When Democrats published the details of their proposed tax increases on Monday, they thankfully did not include repeal of the cost basis step-up of assets held at death.  The entire estate planning industry breathed a huge collective sigh of relief.

Why write about a proposal that is now moot?  Because the fact that it was seriously considered says a lot about the state of our politics and the role that the tax code has come to play in promoting social policy.

The concept of the step-up is fairly simple: at death, the cost basis of assets held directly by an individual is increased to the value of those assets as of the date of death (or, if selected, the date six months after such date). 

The consequence of this basis step-up is that any capital gains tax due on a later sale or disposition of the assets will be calculated on the difference between the value at disposition and the stepped-up basis; the gain in value between the decedent’s acquisition of the assets and death thus “escapes” any gains tax. 

Modern-day class warriors decry this tax result as “unfair” and seek to have it removed in the interest of “tax equality.”  But in so doing they overlook or ignore past history, the rationale underpinning the provision, and the practical difficulties its abolition entails.

We’ve seen this movie twice before.  Basis step-up upon death was first eliminated in the Tax Reform Act of 1976.  It was replaced with a “carryover basis regime” that required extensive, complicated and continual recordkeeping.  The proposed rules were heavily criticized as unworkable, and basis step-up returned.

The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax in its entirety and replaced it with a carryover basis regime, but only for calendar year 2010.  After much opposition, Congress in mid-December 2010 retroactively reinstated the estate tax and basis step-up, allowing the estate representatives of decedents dying in 2010 to elect either to pay the estate tax or adopt the carryover basis regime.  The result was confusion, frustration and disparate results – the opposite of tax equality.

Past difficulties implementing a repeal of the step-up (and complying with a carryover basis regime) argue for its fundamental impracticality.  The reasons for its continued existence are more compelling.

The federal government imposes estate tax on the value of a decedent’s estate at death.  That value includes any built-in gain.  Eliminating the step-up would cause that built-in gain, which would carry over into the hands of an inheritor, to be taxed again on a future sale or disposition by the inheritor.  It is hard to view the resulting double taxation of gain as “fair,” at least to the taxpayers.

The Wall Street Journal’s Robert Rubin recently cited opposition by “rural Democrats” as the reason for omission of the administration’s proposed step-up repeal in the final plan.  This likely refers to the very real concern held by farmers and small business owners of the difficulty of keeping their enterprises in the family through generations. 

As originally proposed, the step-up repeal would have been coupled with realization (and taxation) at death of all built-in gain in excess of $1 million.  This could have forced inheritors to liquidate their principal sources of family wealth and income simply to pay the death tax.

And step-up repeal would not have hurt just the rich.  The dramatic increases in housing prices over the past years have left many moderate-income families sitting on large unrealized real estate gains.  In fact, Howard Gleckman and Robert McClelland of the Urban-Brookings Tax Policy Center estimated recently that the administration’s step-up proposal would have impacted 2% of decedents making less than $400,000, a group on which it had pledged not to raise taxes.

It is said that the two certainties in life are death and taxes.  Joining the two runs the risk of invoking a third: the law of unintended consequences.

The fact that this proposal made it as far as it did in the tax reform process says a lot about our current overly political approach to government financing.  In the rush to find funding sources for ambitious spending plans, some political actors are willing to ignore both history and the practical and economic consequences of any proposal that promises to generate revenue of any amount, regardless of social cost.  And if it appears to “soak the rich,” so much the better.

We deserve better, more serious and more responsible vetting of any and all proposals that impose financial burdens on our citizens and complicate their legitimate pursuit of their own personal and family goals.  Tax policy should not be used as a tool for pursuing social change.  Wishful thinking perhaps, but hope always springs eternal.