The Estate Tax and the Family Farm

I wish to thank Angrybear reader CL for pointing out this bogus argument for repealing the estate tax:

Most obviously, a farm or other small business that’s operating at a small profit would, presumably, not be profitable if it maintained the same revenue stream and expenses plus having to essentially buy back half the business from the government. That would mean, presumably, having to sell the business anyway.

Where to begin? If there were little profit, would not the fair market value of the farm be low? And one does not have to buy back the business from the government – just pay the taxman.

Let me take my earlier example of the family farm that is presumably worth $100 million as its expected operating profits are $10 million a year and it’s cost of capital is 10%. Let’s also introduce the standard hack appraisal technique. Even though the farm does not pay C corporate taxes, the appraiser assumes a 40% corporate profits tax rate and then discounts the remaining $6 million by some absurdly high discount rate – say 15%. That’s how I got the $40 million. If the appraiser does not fear the IRS agent, maybe he uses a 20% discount rate and then takes his customary haircut of 30% to 35% for some junk science garbage.

Estimated value: $20 million with the tax bite being less than $10 million. The poor kids will have to borrow that much at an interest rate of 5%. With $0.5 million in interest, the kids will have to survive on a mere $9.5 million per year. Guess that is why there are not many real world examples of rich farmers losing the family farm.