How does the estate tax affect the number of firms?

The purpose of this paper is to estimate the effect of the combined (Federal and state) estate, inheritance, and gift (EIG) tax burden per decedent on the number of firms in the USA.

Estimates are based on a longitudinal panel of 50 American states from 1988 to 2006.

The paper finds that the growth in the EIG tax burden per decedent significantly reduces the growth in the number of firms, especially small firms. The higher dissolution rate among small firms can be attributed to the asymmetric liquidity effect, which limits the ability of small business owners to raise the funds needed to pay the estate tax without liquidating their estates.

The estimates suggest that the reductions in EIG taxes, brought about by the passage of 2001 EGTRRA, have lead to a higher growth in the number of firms, ceteris paribus.

As of this writing, the future of the Federal estate tax looks uncertain. Policymakers should note that the estate tax lowers competition and economic growth, which hurts both the poor and the rich.

This study is the first to examine the impact of the combined (Federal and state) EIG tax burden on the number of firms using state-level panel data.