Our guest blogger is Seth Hanlon, Director of Fiscal Reform at the Center for American Progress Action Fund.
On January 24, 1963, exactly half a century ago, President John F. Kennedy called on Congress to enact a broad overhaul of the tax code. One of JFK’s boldest proposals was to close a giant tax loophole that allows wealthy people to escape taxes on capital gains — the appreciation in value of stocks, businesses, or other investments — by holding onto assets until death and passing them onto heirs.
Though JFK’s successor, Lyndon Johnson, pushed through much of the Kennedy tax program in 1964, the tax break on inherited capital gains survived. It exists to this day as one of the largest loopholes in the tax code.
The provision is sometimes called the “angel of death loophole” or, in tax-speak, the “stepup in basis at death.” Here is how it works: Let’s say an investor buys stock for $1,000 and over time it shoots up in value to $100,000. If the investor sells that stock, he’ll owe capital gains taxes on the amount it has gone up.
But if the investor holds onto the stock his whole life and bequeaths it to his heirs, the $99,000 of gain is never subject to capital gains tax. The heirs inherit the stock with what’s called a “stepped-up basis,” which means that if they sell the stock at some point, they’ll only owe capital gains tax on any gain above $100,000.
The inherited capital gains loophole has major effects on the budget, on the economy, and on tax fairness. It results in about half of all capital gains going permanently untaxed. It costs the U.S. Treasury an estimated $50 billion per year (perhaps more). It encourages people to hold onto assets even when they would otherwise want to sell them. And since capital gains are highly concentrated at the top end of the income scale, it undermines progressivity.