to take advantage of these tax-skipping transfers. As a consequence, the great-grandchildren of the less wealthy receive their property reduced by transfer taxes as it is passed through each generation, whereas great-grandchildren of the wealthy receive the property undiminished by transfer taxes. The data bearing on generation-skipping transfers are summarized in table 9. Those decedents whose gross estates were under $300,000 made transfers to persons, outright and in trust, amounting to $4.4 billion; of these transfers, only 9.4 percent are estimated to be generation skipping; among decedents with gross estates of $1 million or more, however, 25.4 percent of transfers to persons were generation skipping. This marked tendency of wealthier decedents to more frequently utilize generation-skipping transfers, particularly in trust, can be further illustrated by the following comparison: Among husband decedents with estates below $500,000 who bequeathed to family trusts, 77 percent bequeathed to trusts that were not generation skipping; but among husband decedents with estates over $2 million who bequeathed to family trusts, only 25 percent bequeathed to trusts that were not generation skipping, and 60 percent made their trust bequests entirely in generation-skipping form. TABLE 9.-PROPORTION OF TOTAL NONCHARITABLE TRANSFERS SKIPPING A GENERATION, BY ESTATE SIZE AND TYPE OF DISPOSITION 1 Total value of noncharitable transfers made during life and at death plus the amount of transfer taxes paid. 2 A special study prepared by IRS identified remaindermen of trusts as children, grandchildren, great grandchildren, other relatives and nonrelatives (as well as additional categories not here relevant such as charity, brothers and sisters, etc.). Thus, the bequests to lineals could be clearly distinguished between generation skipping and others. For other, relatives and nonrelatives it was necessary to look to dispositions to lineals to estimate the likely portion of bequests to other relatives and nonrelatives that were generation skipping. With regard to direct bequests to lineals the portion that was generation skipping was 5 percent below $300,000, 10 percent from $300,000 to $1,000,000, and 15 percent above $1,000,000. For trust remaindermen the portion generation skipping among lineals was 33 percent below $300,000, 50 percent from $300,000 to $1,000,000, and 75 percent above $1,000,000. Source: IRS, "Special Tabulation on Estate and Gift Tax Returns, 1957-59."' E. CHARITABLE TRANSFERS Present rules with respect to estate and gift-tax treatment of charitable transfers produce inequity and tend to reduce progressivity. Present artificial rules of legal ownership permit the creation of split interest trusts whereby the donor or an estate can obtain a present deduction in an amout in excess of that which the charity will actually receive from the gift or bequest. For example, a donor may contribute property to a trust requiring the payment of income to a charity for 10 years and the remainder to the donor's family. Under present law, the amount of the allowable deduction would be determined on the assumption that the trust will earn 32 percent a year which will be paid to charity and that the present value of such periodic payments may be determined by discounting the anticipated payments at 32 percent. In fact, however, the trustee may invest the property in the common stock of corporations pursuing a policy of retaining earnings rather than distributing dividends so that the periodic payments to the charity are far less than the 32-percent return assumed. In such circumstances, the trust property is clearly being invested for the benefit of the donor's family to the detriment of the charitable interest. In addition, under present rules, the operation of the charitable deduction can increase the amount of the marital deduction simply by the form in which the transfer is cast. Thus, a person can transfer property to a charity, retaining complete enjoyment and control of the property for his lifetime. While this property is included in his estate for estate tax purposes, the only effect is to increase the amount of property that can pass tax free under the marital deduction. There is no increase in estate tax liability because the full value of the charitable transfer is deductible for estate tax purposes. F. ESTATE TAX RATE STRUCTURE Present estate tax rates in many respects run counter to progressivity. The rates move from 3 percent to 25 percent for the first $50,000 of taxable estate. (See table 5.) Yet, the rates do not go higher than 32 percent until a taxable estate of $500,000 is reached. To be consistent with progressivity, the estate tax rates should be spread in more uniform brackets on