Save the Estate Tax by Smartly Dedicating Its Funds

12/19/2012 11:43 am ET | Updated Feb 18, 2013

An array of the best and the brightest from the U.S. business community, also known as the "super wealthy" -- including Warren Buffett and George Soros -- asked Congress on last week to strengthen the estate tax.

And just as Buffett did two weeks ago with regard to the Alternative Minimum Tax, they didn't merely call for a higher tax -- they called for a higher progressive tax, that is, a tax where the rate increases along with the size of the estate.

This is a major breakthrough.

But it is not enough.

If liberals want to preserve the estate tax, the most progressive tax of all, they need to dedicate its revenues to a broadly desired purpose. Notice that Republicans aren't trying to abolish the gasoline tax, which funds transportation projects. Even while "reforming" Social Security, President George W. Bush didn't propose terminating payroll taxes, which finance Social Security and Medicare.

So, to save the estate tax, its revenues must be dedicated to a specific program, not just deficit reduction.

But not all programs are created equal.

Some believe that these taxes should be dedicated to Social Security. Understandable, but at about $20 billion annually, estate tax revenues are not nearly enough to dent Social Security's shortfall.

Others have proposed that the U.S. follow Britain's "Baby Bonds" program whereby funds are dedicated to a newborn and then made available to pay for college or the down payment on a house at 18.

But over 20 years, these bonds wouldn't pay for much more than a year of college -- if that. And the resulting $20,000 or so won't pay for much of a house, either.

Here's a bigger idea that could transform America: Estate taxes should be dedicated to the same purpose as estates -- to pass wealth to the next generation. Half of Americans own no stock whatsoever. The median holdings of those that do are less than $100,000. The richest 400 and the poorest 70 million American families have roughly the same wealth -- about $1.5 trillion. A program to broaden wealth, to create... hmm... what to call it... how about an "ownership society"... could enlarge the number of heirs who get a small piece of the nation's $35 trillion of household wealth to every American.

Despite President George W. Bush's ownership society rhetoric back in the day, broadening wealth is more a liberal than a conservative project, as reflected by programs ranging from the Homestead Act to the GI Bill to the post-World War II housing programs critical to creating the American middle class.

Democrats need to remember that the power of compound interest is not the property of one political party.

Each year, estate tax revenues could be divided among the nation's newborns. We should start with a tax that generates at least $20 billion -- which is what a 35 percent rate and a $3.5 million threshold should generate. (Or we could graduate the rate so that it starts at 35 percent and then escalates step by step, ultimately to near 50 percent at some point over $18.5 million.)

Dividing this $20 billion+ by just over four million births leaves $5,000 to be invested in a government-managed or supervised equity index fund. Over 60 years, economists foresee equity funds generating 5.5-6.5 percent real returns. At 5.5 percent, the fund would grow to about $250,000 per couple in current dollars. At the 6.5 percent real earnings rate, about $435,000.

Perhaps the income from these accounts could be made available to trust account holders in need during their retirement, but the real purpose of these universal trust funds would be to be passed on to heirs. (Inheritors would also receive trust accounts at birth for their heirs.)

The estate tax was projected to increase to $50 billion per year over the next decade with the terms described above. As the tax revenues increase, so could the accounts, with each account growing to $600,000, $800,000, and, to the children of today's children, $1 million per couple in current dollars, even with increases estate tax thresholds through indexing (assuming our birthrate doesn't explode). (Or use part of the tax to fund these accounts with the remainder being used to reduce the deficit.)

Statistics on how many estates are worth over $435,000 are hard to come by. Some say it's only 1 percent. Why shouldn't we take this "lucky" figure to 100 percent?

Now there isn't room here to go into all the details that this proposal raises: Above the max trust fund account, should a dollar be deducted for every dollar inherited elsewhere? Should you have to earn a high school diploma to qualify? Would felons forfeit their account? Would these become assets that the inheritors are free (at some age) to manage as they see fit. Or should the principal be restricted to investments in assets such as education or housing or investment with only the income available for consumption? And what financial training would people receive?

Universal trust funds could also receive funds from sources other than estate tax revenues. The Wall Street Journal advocated that individual Iraqis be provided an ownership stake in the country's publicly-owned oil wealth. Why not apply the same principle here? The Alaska Oil Trust is a rough model with thousands of dollars going to individual Alaskans. How about the proceeds of long-term leases on public assets, such as the remaining parts of the broadcast spectrum, being split among all Americans and devoted to universal trust funds?

But these are details. After all, if $500 had been invested for every newborn along with Social Security's initial funding in 1937, each of the 54 million American retirees since 2002 would have about $200,000 each, $400,000 per couple, to pass on -- while retaining their Social Security.

Now, some liberals argue that we have too many short-term needs -- including poverty. But the estate tax doesn't generate enough to resolve these needs. Why not devote its revenues to a program that will work, albeit, over the long run. Universal trust funds could virtually eliminate poverty while expanding the middle class. Will any short-run expenditure do the same?

Is this "socialism"? Hardly. Conservatives should appreciate this effort as every American would then have a stake not just in the U.S. government, but in the U.S. stock market as well.

And this proposal does not confiscate estates, so heirs of the wealthy will still inherit enough to become rich -- even super-rich. But why should only the chosen few inherit a real stake in the U.S. economy?

And to those defending the tax: once the estate tax is dedicated to universal trust funds, the issue of its existence will be over. We won't ever have to debate the estate tax again.

But unless we dedicate the tax to this or another popular program, one day, when Republicans control Congress and the presidency, the issue may not be terminated, but the tax will be.