Failing to understand the current tax system, progressives have talked themselves into a serious policy error.
The Biden administration is working to abolish the step-up basis. In doing so, the administration shows it has failed to understand how matters are dealt with currently. As the Congressional Research Service has already explained to everyone, this isn’t all that difficult.
Here’s the basic primer.
Capital gains made on investments get taxed when those investments are sold. This should be obvious. After all, how can we know what the gains actually are without knowing the price at which they are sold? Which does leave a potential problem if someone dies without selling. This is what the “step-up basis” is. At the time of death, the moment inheritors get their hands on the assets, the starting price for capital gains is the market price at that time. That is entirely fair: If you’re going to be taxed on capital gains, it should be your capital gains that get taxed.
However, and this has been going on for decades now, progressives have talked themselves into believing that capital gains never get taxed at all. Therefore, this new idea is to eliminate the step-up and in so doing, tax all the accrued capital gains in the estate. The problem is that the value of the estate is calculated on the stepped-up basis. It is this full market value of all those capital gains that then pay that estate tax. That same value that the inheritors are getting as their starting point. At least the estate tax is currently 35%, not the 20% of long-term capital gains.
True, estate taxes only apply to the very largest inheritances. But note what happens if we eliminate that step-up basis, too. We don’t increase the value of the stocks or investments to their current market value — that’s what the step-up is, stepping up the value from the purchase price to the current price. Then the estate doesn’t pay estate tax on the capital gains, does it?
The other alternative is that we do step up the price and charge capital gains, and then also the estate tax — which, with that mooted 39% capital gains rate for rich folks, plus the 35% estate tax, gives us a 74% tax rate. Which isn’t, I think it’s useful to point out, something that is generally going to be considered fair. Neither is it going to raise any money, as too much effort will be put into avoiding it. Entirely legally, of course.
The insistence of progressives is that the step-up basis means no tax is paid. It’s actually the way of making the inheritors pay the estate tax on the full current value. By getting this wrong, progressives have talked themselves into this corner of trying to abolish it, with the result that if it is done away with, there will be less tax paid either way. Either the estate tax collected will fall as the capital gains aren’t included or near everyone will be motivated to avoid it altogether with trusts, foundations, etc.
As ever, it’s vital to understand the current system before coming up with bright ideas to change it.
