The belief that success should come from your personal initiative and hard work, rather than the good fortune of your birth, is central to our nation’s identity as the “land of opportunity.”
Rags to riches stories are deeply rooted in American history and folklore, with several of our founding fathers, such as Alexander Hamilton and Benjamin Franklin, rising from impoverished backgrounds to build a nation. Conversely, the American ethos has steadfastly rejected the “artificial aristocracy founded on wealth and birth,” as Thomas Jefferson writes, in favor of one built upon “virtue and talents.” Success in America is supposed to be built upon merit and hard work rather than who your parents are.
Despite this national ethos, America has fallen behind many of our international peers in creating opportunities for social mobility. In the World Economic Forum’s measure for social mobility, the United States performs worse than the Nordic countries, France, and even the United Kingdom, with their long history of hereditary aristocracy. Declining levels of intergenerational mobility have come in tandem with rising levels of wealth inequality. U.S. wealth is densely concentrated among relatively few households, with the top 10% of households today owning roughly 67% of the nation’s wealth, compared to the 2.5% for the bottom 50% of households. Even among households that are exclusively above age 50, which removes cases where people are high-income but low-wealth (such as a recent law school graduate), the wealthiest 10% of households own 70% of wealth in that age range, while the bottom 50% of households only have 3%.
This combination of low social mobility and high wealth inequality produces a self-perpetuating hierarchy of economic privilege, making it difficult to get ahead on hard work alone. As much as 60% of all wealth in the United States is inherited rather than earned. Moreover, this inheritance income is skewed toward those who already enjoy comfortable lives: In 2021, the top 10% of earners received 55% of total inherited wealth, while the bottom 40% received less than 10%. It’s perfectly natural that people who have enjoyed economic success would want to pass some of their wealth on to their children. But the privilege cannot be limitless. Entrenched aristocracies built upon generations of inherited wealth create a substantially uneven playing field and pose a threat to our democracy, as concentrated wealth, in turn, leads to concentrated economic opportunities and political power.
The best tool for reconciling this tension between individual liberty and America’s promise of equal opportunity for all is the U.S. tax system. But as the next section of this paper explains, the current estate tax is undermined by large exemptions and loopholes that make it easy to avoid for even the wealthiest families. It has also become deeply unpopular with the general public after years of anti-tax Republicans arguing that, because taxes are already levied on the income a person earns during their lifetime, taxing the assets a person leaves behind is an unfair “death tax” that amounts to double taxation. But these critiques misrepresent who actually pays the estate tax. Someone who is already dead suffers no inconvenience from the estate tax or any other tax policy; the tax is instead borne entirely by heirs who never paid any tax on the income they receive from an inheritance.
The following sections of this paper offer federal policymakers a technical framework for reforming the taxation of intergenerational wealth transfers to progressively raise revenue and undercut the misleading political attacks levied against the current system. To start, we propose to replace the estate tax — which taxes a decedent’s estate — with a new system that would only tax inheritance as it is received by an heir. This approach would both limit Republican “death tax” arguments by making it more clear that the tax is paid by wealthy heirs and create a fairer system for heirs by only taxing the inheritance they actually receive as income. We also propose reforms to the gift and generation skipping transfer taxes — two taxes intended to complement the estate tax — to work better alongside our proposed inheritance tax.
Next, we offer a series of reforms to close the largest loopholes in the current wealth transfer tax system. One of the biggest is the stepped up basis, which permits previously unrealized capital gains to completely escape taxation after an asset has been passed down. In addition, our proposal takes aim at the myriad of loopholes that arise from the IRS’s favorable treatment of non-liquid assets, including tax deductions and discounts commonly abused by wealthy families. However, we also pair these reforms with expanded protections to ensure that no heir has to sell the family farm, home, or small business they inherit just to pay an onerous tax bill. Lastly, we make major reforms to the taxation of trusts, streamlining complicated tax rules and closing the many loopholes that arise from this complexity while preserving the use of trusts for valid reasons unrelated to tax avoidance.
Left out of our proposal are changes to address other vehicles that are sometimes used to avoid estate tax, such as leaving estates to questionable nonprofit “family foundations” or using life insurance to pass along wealth tax-free. Since closing these loopholes would require a much broader rethink of the taxation of nonprofits and life insurance overall, and our proposal makes them no worse than under current law, we have chosen to leave them unchanged. Despite these omissions, our proposal would be a substantial improvement over the status quo, raising several hundred billion dollars over ten years from the wealthiest households while creating a better and fairer tax regime. Furthermore, every dollar raised by taxing unearned inheritance is one that does not need to be raised by increasing taxes on the earned incomes of working and middle-class Americans, making it a strong option for policymakers to consider in the context of future tax reform or deficit reduction efforts.
