Replace the Estate Tax with Capital Gains Taxation at Death

The estate tax applies to estates above a $15 million ($30 million for joint filers) exemption threshold at a top rate of 40 percent. At the same time, 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.

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. Step-up in basis 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 replaces the estate tax and step-up in basis treatment of capital gains at death with a tax on the transfer of capital gains at death. This would increase the overall tax burden on saving, which would reduce the incentive to save. Domestic saving would fall, and foreign investment into the US would increase, causing more of the returns to American investment to flow to foreigners. The smaller budget deficit would reduce federal government borrowing and interest payments to foreigners, with the fall in domestic saving dominating, resulting in a decline in GNP. These estimates do not account for any changes in compliance costs.

On a conventional basis, this option would decrease the primary deficit by $231.2 billion over the budget window. Long-run GDP would be unchanged, while long-run GNP would decline by 0.1 percent. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be lower than baseline, reaching 174.5 percent by 2056.

On average, taxpayers would see decreases in their after-tax incomes of 0.1 percent in 2036 and the long run, concentrated among taxpayers in the top 1 percent.