States Picking Up Where Death Tax Left Off

The government's so-called "death tax" may be on its way out the door, but don't look for the tax bite to completely disappear. States, wary of losing out on easy money, are stepping into the breach to make sure they don't lose their share.

After heavy prodding from President Bush, Congress last year agreed to phase out the estate tax (called "death tax" by its opponents) over the next 10 years. In 2010, it will be eliminated altogether for one year before it is re-instituted and opened once again to debate.

Estate taxes are paid by the inheritor of estates worth more than $1 million. Proponents say it is one of the fairest taxes on the book, affecting only the wealthy. Critics call it unfair, saying it penalizes property owners twice and leaves some inheritors with bills they cannot pay.

States currently collect a portion of the federal tax take each year. Now that it’s being phased out, states are scrambling to find another way to keep the gravy rolling in.

"States don’t want this tax to go away," said Iris Lav, deputy director of the Center for Budget and Policy Priorities in Washington, D.C., which estimates that states stand to lose $23 billion over the next five years.

Some states – like Virginia – already have provisions in their tax codes to ensure they will collect the same credit even when the federal rates go down.

Others are quickly separating themselves from the current sharing scheme with the feds so they can continue to collect the credit. At least 10 states are ready to collect the tax credit at the same rates or are moving in that direction.

"States are choosing to continue collecting the revenues because they’re facing a tight budget situation right now and the timing is extremely difficult," said Alysoun McLoughlin, a policy specialist with the National Conference of State Legislatures.

One taxpayer organization says the amount of money lost by the states is minor compared to the money taxpayers will save and will return to the states in other forms.

"This is probably the worst possible thing that the state could do for the economy as a whole," said Pete Sepp of the National Taxpayers Union. "States can talk all they want about losing revenue, but they are losing a lot more for their economy for keeping it (estate tax) around."

He said that taxpayers will have saved $139 billion from the phase-out of the federal death tax. Over the same period, the government will continue to collect $25.5 trillion from taxpayers. "You’re looking at a one-half of one percent savings as a result of the repeal," said Sepp.

Supporters of the death tax have long argued that because only millionaires pay it, it is fair. "It’s certainly the most progressive part of their (state) tax code," said Lav.

But Sepp said the richest pay good lawyers to help them avoid the tax, and smaller business owners that fall just over the $1 million line are the ones who get stuck with it. In some of those cases, inheritors are forced to liquidate businesses — and jobs — they might otherwise have maintained in order to pay the tax tab.

"This tax penalizes those who aren’t clever enough to avoid it," Sepp said.