Succession taxes are costly for family firms

Robin Mordfin | Aug 12, 2015

Sections Finance Public Policy

Collections Tax Policy

Estate and inheritance taxes can reduce investment in family businesses by 40 percent around the time a succession takes place, according to research by Chicago Booth’s Margarita Tsoutsoura. Her findings suggest the taxes also may slow sales growth, deplete cash reserves, and ultimately cause some families to sell their companies.

Family businesses play a critical role in the global economy. In the European Union alone, 690,000 family firms, employing 2.8 million people, change hands every year.

Tsoutsoura focused her study specifically on family firms in Greece, creating a database of all limited-liability-firm transfers between 1999 and 2005, before and after a 2002 policy change that lowered the succession tax from 20 percent to 2 percent. (Limited liability firms are often family firms.)

The data indicate that the type of assets owned by a business impact how a succession tax will affect a firm’s level of investment. For instance, when succession taxes were at the higher, 20 percent level, in Greece, families whose firms had nonphysical assets experienced a larger decline in investment than other types of firm. Similarly, families that had little to no income from sources outside of their companies, or whose companies paid more to borrow money, also experienced larger drops.

The tax rate also affected whether families kept or sold their companies. When the tax rate dropped, the number of firms that transferred to family members rather than outsiders increased by nearly 65 percent.

At the higher tax rate, investment in property, plant, and equipment dropped from 18 percent before a transfer to 10 percent after. The taxes also led to declines in sales and profitability. Faced with higher tax rates, businesses that transferred within families had a 4 percent decline in sales growth, whereas those that went to unrelated owners showed little change. The cash ratio in family firms dropped from 18 percent of assets three years before a transfer to 12 percent of assets two years after. All in all, the research supports claims that succession taxes hurt family firms.

Margarita Tsoutsoura, “The Effect of Succession Taxes on Family Firm Investment: Evidence from a Natural Experiment,” Journal of Finance, March 2015.