After passing President Biden’s $1.9 trillion American Rescue Plan, Congress is beginning to move on enacting the rest of his “Build Back Better” recovery agenda. This next bill presents a unique opportunity to finally fund long-neglected public investments in infrastructure and scientific research that lay the foundation for robust economic growth. But at a time of skyrocketing budget deficits and rising inequality, lawmakers should also be pursuing changes to our tax code that equitably and efficiently raise enough revenue to fund these and other national priorities.
Unfortunately, Republicans in Congress seem to believe the opposite: on the same day they voted unanimously against giving aid to help lower- and middle-income Americans weather the pandemic, Senate Republicans introduced a bill to cut taxes exclusively for multi-millionaires who inherit their wealth. The GOP’s tone-deaf pursuit of their tax-cuts-at-any-cost agenda is galling: there is simply no good reason that a wealthy heir should pay less in taxes than a middle-class schoolteacher or an entrepreneur who earns their wealth through hard work. Lawmakers should raise taxes on inheritances, not cut them.
The federal government currently levies a tax of up to 40 percent on the value of estates that exceeds an exemption of $11.7 million if the estate belonged to an individual or $23.4 million if it belonged to a couple. When Republicans raised the exemption threshold to these levels in 2017, they claimed to be doing so to alleviate an onerous burden on estates primarily comprised of small businesses and family farms. But the reality is that less than 0.1 percent of estates were subject to the tax before Republicans doubled the exemption, and less than 2 percent of those estates included family farms or small businesses. Senate Republicans now seek to eliminate this tax on the ultra-wealthy entirely on the basis that it is an unfair form of double taxation – a “death tax” – because the person who died paid income taxes when they earned the money that is being left to heirs.
The GOP’s complaints about double taxation are a red herring: although the tax is technically applied to the decedent’s estate, the person who bears the tax is the heir because the tax comes out of their inheritance. Why should someone pay a tax on income they earn through their own hard work but not on income they receive solely because they were lucky enough to be born to wealthy parents? Over a third of all wealth in the United States comes from inheritance and over 40 percent of that inherited wealth came from the top 4 percent of inheritances worth over $1,000,000. Every dollar raised from taxing the unearned income of the wealthy is a dollar the government does not need to raise by taxing work or productive investment.
Democrats should thus meet Republicans’ proposal to repeal the estate tax with one of their own: instead of taxing a person’s estate at death, the federal government should tax the inheritance as income received by heirs through a progressive inheritance tax. Inheritance above a lifetime exemption of $1 million (or however low lawmakers can get political consensus for) should be subject to the heir’s personal income tax rate plus a 20 percent surtax, with heirs who are otherwise middle-income being allowed to amortize (or spread out for accounting purposes) their inheritance over five years so it falls into lower tax brackets than those of the ultra-wealthy. The very few people who inherit less in liquid assets than they owe in tax on illiquid assets they inherit, such as a family farm or small business, would be given the option to delay paying the remaining the tax (plus market-rate interest) indefinitely until the asset is sold.
Taxing inheritances in this manner focuses the burden on the heir and makes clear that this is a tax on unearned income, not a tax on the dead. This change results in a tax that is both more equitable and more sensible: under the estate tax, the amount of inheritance that can be passed along tax-free is greater if the estate was accumulated by a couple than an individual, but that has no practical impact on the heirs who are actually paying the tax. By contrast, the total amount of money that can be passed along tax-free under an inheritance tax depends on how much is left to how many heirs – the more heirs the inheritance is divided amongst, the less tax is owed. In other words, moving from an estate tax to an inheritance tax structure encourages deconcentration of wealth in America. It would also be consistent with President Biden’s pledge not to raise taxes on Americans with incomes below $400,000 because everyone subject to the tax would have inherited over $1 million.
As part of this reform, lawmakers should repeal the “step-up basis” provision that allows recipients of inherited assets to permanently avoid paying taxes on untaxed capital gains that accrued during the original owner’s lifetime. On top of providing an enormous tax loophole for wealthy families, step-up basis limits how much the federal government can raise from capital gains taxes by creating an enormous incentive to hold assets until death. The Joint Committee on Taxation and Treasury Department currently estimate that raising the capital gains tax rate much above 28 percent would not raise any additional revenue, because after that point, more assets will be held until death – and thus never subject to paying capital gains tax – than would be subject to the higher rate.
According to the Tax Policy Center, taxing capital gains at death would raise the capital gains tax rate at which the government could raise the most revenue closer to 50 percent. That change would enable policymakers to significantly reduce the disparity between tax rates on capital gains (which are currently taxed up to 23.8 percent) and those on ordinary income (which are taxed up to 37 percent). Capital gains account for roughly 40 percent of income for households in the top 1 percent of the income distribution, compared to less than 2 percent of income for households in the bottom half of the income distribution, so reducing the disparity is essential to ensuring an equitable and progressive tax system.
When the Progressive Policy Institute proposed a similar package of tax changes as part of a comprehensive budget blueprint in 2019, the Tax Policy Center estimated that they would raise roughly $1 trillion over 10 years. This additional revenue could provide an enormous down payment on the rest of President Biden’s recovery agenda. Lily Batchelder, who is President Biden’s nominee for Assistant Treasury Secretary for Tax Policy, has also been one of the leading proponents for adopting a progressive inheritance tax. Now is the right time for policymakers to make a long-overdue change to our tax code that reinforces rather than undermines the dignity of work and self-determination.