Republican tax plan would give up tens of billions because of two words
“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 In fact, President Trump’s campaign plan would have repealed the estate tax but taxed capital gains accumulated at death.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.
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.
House Speaker Paul D. Ryan (R-Wis.) answers questions about the House Republicans’ tax bill Thursday on Capitol Hill.