In left-leaning tax policy circles, much energy has focused on taxing unrealized gains. There are two main reasons why. First, the wealthiest Americans hold lots of unrealized gains—perhaps as much as $13.4 trillion—and they will avoid income tax on those gains if they simply hold their appreciated assets until death. Second, this and other aspects of current law encourage taxpayers to hold assets even when selling would make sense from an economic perspective. That “lock-in” effect is a powerful distortion.

A targeted solution to this first problem—and a partial solution to the second—is to deem death to be a realization event. If death is a realization event, unrealized gains will eventually be taxed, and the incentive to hold assets until death will be relaxed. Proposals along these lines date back to the Kennedy administration, and they were revived by Presidents Obama and Biden.

In a new paper, Steven Rosenthal and Robert McClelland argue that those earlier proposals don’t go far enough. Prior proposals to deem death a realization event would apply the preferential rate for capital gains (currently 23.8% for top-earners, including the tax on net investment income) to any gains realized on death. Rosenthal and McClelland would go further. They propose to apply the ordinary rate (currently 40.8% at the top, again including the tax on net investment income) to gains realized on death. Thus, capital gains at death would be taxed at a rate higher than during life.

The authors’ core insight is that there’s no good reason to apply a preferential rate to gains realized at death. According to the standard rationale for the capital gains rate, a preferential rate is needed to encourage realization despite the tax code’s powerful incentives to hold. But death is, in effect, a forced sale. Since there’s no need to encourage that involuntary realization of capital gains, we might as well tax the gains at the ordinary rate.

Building on that insight, Rosenthal and McClelland build out a detailed policy proposal with several features:

• First, the tax would target ultra-wealthy taxpayers. Anyone whose net worth is less than $100 million would be exempt, and the tax would gradually phase in for those whose net worth is between $100 million and $200 million.
• Second, gifts made while living (inter vivos) would also count as realization events. If inter vivos gifts were not realization events, taxpayers would still have access to unlimited deferral: they could simply gift property repeatedly without ever realizing gain. Nonetheless, the authors propose that gains realized upon gifting should be subject to the capital gains rate, not the ordinary rate. That would encourage property to circulate before death.
• Third, and relatedly, Rosenthal and McClelland propose to allow taxpayers to elect into mark-to-market treatment (again, at the capital gains rate). This would allow taxpayers to retain property that has personal significance (such as a family business) without deferring or avoiding tax.
• Finally, sales or gifts made within three years of death would be deemed to occur at death. This is to prevent deathbed gifts and below-market sales.

The authors estimate that this proposal, if enacted, would raise approximately $851 billion over the next ten years.

Of course, deeming death to be a realization event is not the only way to tax unrealized gains. Rosenthal and McClelland compare their proposal to five prominent alternatives: providing carryover basis at death, treating borrowing as a taxable event, mark-to-market accounting, lookback interest charges (aka “retrospective capital gains taxation”), and prior proposals to treat gratuitous transfers as realization events. The authors argue that their proposal has various advantages over these alternatives. Some are administrative, some political, and some are fiscal: the authors estimate that their proposal will bring in considerably more revenue than many alternatives.

The authors make a strong case that prior proposals to treat death as a realization event do not go far enough. But I wondered whether the same point could be made about their own proposal. Why tax capital gains realized on death at the ordinary rate? Why not go higher? The authors anticipate that many taxpayers will not actually pay the rate applied to capital gains realized on death; instead, the upon-death rate will encourage them to realize their gains during life. If that’s right, our principal concern in setting the upon-death rate shouldn’t be whether it will distort consumption-savings or labor-leisure choices (since it’s probably not going to be the effective tax rate that many people pay). Rather, our principal concern should be whether this rate provides the right incentive to encourage realization while living. It’s not obvious that the top marginal rate on ordinary income is optimal for this purpose—indeed, it would be surprising if that rate, designed for different policy objectives, happened to be exactly right.

Of course, questions could be raised about the political feasibility of both the authors’ proposal and an even higher rate on capital gains realized upon death. The authors touch on political feasibility only briefly, noting the unpopularity of some alternatives like mark-to-market accounting. President Biden’s failure to reform the step-up in basis on death even with a Democratic trifecta suggests the difficulty of any reform in this area. At the same time, the authors’ proposal may have political advantages over previous efforts, particularly its targeted focus on the ultra-wealthy.

All told, this is an illuminating and thought-provoking article. Rosenthal and McClelland have developed a novel and thoughtful policy proposal—one that is interesting in its own right and sheds new light on the problems that it strives to solve.