010. As a consequence, in 2011 the death tax is scheduled to be back almost at its pre-2001 level. So much for a repeal.

Once again, U.S. policy makers may want to learn from reforms in other nations. Hong Kong is actually in the mist of a major debate about its death tax system. Aware that a competitive global economy demands constant improvements, the Hong Kong government is considering whether to abolish permanently the misguided levy.

For several years now, Hong Kong has ranked as the world's freest economy. Not surprisingly, the territory also has one of the best tax systems in the world -- a simple and fair flat tax. But, Hong Kong is committed not to rest on its laurels. One of the weaknesses in Hong Kong's current system is its death tax. Hong Kong's death tax is rather mild compared to the United States and Western Europe. And it is modest compared to its competitors in Asia. Japan, Korea, and Taiwan for instance have estate tax rates of up to 50 percent while the territory's rates rage from 5 to 15 percent. However, even a modest death tax is bad tax policy because of the adverse impact on saving and investment.

Many experts have made pronouncements in favor of abolishing the tax. For instance, the accounting firm Ernst & Young has urged the government to scrap the death tax arguing that the levy is no longer relevant in the country's modern economy. The firm points out that among the 1,300 cases which attracted the tax during the past two years, only 300 resulted in the duty being paid, making the death tax very ineffective from a cost-benefit perspective.

In addition, even though under the current system, the tax is payable on all properties irrespective of nationality, residency, or domicile while most countries that impose the tax grant exemptions, it hardly raises any revenue. According to a Deloitte and Touche audit, the revenue from the tax only accounts for 0.7 percent of the government's revenue on average -- 4 percent of government capital revenue -- which is not worth the cost of a complicated and expensive collection process.

Tax policies that punish savings and investment are counterproductive. As such, the estate tax is one of the most destructive taxes. Because the estate tax falls on assets, it reduces incentives to save, invest, and build wealth. Economic theory teaches that capital formation is necessary to raise wages and stimulate long-term economic growth. Therefore, the death tax almost certainly suppresses growth. Also, like the income tax, the estate tax helps raise the tax rate on income from assets relative to income from working leading to an inefficient mix of capital and labor. Of course Hong Kong's lower rates mean fewer distortions than exist in the United States and other developed nations, yet the economy would be better off without any distortions at all.

Good tax policy also implies that people should not be taxed twice on their income. Because the death tax is imposed on taxpayers' assets at the time of their death and given that assets are usually purchased with after-tax income, the tax is clearly a form of double -- if not triple -- taxation. Moreover, its sheer complexity results in high compliance costs, avoidance, administrative, and enforcement costs -- as much as estate taxes raise, according to many scholars.

Moreover, the people clobbered by the death tax generally are not the billionaires. The "super-rich" rely on accountants and lawyers to put together comprehensive tax-planning strategies. The cost of the tax falls disproportionately on entrepreneurs with medium-sized estates, and is particularly harmful to families that own businesses or farms. Even though the amount of the tax is based on asset value, the tax must be paid out of income, making it doubly painful. This explains the apparent paradox that the richest people in the planet, including George Soros and Warren Buffet, repeatedly oppose the repeal of the death tax. These ultra-rich rarely have to pay for the tax as their families engaged a long time ago in effective estate tax planning to prevent the IRS from reaching into their graves.

Finally, one of biggest problems with the death tax is a moral one. According to a Cato Institute study, "the death tax rewards a 'die-broke' ethic, whereby the wealthy spend down their wealth on lavish consumption, and discourages economically and socially beneficial intergenerational savings." In other words, the death tax rewards unproductive consumption while it punishes parents who want to transmit some money to their kids in hopes that they will have a better start in life.

High compliance costs, bias toward unproductive consumption, along with distortions to economic activity, necessitate outright elimination of estate taxes. These findings are consistent with the global trend that the estate tax should be abolished. Australia, Canada, Malaysia, New Zealand, and Italy have scrapped their death tax. And according to experts, it might not take long before the Hong Kong government to decide to bury the death tax for good The United States should too.


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