One reason why outside investors are attracted to farmland is the tax shelter opportunities that farming affords. For instance, certain capital expenditures may be deducted immediately as current expenses, rather than depreciated over their useful lives. Federal subsidy programs vested in, or tied to, the land also attract nonfarming investors, increasing the price of farmland. Thus, programs designed to aid farmers may complicate their estate planning by adding to the price of farmland and raising farm estate values.

Several of the objections to the estate tax treatment of farms raise issues that are not unique to farming. As chapter 2 notes, some tax authorities believe that the Federal estate tax is primarily an instrument for reducing concentrations of wealth rather than a source of revenue. To achieve its objective, the tax must take wealth from those who have it. Accordingly, it is not surprising that the tax erodes the value of estates.

Any estate or inheritor may have to sell assets, reduce cash balances, or borrow to pay the estate tax. No empirical evidence demonstrates that illiquidity is an unavoidable problem peculiar to farm estates or that farm estates warrant special tax preferFarmers can use estate planning methods to provide adequate funds for the payment of estate taxes, as by purchasing life insurance, just as other types of businesses may do. Nor do farm estates appear to be victims of unfair valuation. The claim that tax equity requires unique estate tax rules for farmers is difficult to sustain. The decision to impose an estate tax is inevitably also a decision to force some inheritors to forego a part of their inheritance. 1/ For many reasons, however, farming has long received special consideration in the making of public policy.

SPECIAL ESTATE TAX TREATMENT OF FARMS IS
CONSISTENT WITH AMERICAN AGRICULTURAL POLICY

Farming, especially family farming, has always occupied a unique place in American economic, political, and social life. The economic and political importance of steady farm production has been recognized since the founding of the Republic, and farm life has had a profound influence on our way of life and social values. American agricultural policy has attempted to encourage family farming and family farm ownership. This goal provides a stronger justification for special tax preferences than the equity arguments do.

Estate tax preferences for farm estates may help achieve several objectives. They may be used to help the agricultural sector of the economy become stable and moderate fluctuations in agricultural production. They may serve some social goals, such as encouraging families to remain in farming. They may help slow the conversion of farmland into other uses. Reducing estate

1/See also chapter 2.

taxes may promote all of these objectives, as well as provide a tax expenditure to farm inheritors.

The role of the Federal estate tax in the decline of family farming

The burden that the Federal estate tax places on farm estates is not the main reason why many small family farms go out of business. Operating problems encountered by farmers and changes in agriculture are much more likely to prompt the sale of farms when farmers die. The difficulty of establishing the new farm management, disagreements among heirs, and distance of inheritors from the farm location may also discourage retaining the property. Technological advances in farming have created incentives for innovative farmers to enlarge their operations by buying out their neighbors. Many of these expanded farms have been organized as family-owned corporate farms, conferring considerable financial advantages on the owners and promoting the acquisition of additional farmland. This drive to expand pushes up the demand for the relatively fixed supply of farmland. As a result, farmland prices increase and farm ownership and successful operation become less likely for new farms or families owning small farms. 1/ The opportunity to realize the capital gains that had accumulated during the decedent's lifetime can also be a significant inducement for the heirs to sell the estate. Farmland values have increased dramatically in the last decade. According to the USDA's Economics, Statistics, and Cooperatives Service, the average value of an acre of farmland increased 85 percent nationally between March 1974 and February 1979, following a 60 percent increase between March 1969 and March 1974. 2/

Small family farms are disappearing as American agriculture changes. Increased opportunities for nonfarm employment and decreased requirements for farm labor have caused a sizeable loss of population in farm areas over at least the past 50 years. The fraction of the U.S. population that lives on farms has declined, from 24.9 percent in 1930 to 3.6 percent in 1977. Farm employment has declined during the same period, from 12,497,000 to 4,152,000. In 1930 over 6.5 million farms were operating, by 1977 the number had fallen to 2.7 million. Over the same period the average farm grew from 151 acres to 300 acres. Farm productivity also grew. The index of farm output per worker hour (1967 = 100) rose from 16 in 1930 to 34 in 1950 and 171 in 1977.

1/For an extended discussion of these points see U.S. General Accounting Office, Changing Character and Structure of American Agriculture: An Overview, CEDD-78-178 (September 26, 1978).

2/The increases have not been even across all States. Appreci-
ation rates ranged from 158 percent in Indiana and Minnesota
to 22 percent in Arizona and Nevada between 1974 and 1979.
See U.S. Department of Agriculture, Agricultural Finance
Outlook (November 1979), p. 6.

No evidence suggests that the Federal estate tax has played other than a minor role in promoting these changes. Fred Woods and Charles Sisson, for example, have said that "it is difficult to find evidence of major aberrations in the behavior of farm families which might have been caused by the . . . estate tax laws" before the 1976 Tax Reform Act. 1/ Voluntary sales and trades have been the predominant form of farm transfers during the 1970s, according to the Department of Agriculture's statistics in table 1. Sales by administrators and executors comprise a much smaller share of all farm sales, according to these data. Since 1969 they have accounted for about 15 percent of all farm transfers each year, less than the roughly 20 percent common in the 1960s. In his study of Illinois farm estates, Harold Cuither reported similar findings:

Land sales made to settle estates did not occur
frequently. When such sales were made, the reasons
varied. Most often, the reason was to divide funds
among the heirs. This happened in about 8 percent
of the cases studied. Next was paying estate and
inheritance taxes, which occurred in about 6 percent
of the estates. Other reasons given were to enable
one heir to buy out others, to pay off debts on

property, and to comply with the terms of the will. 2/

The preferences contained in the 1976 Act are not generally successful as a land use planning device designed to keep land in farming. First, the tax is infrequently imposed. Farmland will bear a tax once--or possibly twice--each generation. Furthermore, since the decedent does not bear the tax, its effect on the farmland's use is uncertain. Family relationships and financial circumstances during the decedent's life may well play much more important roles in determining land use than a death tax. If the family decides to maintain a farm through several generations, they probably will take the necessary steps to anticipate the tax.

SUMMARY

Special estate tax treatment of farm estates is best viewed as a method used by the Federal Government to encourage families to continue owning and operating family farms after the death of the owner. The preferential treatment reduces the chance of farm estate shrinkage due to the tax. The other reasons for preferential treatment appear weaker. Farm estates are not treated unfairly under the estate tax. Although some farm estates are

1/w. Fred Woods and Charles A. Sisson, "The Tax Reform Act of 1976 and American Agriculture, Tax Notes, vol. 5 (August 29, 1977), p. 5.

2/Guither, p. 2.

Table 1

sold in satisfaction of death taxes and estate administration expenses, their number is small and the pressure to sell may be no different from the pressure on nonfarm estates. The very

imposition of a tax on an estate will often require some of the value to be given up. Further, farm estates do not appear to be unavoidably illiquid or cash-starved. While illiquidity is often characteristic of farm operations, proper financial and estate planning techniques should be adequate to alleviate the condition in most cases.

Preferential estate tax treatment of farm estates illustrates how an instrument designed to serve one policy goal is sometimes modified to serve another. The Federal estate and gift tax exists to serve certain redistributive objectives. Estates incurring an estate tax are inevitably reduced in value, although the tax may be lessened or avoided and the tax burden mitigated by effective estate and financial planning. Special use valuation and deferred and installment payment options have been introduced, however, because a possible effect of the estate tax--sale or shrinkage of family farms--is inconsistent with American agricultural policy, a goal of which is fostering family farms.