Eliminate Step-Up in Basis on Capital Gains at Death

Under current law, the tax basis of property transferred to an heir at death is “stepped up” to its current market value, such that only the asset appreciation after the inheritance faces capital gains tax upon sale. Step-up in basis ensures that when an asset is passed to an heir, the value of the asset is not subject to both the estate tax and the capital gains tax. It has been critiqued for discouraging taxpayers from realizing capital gains and for benefiting high-income taxpayers, allowing some capital gains to fully escape taxation.

This option repeals step-up in basis and transfers the original owner’s cost basis to heirs. Eliminating step-up in basis would raise the effective tax rate on saving. Domestic saving would fall, but foreign investment into the US would increase, preventing a decline in output but causing more of the returns to American investment to flow to foreigners. The smaller budget deficit would reduce federal government borrowing as well as interest payments to foreigners, but GNP would still decline by 0.1 percent.

On a conventional basis, this option would decrease the primary deficit by $206.4 billion over the budget window. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be lower than baseline, reaching 174.3 percent by 2056.

On average, in 2036, taxpayers would see decreases in their after-tax incomes of 0.1 percent. The top quintile of taxpayers would experience a 0.1 percent decrease, whereas the bottom four quintiles would be unaffected on average.