Faced with taxpayer flight from New York State, the tax collectors have begun to back off. New York State’s tax commissioner, James Wetzler, announced in February that he was reining in his auditors, who have overzealously pursued out-of-state taxpayers in an effort to prove that they are residents who owe high state taxes. To avoid being considered residents, according to a New York Times report, “many people have closed bank and brokerage accounts; sold businesses in the state; stopped using New York professionals like accountants, doctors, and dentists; stopped giving to New York charities and politicians; limited trips to New York; and even avoided taking vacations in the state.” Wetzler realized that the incentives to avoid visiting or doing business in New York were doing more harm than good to the state’s economy and tax revenues.

Legislators in Albany should take a cue from Wetzler and eliminate another tax that is driving people from New York: the estate tax, the highest in the nation.

Passing on an estate is an expensive proposition anywhere in the United States. The Federal Government levies a heavy estate tax with a top rate of 50 percent. But federal law allows a taxpayer to take a credit for a portion of a state death tax. This credit amounts to $12,400 on a taxable estate of $500,000 and almost $400,000 on an estate of $5 million. Most states impose an estate or inheritance tax equal to the federal credit. (The distinction is that estate taxes are imposed on the entire estate before it is distributed to the heirs, while inheritance taxes are paid after the fact by the individual inheritors.) Residents of those states end up paying no more than the federal tax, with the federal credit “picked up” by the state.

New York State, however, imposes a tax that amounts to $20,000 on a $500,000 estate$7,600 more than the federal credit. On a $5 million estate, New York’s levy grows to roughly $145,000 above the federal credit. New York’s top marginal estate tax rate is 21 percent, while the maximum federal credit is 16 percent. For estates left to one’s own children, this rate is higher than that of any other state; for other bequests, New York’s top rate ranks behind only those of Montana and South Dakota. New York, moreover, is one of only six states to impose a gift tax.

The estate and gift taxes provide substantial revenues for the state-some $700 million in fiscal 1993. But they also put New York at a competitive disadvantage in its efforts to stimulate growth of the small and medium-sized businesses that are increasingly vital to the economy.

“People are leaving the state to avoid the ’extra’ New York State tax in excess of the federal credit for state death tax,” according to a 1987 report by the Trusts and Estates Law section of the New York State Bar Association. When a business moves, Albany forgoes income and other taxes, as well as its share of the estate tax when the owner dies.

Moving out of state is not a viable option for all businesses. But even when a firm cannot move, the cost of estate taxes saps the financial strength it needs to survive its owner’s death. Few $5 million businesses, for example, are so flush that they can easily absorb New York’s additional tax bill of $145,000. Often, much of a company’s net worth consists of assets that cannot be sold to pay off taxes without destroying the enterprise itself: buildings, equipment, and intangibles such as a good reputation. That means the tax payment typically must come out of payroll, growth capital, and other essentials.

Ironically, many people believe that estate taxes only take money from the “idle rich” and make it available to the less fortunate. But when a company is caught between estate tax bills and a tight cash flow, its inheritors may find that the easiest course is simply to close shop. Thus, high estate taxes actually encourage the heirs to a family firm to adopt a life of idleness by selling the business, investing the proceeds, and living off the interest. Selling partial ownership of a family business is a much more difficult way to raise cash, one that vastly increases the likelihood of destructive disputes.

During the past decade, many states have recognized the harmful effects of death taxes and have reduced or repealed their levies on inheritances or estates. Meanwhile, only one state-Connecticut-has imposed a new estate or inheritance tax.

New York, however, has bucked the national trend toward lower death taxes. As part of its multibillion-dollar tax increases over the past four years, Albany instituted several measures to increase the estate tax burden. Most notably, the state expanded the base of estate and gift taxes to include out-of-state property for calculation of the marginal tax rate. Because New York’s estate tax rates are highly progressive, the effect is to force inheritors into higher brackets.

As other states have lowered or eliminated their death taxes, New York’s high rates have become even more pronounced by comparison. Moreover, inflation has created a “bracket creep” effect that has driven taxes up sharply in real terms.

Although inflation has run at a cumulative rate of some 350 percent since 1959, New York’s estate tax rates have not been changed during that period. An estate worth $350,000 in 1959, for example, was subject to a marginal state tax rate of 5 percent. In 1992, because of inflation, an equivalent estate would have been worth about $1.2 million and subject to taxation at a 9 percent marginal rate. In 1959, New York’s estate tax was comparable to that of most other states; today, when most states no longer impose any death tax beyond the federal credit, the incentive to leave New York is much stronger.

The ideal solution would be to reduce the New York estate tax to the level of the federal credit. Though this move would undoubtedly mean less revenue for the state in the short run, its long-term effect would likely be to increase revenue by removing a major incentive for business owners to leave the state. The legislatures in at least two other states have accepted this argument. Two 1991 studies concluded that Massachusetts’s tax revenues would ultimately rise by $86 million a year if the state reduced its estate tax to the federal pickup level, and a University of South Carolina study several years ago estimated that state would gain a thousand new retirees a year if it made a similar change. An estate tax limited to the federal pickup level would still raise substantial amounts of revenue. In 1990, such taxes raised $386 million in California and $251 million in Florida.

If legislators in Albany are skeptical about the state’s ability to afford such a change, they should at least set a long-term goal of eliminating estate taxes above the federal pickup level for family-owned businesses and farms. In the interim, the legislature should take other steps to reduce the estate tax burden. Lawmakers should gradually eliminate all or most of the “bracket creep” that has taken place since 1959 and change the state’s “unified credit,” which currently exempts only the first $108,333 of an estate from taxation, to the federal level of $600,000. Under the current threshold, a New York State resident who owns no assets other than a moderate-value home can be subjected to estate taxes.

The businesses that would benefit most from these changes are the small and medium-sized companies that produce the most jobs in today’s economy-those that should most be encouraged to grow and remain in New York State.

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