Minnesota should abolish its estate tax

Taxes and incentives

In 1955, the Marquis de Maussabré was faced with a tax bill on his château in Airvault, near Poitiers in France. Rather than pay it, he took 150kg of dynamite and blew the place up.

Taxes alter incentives. Tax something and you get less of it. Indeed, this has been a key plank of public policy for centuries. When Peter the Great wanted fewer beards in late 17th century Russia, he taxed them. When Governor Mark Dayton wanted fewer cigarettes smoked in 21st century Minnesota, he taxed them.

Sometimes, however, tax policy fails to take incentives and people’s reactions into account. This failure also has a long history. In the 18th century, the British government wanted to tax people’s wealth and taxed their windows as a proxy. To the government’s surprise, people responded by bricking up their windows to reduce their liability. Likewise, the French government can hardly have been expecting the Marquis de Maussabré to blow his house up when they handed him his tax bill.

The key problem is inconsistency. The logic that is applied to Russian beards and Minnesotan cigarettes needs to be applied to British windows, French châteaus, and labor income as well. It should also be applied to estate taxation.

The estate tax

We apply this logic in our new report, The Cost of Minnesota’s Estate Tax

Minnesota taxes estates more heavily than most states. It is one of only fourteen states plus the District of Columbia to levy an estate tax. Eight of those fourteen states and the District of Columbia have a higher exemption. The state’s starting rate of estate taxation—12%—is higher than any of the other jurisdictions that levy one. Its top rate is 16%. Only the state of Washington has a higher top rate.

This gives individuals an incentive to take steps to lower or eliminate their liability. There are many legal avenues open to those who wish to do this. They can divest assets prior to death by sale or donation. They can also leave the state for a jurisdiction with a lower rate or no estate tax at all. This is very easy in the U.S. There is a wealth of evidence showing that all of these methods are utilized to lower estate tax burdens.

How much does Minnesota’s estate tax cost? 

But what is the impact in dollar terms of people leaving Minnesota to avoid the state’s heavy estate taxes? To know this we need to know 1) the revenue the tax brings in (the revenue effect) and 2) the revenue from other taxes lost when people leave (the incentive effect).

The first of these is straightforward. According to official data, Minnesota’s estate taxes brought in $183.2 million in revenue in 2016, 0.8% of the state’s total income.

But how about the second? Using survey evidence and official data, we are able to estimate the current and future value of income tax and sales & excise tax revenue the state of Minnesota loses when people leave to avoid the estate tax. In 2016, for example, we estimate that the state government lost $230.5 million in current and future revenues as a result of the incentive effect of the estate tax.

Ideally, taxes are levied at low rates on broad bases. Neither is the case with the estate tax in Minnesota. And, with the increase in the federal estate tax exemption in the recent tax bill, the incentive for Minnesotans to leave the state has grown. Policymakers in Saint Paul ought to be consistent from cigarettes to estates. The estate tax exemption should be raised to at least the new federal level. Better still, our state should follow other states in recent years and eliminate this inefficient and costly tax completely.

John Phelan is an economist at Center of the American Experiment.