Bacon's Rebellion

James A. Bacon



 

Think first, veto later

Do the Math

 

Defenders of Virginia’s death tax say repeal would cost the state tens of millions of dollars. But their revenue analysis ignores the real-world behavior of rich people.


 

Life is unfair. Rich people have lots of options that their poor and middle-class brethren do not, especially when it comes to paying taxes.

 

Unlike most of us schmucks, who have limited choices about how and where we make our money, rich people can move their capital to wherever it gets treated best. While the schmucks get headaches deciphering IRS forms at tax time, rich people hire tax lawyers and estate planners to guide them. While the schmucks count themselves lucky to rent a beach house a couple weeks a year, rich people can afford to buy second houses in Florida, set up official residence there, and shuttle back and forth to Virginia whenever it suits them.

 

On a gut level, I can sympathize with Gov. Mark R. Warner as he ponders this month whether or not to veto a bill that would eliminate the death tax on rich peoples’ estates. As the governor has argued, the tax break would benefit Virginia’s richest citizens at the very time that a fiscally strapped state government was raising fees and cutting services for everyone else.

 

Why should the state lavish tax breaks upon some rich guy’s heirs while ordinary, hard-working Virginians (like me) get stuck with higher college tuitions for their heirs (yes, I have a daughter in UVa) not to mention higher “fees” for everything from a new drivers license to a fifth of tequila at the ABC store?

 

But, as a card-carrying rich guy himself, Gov. Warner should know better. With an estimated net worth of $200 million, he knows full well the perks available to the rich. The governor knows, or he should know, that payment of Virginia’s tax on estates will be largely discretionary because rich people can easily transfer residence to a more tax-friendly state -- in other words, that no rich person who wants to avoid the tax will actually pay it.

 

Yeah, life is unfair. But as an old boss frequently reminded me, “It is what it is.” Gov. Warner can strike a rhetorical blow for “fairness” by vetoing the death-tax repeal. But it won’t make the reality of life any fairer. A veto won’t keep rich people from avoiding the tax by the simple expedient of changing domiciles. To the contrary, a veto would actually encourage rich people to leave Virginia in favor of friendlier tax climes.

 

Far from plugging a revenue hole in Virginia’s budget, a veto might well blow a bigger hole in Virginia’s budget. News flash: Rich people pay income taxes. When they move their official residences to Florida to avoid paying estate taxes when they die, they stop paying income taxes to Virginia while they’re still alive.

 

In sum, vetoing the death tax repeal will set into motion an entirely foreseeable chain of events: (1) To avoid paying the tax, many rich people will transfer their residences to Florida or some other tax-friendly state; (2) they will stop paying Virginia income taxes while they’re alive; (3) they won’t pay Virginia’s estate tax when they’re dead; (4) Virginia could wind up losing revenue; and (5) the General Assembly will make up the difference by imposing more “fees” on schmucks like me.

 

As much as I’m jealous of rich people, I’d rather keep them here in Virginia than chase them away. I’d rather have them pay their income taxes to Virginia, donate to Virginia philanthropies, contribute their time to Virginia civic causes and, most significantly, invest their time and energy in business enterprises that will stimulate Virginia’s economy. That would help me.

 

Before the U.S. Congress passed its latest round of tax cuts, the state death tax was not a significant issue for Virginia taxpayers. The Old Dominion levied a tax of up to 16 percent on larger estates, but the sum was credited dollar-for-dollar toward payment of the federal tax. Thus, the total estate tax payment remained the same: The tax burden in Virginia was no more onerous than it was in any other state.

 

The logic of estate planning changed dramatically, however, when Congress enacted a phase-out of the federal inheritance tax. Suddenly, estate taxes at the state level really mattered. Not wanting to create a hostile tax climate for wealthy people, many states repealed their estate taxes. However, Maryland, Washington, D.C. and a number of other states did not.

 

In Virginia, the General Assembly passed a bill this session eliminating the tax here as well, seemingly with a bipartisan, veto-proof majority. But Gov. Warner has expressed strong reservations. He put it this way in his wrap-up of the 2003 session: “At a time when we’re asking young people to pay hundreds of dollars more in tuition ... when the poor and elderly are having important social services curtailed ... when we are reducing the hours at parks, museums, DMVs and other state facilities ... and at a time when we have failed to complete car tax relief or food tax relief, the General Assembly has elected to give a new tax break to the wealthiest Virginians.”

 

Commentators like my Bacon’s Rebellion colleague Paul Goldman (See “Teaching the Facts of Life” and “The Moment of Truth”) have raised a number of valid points. Repealing the death tax will benefit only a handful of wealthy families each year. The state treasury will be drained of funds that it had been getting before the federal legislation passed. Indeed, opponents have raised enough concerns that a number of Democratic legislators may recant their support for the repeal, giving Gov. Warner enough votes to sustain a veto.

 

However, absent from the analysis of death tax supporters analysis is a recognition that protecting the Virginia death tax amounts to a purely symbolic gesture: A veto sticks it to rich people without doing a lick of good for poor people -- or even shoring up the state’s budget.

