The Capital-Gains Revenue Illusion

House Democrats are already asking for death-tax exceptions

WSJ editorial.

"Evidence that President Biden’s capital-gains tax increase is counterproductive keeps rolling in, and the latest is from the Penn Wharton Budget Model, a nonpartisan outfit often cited as an authority by Democratic economists.

Penn Wharton estimates that raising the top capital-gains tax rate to 43.4% would shrink federal revenue by $33 billion over 10 years. That’s a smaller hit than the Tax Foundation’s $124 billion loss, but it acknowledges the same economic reality. Taxpayers in range of the higher top rate will find ways to shrink their bills.

To compensate, the Biden Administration has proposed a $1 million cap on the “step-up in basis,” which excludes unrealized gains from taxation at death. This is a backdoor death tax, and Penn Wharton estimates the change would raise up to $113 billion over a decade.

But that is also a static analysis that doesn’t account for other taxpayer behavior. The wealthy already employ legions of tax lawyers and accountants to avoid the current 40% estate tax, and they can do the same to duck the new capital-gains death tax. Charitable donations and creating trusts and foundations are popular methods.

Meanwhile, 13 House Democrats have written to Speaker Nancy Pelosi asking for an exemption for family farms from the step-up in basis tax hit. “The requirement to recognize capital gains at death runs the risk of forcing farms and ranches to sell part, or all, of a farm that may have been passed down for several generations in order to pay the tax burden,” wrote the Members, who include some of the most vulnerable incumbents.

Once the exceptions start, more will get in line, and the estimate of a revenue gain will look even more fanciful."