Nothing may be as certain as death and taxes, but one thing comes close: predictions that the current state budget mess would cause lawmakers to attempt to resuscitate Michigan’s death tax. Gov. Granholm has made that prediction come true with her fiscal year 2005 budget recommendation. She proposes a 5 percent tax on estates worth $1 million or more.

Contrary to reports of its demise contained in 1993 Engler-era press releases, the state death tax lives on. It does so in a stealthy form that Michigan heirs never feel. This is because the tax is linked to the federal death tax.

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Here’s how it works: Prior to the 2001 Bush tax cut, which phases out the federal death tax by 2010 (the phase-out actually has a sunset provision that will bring back the tax if federal lawmakers do nothing, but that’s another story) the IRS tax code allowed Michigan to "pick up" (or "sponge") almost a third of a decedent’s federal estate tax liability. The maximum federal estate tax rate was levied at 55 percent of the taxable value of the estate, but a credit for up to 16 percent of the taxable value paid in state death taxes was allowed.

In other words, Michigan’s estate tax law never really disappeared. Lawmakers simply established that the state death tax rate would equal the maximum amount of the federal credit. So if your estate owed $110,000 the feds would allow the state to "sponge" up to $32,000 of this, leaving $78,000 for the IRS.

The federal Economic Growth and Tax Relief Reconciliation Act of 2001 upset this cozy relationship. It phases out the federal death tax over 10 years, but the state tax credit disappears much more quickly. For those who died in 2002, the state was allowed to pick up just 12 percent or $24,000 in the example above. For those who died in 2003 the amount was only 8 percent, this year it’s 4 percent, and after that the credit will be replaced by a tax deduction.

But since Michigan’s estate tax has no independent existence without the federal credit, there will be no payments to the state, and therefore no federal deduction. The un-dead Michigan death tax will finally have a wooden stake driven through its heart.

Not so fast, says Gov. Granholm, who has proposed breaking the link between the state and federal death taxes, in effect creating a new 5 percent Michigan death tax. Her tax would deprive the heirs of Michigan decedents of some $130 million a year. As parents of the baby-boom generation begin to pass away in larger numbers, this amount will rise substantially.

Restoring Michigan’s death tax would be unfortunate. Aside from making the 2001 federal tax cut a "give with one hand, take away with the other" affair, the bill would saddle the state economy in perpetuity with all the pernicious effects of a death tax, which is really a tax on the American dream. Death taxes steal the chance of many small business and farm owners to leave the enterprises they built to their descendants, because the heirs are often forced to liquidate their assets in order to pay the taxes.

In addition, the death tax is harmful because it encourages spending, not saving. It sends a powerful signal that the accumulation of even modest wealth will lead to heavy taxes. When an owner realizes that the estate will take a large tax hit, he or she may spend down the estate or remove the business from the family. Economist William Beach of The Heritage Foundation says that because of the death tax, "it makes sense to buy vacations in Aspen, Colo., or a painting by Rubens instead of investing in new productive equipment or expanding a business."

Beach and his fellow economists used two of the nation’s best statistical models to forecast what will happen as the federal death tax is repealed. They found numerous benefits that will likely flow from the increased incentives to save and invest.

  • The U.S. economy could gain as much as $11 billion per year in economic output.

  • Approximately 145,000 new jobs will be created.

  • Personal incomes will rise an average of $8 billion per year above current projections.

Sadly, Michigan’s economy will not fully enjoy these benefits if the governor’s death tax proposal becomes law.


Note: Jack McHugh is legislative analyst for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich.