Congress will need to address the estate tax as it seeks to simplify the whole tax code, experts told the Senate Finance committee at a hearing on May13.

Currently, the estate tax is in the midst of a gradual phase-out, with the tax set to be eliminated in 2010 under a 2001 law. However, the law did not make the repeal permanent, and the tax would return at 2000 levels in 2011.

“It seems unlikely that Congress will simply let the tax cuts expire as scheduled,” said Leonard Burman, director of the Tax Policy Center and a senior fellow at the Urban Institute in Washington. Among the main reasons why, he said, is that “the potential behavioral responses to the one-year estate tax holiday are too ghoulish to contemplate.”

Extending the estate tax, and others passed in the first 4 years of President Bush’s term, would be costly, however, Mr. Burman added, noting a Congressional Budget Office estimate of $2.3 trillion in lost tax revenue from 2008 through 2018 if the cuts are extended.

The question of what to do with the estate tax has been debated between members of Congress who seek to eliminate it entirely and those who seek to reform it to affect only the wealthiest estates. To illustrate the confusion, Mr. Burman noted a survey that showed a majority of respondents who felt the rich should pay more in taxes actually opposed the estate tax, which he referred to as “highly progressive” in its nature.

“The estate tax is obviously fraught with controversy,” he said in testimony, “but a reasonable compromise would be to extend the 2009 exemption of $3.5 million and top tax rate of 45%. This would exempt all but very wealthy estates from the tax and might defuse the issue politically.”

Additionally, Mr. Burman said lawmakers could further simplify the estate tax by allowing surviving spouses to carry over the exemption, effectively providing a $7 million exemption for couples.

However, Stephen Entin, president and executive director of the Institute for Research on the Economics of Taxation in Washington, disputed the idea that eliminating the tax cuts, including the estate tax repeal would prove costly to the government, arguing that supporters of that argument failed to look at the economic picture as a whole.

“Joint Tax Committee revenue estimators may tell you to expect to gain about $200 billion a year from letting these tax changes lapse,” he said. “They assume no macroeconomic consequences from the higher tax rates.”

Mr. Entin said in testimony that eliminating the tax cuts would effectively increase the “service price of capital,” meaning the required pre-tax return, by about 10%. “To increase returns by enough to cover the added tax, the stock of private business capital (plant, equipment, inventory and land) would have to fall by about 16%, giving back the increases since 2003,” he added.

Overall, Mr. Entin argued that the drop in private sector income due to allowing the tax cuts to lapse would reduce income tax revenues “by about $140 billion a year” and payroll tax, corporate income tax, and excise, customs and estate tax revenues by roughly an additional $85 billion a year. “The dynamic losses would exceed the static gains,” he said. “The net loss would be $25 billion. That does not include a figure from the likely collapse of capital gains realizations or reduced dividend payouts. The Congress will not see a cent.”