Fiscal Cliff Deal Means States Will Lose Estate Tax Revenue
Shortly before the 112th Congress adjourned last week, members passed a sweeping deal to save the U.S. from hitting the fiscal cliff. Some of the revenue measures in the cliff deal may surprise state leaders, especially those with a focus on state estate taxes.
One of the more widely publicized outcomes of the fiscal cliff deal was a compromise over the estate tax. The deal raised federal tax rate on inheritance from 35 percent to 40 percent, with the first $5.25 million dollars exempted. Less publicized was the permanent elimination of an obscure federal tax credit that once generated billions for state budgets by siphoning off federal estate tax revenues.
Until 2001, all 50 states imposed estate taxes that were linked to a federal tax provision ominously called Credit for State Death Taxes. The credit allowed individuals to receive a federal tax credit for any state estate taxes paid up to 16 percent of the value of the estate. This allowed states to collect estate tax revenue without burdening their taxpayers. But when Congress passed the Bush tax cut in 2001, the credit was phased out. Since almost all states linked their estate taxes directly to the federal credit, states had to choose whether to let their own estate taxes fade away or enact new laws.
According to a study by Norton Francis at the Urban-Brookings Tax Policy Center, estate tax provisions in 25 states simply went dormant with the expiration of the federal law. Five other states formally repealed their estate tax laws. The remaining 20 states either created their own estate taxes delinked to federal credits or came up with a hybrid to reduce the impact of the revenue hit. Overall state revenue from estate taxes dropped from nearly $7.5 billion in 2001 to roughly $4 billion in 2010.
Had Congress not passed the cliff deal, the federal tax code would have reverted to its 2001 form with the Credit for State Death Taxes fully reinstated. The 25 states with dormant estate tax laws still on the books would have experienced a revenue windfall of nearly $3 billion. Buried within the 150 pages of legislative language in the cliff deal, however, is a provision permanently eliminating the credit.
A few states were counting on the return of estate revenue to provide a needed bump to their general funds. Those states will need to delink from the federal code if they want to collect estate tax revenue in the future. Most states, however, including those with dormant provisions left on the books, have paid little attention to estate taxes and were not counting on the revenue in their budget provisions. Enterprising legislators in these states, eager to clean up the state tax code and get credit for eliminating taxes without damaging the state bottom line, may begin looking to Arizona, Kansas and other states that have voted to repeal their estate taxes over the past few years.