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One offered justification for the estate tax, aka the “death tax,” is that the wealthy would otherwise pay no tax at all. The Center for Budget and Policy Priorities (CBPP) recently tried, and as we shall see failed, to put substance to this argument, an attempt that was then parroted by Matt O’Brien of the Washington Post. Theirs was an argument not difficult to refute.
The CBPP/O’Brien argument hinges on a feature known as “step up basis.” It works like this: Suppose you buy an asset. Normally, when you sell the asset you owe capital gains tax on the increase in value. But if you hold the asset until you pass, then the “basis,”i.e. the price for capital gains purposes, rises to the current value, eliminating any capital gain and thus any capital gains tax. Absent the death tax, such a gain would go untaxed. To this point, CBPP and O’Brien are quite correct.
O’Brien emphasizes, “If it weren’t for the estate tax, the majority of the super-rich’s money would never be taxed at all.” But is that really true? Not in the slightest.
How was the asset previously taxed? As the second sentence of Elizabeth Barrett Browning’s famous poem insists, “Let me count the ways.”
If the asset has a deferred capital gain and benefits from step up basis, the estate owes no capital gains tax; but how often previously had the capital been invested, the asset sold, and capital gains tax paid? It surely happens that somebody acquires a bit of saving and invests it once and for all, never to sell unto death, but that’s obviously a great rarity. Far more likely, this bit of wealth generated a long and marked history of generating capital gains tax liability.
Also, as the asset is held, it is almost certainly throwing off some stream of income subject to tax. If the asset is commercial real estate, it is throwing off rents; if stocks, then dividends; if bonds, then interest. Not only is the appreciation of the asset typically taxed, but the stream of income generates a stream of income tax liabilities.
No capital comes into existence out of thin air. It must first be saved out of other income, income which was likely subject to income and payroll tax. It’s fascinating watching the “soak the rich” crowd simultaneously argue for a highly progressive tax system while complaining the rich pay no tax.
One final aspect worth mentioning is that the death tax operates as a system. Step-up basis exists because the death tax exists. As long as capital gains are taxed in general, then any serious proposal to eliminate the death tax also eliminates step-up basis. Curiously, neither CBPP nor O’Brien mention this little detail.
The CBPP knows all this, of course, as does O’Brien, indicating theirs was not analysis or reporting. The reader can decide the better description.