A Model of the Estate Tax Len Burman Bill Gale Jeff Rohaly April 29, 2004 Presentation for

1. A Model of the Estate Tax Len Burman  Bill Gale Jeff Rohaly April 29, 2004 Presentation for AFET Steering Committee

2. 2001* $675,000 60% 2011 $1 million 60% Changes in Transfer Tax Exemptions and Rates Due to EGTRRA, 2002-2011 Highest Estate and Gift Tax Rates Calendar Year Estate and GST Tax Transfer Exemption 2002 $1 million 50% 2003 $1 million 49% 2004 $1.5 million 48% 2005 $1.5 million 47% 2006 $2 million 46% 2007 $2 million 45% 2008 $2 million 45% 2009 $ 3.5 million 45% 2010 N/A (taxes repealed) 35% (gift tax only) * Pre-EGTRRA law

3. Revenue and Returns

4. Need for a Distributional Model • Necessary for evaluating burden of whole tax system • Calculate winners and losers under reform options

5. Modeling Strategy • Pretend all owe estate tax • Use SCF data to impute wealth, liabilities onto tax model • Calibrate to match published estate tax tabulations • Assign average level of deductions, credits • Calculate estate tax liability (if any) for each record • Use mortality probability to calculate expected estate tax

6. Estate Tax Computation • Gross Estate = Assets - Liabilities • Taxable Estate = Gross Estate - Deductions • Calculate Tentative Tax • Tax = Tentative Tax - Credits

7. Assets Imputed • Cash • Tax-exempt bonds • Taxable bonds • Stock • Retirement assets • Life insurance • Other financial assets • Vehicles • Personal residences • Other real estate • Farm assets + land • Active business • Passive assets • Other nonfinancial assets

8. Liabilities • Mortgage and home equity line of credit • Real estate debt • Farm debt • Credit card balances • All other debt

9. # dependents age brackets income taxable interest tax-ex interest dividends farm + business income rental income pension capital gains negative income zero dummies itemize schedule dummies Explanatory Vars

10. From NW to Estate • Randomly assign deductions • Married people--tax is optional • 80% don’t pay • assign average marital deduction to others • Assume maximum death tax credit

11. Modeling QFOBI • 1/5 of potential eligibles take it • We assign QFOBI randomly • Other strategies? • P(QFOBI) depends on expected gain

12. Two Measures of Income • Cash Income • AGI plus items excluded from income such as pensions, IRAs, health insurance, and transfers • Economic Income • Assumes imputed return to capital • Adjusted for family size

13. Economic Income is Better Measure • Many people with low or even negative realized income are extremely wealthy • Economic income says that if you have $10 million of stock, you are high income, even if you sell none of it and have business losses • But cash income is easier to explain to noneconomists

14. Distribution of Estate Tax by Cash Income, 2001

15. Distribution of Estate Tax by Economic Income, 2001

16. Distribution of Estate Vs. Income Tax, 2001

17. Distribution of Estate Tax by Amount Paid, 2001

18. Small Farms and Businesses, 2001

19. All Farms and Businesses, 2001

20. Revenue Options, All Sunset 2010

21. Permanent Revenue Options vs. Current Law10-Year Revenue Change

22. Permanent Options v. Permanent Baseline10-Year Estate Tax Gain

23. Option 1: Distribution of Estate Tax, 2004

24. Taxable Farms and Businesses by Size of Exemption, 2004