 

Estate-tax advocates suppose that the state tax is like the federal tax in that there’s not much that people – even rich people – can do to avoid it. But that assumption is dead wrong.

 

The state tax is much easier to duck than the federal tax, says estate planning expert Ronald D. Aucutt. To avoid Uncle Sam, you have to move out of the country and relinquish your citizenship. To escape state state taxes, you only have to move to a different state. A partner in McGuireWoods’ McLean law office, Aucutt knows what he’s talking about. He was inducted just this weekend as president of the American College of Trust and Estate Counsel. He’s also testified on behalf of Virginians for Death Tax Repeal.

 

“If a U.S. citizen moves outside the country,” Aucutt says, “he hasn’t accomplished anything. He has to relinquish his citizenship” – something most Americans are reluctant to do. Even then, U.S. law treats them as taxable for 10 more years, and if they have children, grandchildren or other beneficiaries remaining in the country, the Internal Revenue Service has ways of getting any money intended for them.

 

The barriers are much lower against re-domiciling from one state to another. In Virginia, many wealthy people already maintain dual residences – one in their home town and one in Florida – to take advantage of the Sunshine State’s lower income taxes. To pass muster with tax authorities, someone has to demonstrate that they really have changed their residence. Maintaining a Florida address is a must, preferably for half the year or more. It also helps to show a Florida auto registration, driver’s license, voting registration, club and church memberships.

 

Plenty of people are eager to help walk you through the process, says Aucutt, who held up a handbook, So, You Want to be a Florida Resident, when he testified before the House and Senate Finance committees.

 

Aucutt, who started his practice in 1975, knows first-hand that people do change residences based on tax considerations. In 1978, Virginia altered its inheritance tax in a way that treated wealthy estate more favorably than in Maryland or Washington, D.C. “People moved from D.C. and Maryland to Virginia just for this reason.”

 

If Virginia does repeal its death tax, Aucutt says, he expects a replay of that scenario. Once again, Virginia would offer significant tax advantages over D.C. and Maryland. He would expect wealthy residents across the Potomac to move to the tonier neighborhoods of Northern Virginia – Arlington, McLean, Great Falls -- in order exploit favorable Virginia’s tax status. The move would far less disruptive than, say, moving to Florida: People could maintain the same friends, the same business contacts, the same club memberships, even the same civic memberships.

 

Any loss of estate tax revenues from the repeal of the death tax would be offset in part by an increase in income tax revenues from wealthy people moving to Virginia. Rich people relocating to Virginia also will spend more of their money here, generating more sales tax as well. They might even invest more of their money in Virginia, too, stimulating the economy.

 

Conversely, if Gov. Warner vetoes the repeal, the state won't generate nearly as much revenue as anticipated. Based on 2001 tax filings, Virginia’s tax on estates yielded about $130 million in revenue. If the new federal law, with its higher exemptions, had applied back then, the tax take would have been closer to $70 million, according to Virginians for Death Tax Repeal. So, the state will lose some $60 million in revenue no matter what.

 

But the governor will be unpleasantly surprised if he’s counting on even that $70 million. Much of that sum will never materialize because rich Virginians, many of whom already own real estate in Florida, will transfer their legal residences there. Furthermore, when they leave, they'll take their income tax with them.

 

So, how do the numbers shake out? Let's use Gov. Warner as an example. Virginia Business magazine estimates his net worth at $200 million. When the governor dies -- hopefully not for another four or five decades -- the state would reap 16 percent, or about $32 million, on his estate

 

Now, for purposes of comparison, let's assume that Warner's estate, which is held in blind trust, generates a modest 8 percent annual return, or about $16 million in annual income. Unless the assets are invested in tax-free bonds or other tax shelters, that income would generate about $900,000 a year in state taxes -- not just for one year, but every year until he dies.

 

Whether it's more advantageous for the state to tax Mark Warner's estate or his income depends on what kind of actuarial assumptions we make about him. If we take the present value of money into account, Virginia would be better off taxing his income if he lives some 14 to 15 years or more.

 

Mark Warner, a loyal Virginian, may never leave the state for tax reasons. Furthermore, most people don't re-domicile until later in life, usually when they have reached retirement or pre-retirement and estate planning weighs more heavily on their minds. But once a successful entrepreneur or business executive reaches a phase of life where he (or she) is no longer tied to Virginia by a job or business, estate-planning considerations do enter into their decisions of where to live. 

 

Unfortunately, we don't know how many Virginians would re-domicile to a more tax-friendly state if Gov. Warner vetoes the death tax repeal, much less how much income tax the state would lose upon their departure. Perhaps the Virginia Department of Taxation could hazard an informed guess. Whatever the final tally, it would be the height of fiscal negligence to project tens of millions of estate-tax revenues in the years ahead without adjusting for the real-world, tax-avoidance behavior of the people to be taxed.

 

Remember, life is unfair. Rich people don't like paying taxes any more than poor people do, and they have a lot more options. Repealing the death tax keeps them here in Virginia where they can contribute far more alive -- through philanthropy, business investment and state taxes -- than when they die.

 

-- March 10, 2003

 

Bring Home the Bacon

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