Repub­li­can tax plan would give up tens of bil­lions be­cause of two words

The Washington Post Sunday - - POLITICS & THE NATION - GLENN KESSLER glenn.kessler@wash­post.com

“We just think it’s un­fair. Death should be not a tax­able event, and we should not be stop­ping peo­ple from be­ing able to pass their life’s work on to their kids.”

— House Speaker Paul D. Ryan (R-Wis.), in­ter­view on “Fox News Sun­day,” Nov. 5

We’re fea­tur­ing this Ryan quote be­cause it il­lus­trates a bit of a mys­tery about the House GOP tax plan: Why would it al­low the su­per wealthy to es­cape tax­a­tion on a huge hunk of cap­i­tal gains seem­ingly for­ever?

Killing the es­tate tax has long been con­sid­ered the holy grail for Repub­li­cans. (They even suc­ceeded one year, 2010, but then it came back.) So it is not sur­pris­ing that the tax bill in­cludes an es­tate-tax re­peal.

But what is sur­pris­ing is that the mea­sure also would al­low the ben­e­fi­cia­ries of es­tates not to pay cap­i­tal gains taxes on the in­crease in the value of the as­sets held by the es­tates. That has not been a feature of most pre­vi­ous es­tate-tax bills. In fact, Pres­i­dent Trump’s cam­paign plan would have re­pealed the es­tate tax but taxed cap­i­tal gains ac­cu­mu­lated at death.

Now, not even death would be con­sid­ered tax­able. Bear with us; this is wonky but im­por­tant. There are tens of bil­lions of dol­lars in rev­enue that the gov­ern­ment would be giv­ing up be­cause of a dif­fer­ence in two la­bels.

The facts

Es­tate taxes in some form have ex­isted for cen­turies, even among the Ro­mans, and the ver­sion to­day in the United States was en­acted in 1916 to help fund World War I. Part of the ra­tio­nale for the es­tate tax is to help cap­ture rev­enue from huge gains in stock and bond in­vest­ments that other­wise are not taxed un­less they are sold. Over time, the es­tate tax has never raised a sig­nif­i­cant por­tion of fed­eral tax rev­enue, gen­er­ally less than 1 or 2 per­cent of the over­all pie.

As Congress has nib­bled away at the es­tate tax over the years, by rais­ing the amount ex­empt from tax­a­tion and low­er­ing the tax rate, its im­pact has frit­tered away. In 1977, 139,000 es­tates had to pay the tax. In 2000, it was 52,000. Now in 2017, ac­cord­ing to the non­par­ti­san Tax Pol­icy Cen­ter, only about 5,500 es­tates — out of nearly 3 mil­lion — would have to pay any taxes. About half of the es­tates sub­ject to the tax would pay an av­er­age tax of about 9 per­cent.

Cur­rently, the first $5.49 mil­lion of an es­tate, or nearly $11 mil­lion for a cou­ple, is ex­empt from tax­a­tion. So anything be­low those lev­els is not sub­ject to any tax. Once the size of the es­tate passes that level, any ad­di­tional value is sub­ject to a 40 per­cent tax.

In other words, a $15 mil­lion es­tate of a cou­ple would be taxed 40 per­cent on the amount above $10.98 mil­lion, or $1.6 mil­lion. That means the ef­fec­tive tax rate on that es­tate would be 10.7 per­cent, which is rel­a­tively small.

More­over, the value of the as­sets given to heirs would be set at the value at the time of death. Imag­ine a house that was pur­chased for $250,000 but is now worth $1 mil­lion. The “stepped-up ba­sis” would be $1 mil­lion. If the heirs sold the house for $1.1 mil­lion, they would owe cap­i­tal-gains tax only on the $100,000 dif­fer­ence, not the $850,000 dif­fer­ence from the orig­i­nal pur­chase price. (That is known as “car­ry­over ba­sis” in the tax trade.)

This was the im­plicit bar­gain of the es­tate tax. A lot of cap­i­tal gains would re­main un­taxed, but at least for the su­per wealthy, some gains would be taxed.

Trump’s cam­paign tax plan is­sued in 2016 would have kept this ar­range­ment. The first $10 mil­lion of an es­tate would be ex­empt from tax­a­tion, but then the cap­i­tal gains tax would be levied on the rest. The max­i­mum cap­i­tal-gains tax rate is cur­rently 23.8 per­cent, and it would have ap­plied to the orig­i­nal price — the ba­sis — of the as­set.

“We al­ways said we’d get rid of stepped-up ba­sis. It’s bet­ter for the econ­omy and bet­ter for tax pol­icy,” said Stephen Moore of the Her­itage Foun­da­tion, who helped craft the Trump cam­paign plan. “Other­wise you will have a mas­sive tax shel­ter. You are go­ing to have peo­ple with an in­cen­tive not to sell.”