taxable estates up to $500,000. In addition, the structure and level of rates should be examined in light of changes to deal with other problems so that the overall burden on transfers, including that involved in any change in the income taxation of appreciation transferred at death, is appropriate. G. ILLIQUID ESTATES Estates which contain farms or closely held businesses sometimes encounter difficulty in finding the cash needed to pay the Federal taxes which become due shortly after death. This can result in different disposition patterns than would have been selected had sufficient cash been available to pay the Federal tax on the transfer at death. These problems can be alleviated by permitting tax free interspousal transfers and by easing rules for payment of taxes for estates consisting largely of farms or closely held businesses. IV. SPECIFIC REFORM PROPOSALS A. TAXATION OF APPRECIATION OF ASSETS TRANSFERRED AT DEATH OR BY GIFT An income tax on appreciation in value of property transferred at death or by gift would be imposed. Generally, gains (or losses) on assets held at death would be subject to a tax as long term capital gains (or losses); however, appreciation and depreciation in value occurring before the date of enactment would not be considered. Any income tax due on such gains would be deductible in computing the transfer tax base (i.e., the value of the estate). The exclusions that apply to the unified transfer tax (unlimited marital deduction, orphan exclusion, and charitable exclusions) would also apply to exempt gains on property transferred to those beneficiaries. In addition, a "minimum basis rule" is proposed which would generally exempt appreciation from tax in smaller estates. Data on the operation of the proposal for taxing appreciation on property transferred at death or by gift are set forth in table 10, which show the effects of the proposal after full implementation. TABLE 10.-DATA ON THE OPERATION OF THE PROPOSAL FOR TAXING GAINS AT DEATH, 1981 1 *Includes stock, real estate, trust interests, and noncorporate business assets. The economic estate is gross estate less debts. This takes into account the observed patterns that appreciation rates and holding period are higher at the upper wealth levels plus soine shifting a set composition. (E.g., the personal residence with a low appreciation rate is more important at low wealth levels) This takes into account 4 factors: (a) the tendency for appicable capital gain rates to be higher at upper wealth levels, (b) the deduction for contributions which is higher at upper wealth levels, (c) the deduction of marital bequests which is greater at lower wealth levels, and (d) the deduction of the capital gains tax against the estate tax (at 1989 rates) which is more valuable at higher wealth ievels. B. TAX-FREE TRANSFERS BETWEEN HUSBAND AND WIFE The present 50-percent limitation on the marital deduction for transfers to a spouse would be removed, thus permitting transfers between spouses to be made free of transfer tax. The marital deduction would al-o be expanded to cover gifts of income interests. These changes would greatly simplify the transfer tax law by recognizing that most married couples regard themselves as a single economic unit with'n which individual title to property is not significant and by eliminating transfer tax consequences from shifts of property within that economic unit. C. UNIFICATION OF ESTATE AND GIFT TAXES Instead of the present separate gift and estate taxes, a single cumulative tax rate schedule would be applied to all transfers of property whether made during life or at death. This would include a single exemption for all transfers during life and at death. Table 11 shows the tax change due to elimination of the present double exemption accorded lifetime and deathtime transfers. TABLE 11.-TAX CHANGE DUE TO UNIFICATION UNDER A $60,000 EXEMPTION, ALL DESCENDANTS D. TAXATION OF GENERATION SKIPPING A substitute tax would be imposed to reach certain transfers which, by passing property to a distant generation, presently avoid the taxes which would have been imposed had the property passed outright to each intervening generation. E. RATE REDUCTION AND REVISION Reductions in the present level of estate tax rates are proposed which would take place in month-to-month steps over a 10-year period. The new single set of rates would apply both to lifetime and deathtime transfers. In addition, structural revisions in the width of the brackets would be made to improve the structure of the rate tables (see table 11A). Chart I shows the relationship between the new unified transfer tax rates and the present separate estate and gift tax rates. TABLE 11A.-STRUCTURAL REVISIONS OF SELECTED ESTATE TAX BRACKETS |