What Are Some Proposed Reforms to the Capital Gains Tax?

If, and how, the capital gains tax should be reformed is a subject of many tax policy debates. Some economists and policymakers contend that the tax’s burden on certain taxpayers should be increased to help mitigate any undesirable economic effects, promote a more equitable tax base, or increase federal revenues. Others suggest that the tax’s impact should be reduced to spur investment and promote entrepreneurship. Some common proposals to reform the tax include:

• Increasing the capital gains tax rate. Proponents of raising the tax rate on capital gains argue it would increase tax fairness by limiting the preferential treatment of long-term capital gains, which mostly benefits high-income taxpayers. The Tax Policy Center estimates that the revenue-maximizing rate on capital gains is about 28 percent, but warn that increasing the tax rate without other reforms could exacerbate existing lock-in effects. Accounting for such tradeoffs, the Penn Wharton Budget Model estimated that increasing the top rate from 20 percent to 24.2 percent would increase revenues by $66 billion over a 10-year period.
• Removing the ‘step-up’ basis of capital gains at death. Currently, if the owner of a capital asset passes away and bequeaths that asset to someone else, the basis of the asset will be adjusted to reflect the asset’s current value. For example, if an asset was purchased for $100,000, then bequeathed and inherited at $150,000, the tax basis of the asset would be adjusted to $150,000. If the heir then sold the asset at that price, they would not owe any taxes on the gains accrued prior to their inheritance (the $50,000 in profits). Removing that step-up basis would subject the full $50,000 profit to taxation. In 2020, the Congressional Budget Office estimated that such a policy would increase revenues by $110 billion over a 10-year period.
• Taxing capital gains on an accrual basis. Instead of taxing capital gains when an asset is sold, an accrual system would tax the annual increase in an asset’s value, even if the asset were not sold (also known as a mark-to-market system). While such a system would involve an annual valuation of capital assets and likely require significant resources from the Internal Revenue Service, it would limit the amount of capital gains that are deferred and raise a significant amount of revenues. Tax policy experts at New York University estimated that an accrual system limited to only marketable assets for the top 1 percent of households would raise around $1.7 trillion over 10 years.
• Indexing capital gains to inflation. Currently, capital gains are not adjusted for inflation over the time the asset was held. Such an adjustment would decrease the income subject to taxation, thereby reducing tax liabilities. For example, a $10,000 purchase in January 2014 had the same buying power as $13,185 in January 2024; if sold on that date for $20,000, the seller would be subject to taxes on an inflation-adjusted $6,815 gain opposed to the nominal $10,000 gain. The Tax Policy Center estimated that such a change could decrease federal revenues by $20 billion per year.