When the es­tate tax was elim­i­nated in 2010 for one year — un­der a Ge­orge W. Bush tax bill — car­ry­over ba­sis also would have ap­plied. Many heirs found the es­tate tax less costly, so Congress al­lowed es­tates in that year to make a choice of which tax sys­tem they pre­ferred.

But the House GOP tax plan, by con­trast, would kill the es­tate tax (start­ing in 2024) and con­tinue to value as­sets passed to heirs on a stepped-up ba­sis. (The only ex­cep­tion is cer­tain in­ter­est in foreign en­ti­ties, such as a pas­sive foreign in­vest­ment com­pany.)

Given the rise in the stock mar­ket since 2009, that means many heirs could have a bo­nanza.

As­sume a par­ent was shrewd enough to buy Ama­zon stock at $10 a share in 1998 and died on Nov. 6, when it closed above $1,120.

Un­der the House GOP plan, if an heir sold the stock for $1,125 a share, the cap­i­tal gains tax would have been a lit­tle more than $1 a share.

By con­trast, Trump’s cam­paign tax plan would have re­quired pay­ing a cap­i­tal-gains tax of about $264 per share (as­sum­ing the es­tate had passed the $10 mil­lion thresh­old).

The amount of rev­enue in­volved is dif­fi­cult to es­ti­mate, but we have some clues. The Joint Com­mit­tee on Tax­a­tion, in its re­port on “tax ex­pen­di­tures,” es­ti­mates that the rev­enue loss of not tax­ing cap­i­tal gains at death is $179.4 bil­lion over a fiveyear pe­riod, or about $36 bil­lion a year. That es­ti­mate does not in­clude the be­hav­ioral ef­fects of elim­i­nat­ing the es­tate tax while keep­ing stepped-up ba­sis, but it is a rough ap­prox­i­ma­tion be­fore any pos­si­ble ex­emp­tion.

The net ef­fect could be even higher, be­cause peo­ple would be en­cour­aged never to sell as­sets dur­ing their life­times so their heirs es­sen­tially would re­ceive them tax free.

“The es­tate tax func­tions as a toll that must be paid to shield cap­i­tal gains from in­come tax­a­tion,” the Joint Com­mit­tee on Tax­a­tion noted in a 2012 re­port. “As this toll falls (i.e., the es­tate tax rate is re­duced and/or the es­tate tax ex­emp­tion amount in­creases), it is rel­a­tively more at­trac­tive to pay the es­tate tax to avoid the in­come tax on cap­i­tal gains re­al­iza­tions. Sim­i­larly, as cap­i­tal gains taxes rise (fall), pay­ing the es­tate tax toll be­comes more (less) at­trac­tive be­cause the step-up in gains at death is more (less) valu­able. High es­tate tax rates make the trans­mis­sion of wealth to heirs less ef­fi­cient and so en­cour­age the re­al­iza­tion of cap­i­tal gains.”

A spokes­woman for the House Ways and Means Com­mit­tee de­fended the pro­vi­sion. “The re­peal of the es­tate tax en­sures that death is not a tax­able event,” she said. “Pro­vid­ing for step-up in ba­sis con­tin­ues the his­toric pol­icy ap­pli­ca­ble to as­sets trans­ferred through an es­tate re­gard­less of whether or not they are sub­ject to tax.”

The House Ways and Means Com­mit­tee ap­proved the tax plan Thurs­day on a party-line vote. The Se­nate Fi­nance Com­mit­tee, when it in­tro­duced its ver­sion of a tax plan, did not in­clude this pro­vi­sion on the es­tate tax; it merely pro­posed dou­bling the ex­emp­tion (as the House does ini­tially) but does not en­tirely wipe out the es­tate tax.

The bot­tom line

The Fact Checker, of course, takes no po­si­tion on the House tax bill.

But it’s in­ter­est­ing that House tax writ­ers would press for­ward with an elim­i­na­tion of the es­tate tax that would go far beyond pre­vi­ous ef­forts — or even Trump’s cam­paign tax plan — to al­low tens of bil­lions of dol­lars in un­tapped cap­i­tal gains to re­main beyond the reach of the U.S. gov­ern­ment. The money left on the ta­ble be­cause of a dif­fer­ence be­tween two la­bels — “steppedup” and “car­ry­over” — is cer­tainly stag­ger­ing.

KEVIN LAMARQUE/REUTERS

House Speaker Paul D. Ryan (R-Wis.) an­swers ques­tions about the House Repub­li­cans’ tax bill Thurs­day on Capi­tol Hill.

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