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Inheritance wealth: One reason the rich get richer

The Biden Forum Highlight is a series of quick reads on the middle class. Each week, editors at the Biden Forum will highlight a key insight from new economic research and break down what it means for middle-class Americans. What should we highlight next? Email your questions or recommendations to [email protected].

Inheritances are an important source of income in the United States. As noted in a recent post by New York University School of Law Professor Lily Batchelder, inheritances make up about 40 percent of all wealth and 4 percent of household income every year.

But inheritances aren’t distributed evenly across households. As one might expect, households with higher income receive substantially higher inheritances — with marked disparity among those with incomes over $500,000. Households with “economic income” — earned income plus inheritance wealth — below $100,000 receive less than $100,000 in inheritances over the course of their life. But lifetime inheritances skyrocket for households with more than $1 million in economic income, as these households receive well over $600,000 in inheritance, on average.

The U.S. has traditionally addressed this disparity through an estate tax which typically taxes wealth above a given threshold. However, in recent years, the estate tax has been weakened considerably, with the per-couple threshold for taxation rising from $1.35 million in 2001 to over $22 million today — in large part due to the 2017 tax act’s generous estate tax cuts which doubled the per-couple threshold.

Source: Washington Center for Equitable Growth

A major justification for the estate tax is to capture capital gains income which has entirely escaped taxation throughout a decedent’s life. The “stepped-up basis” loophole — which costs about $40 billion annually — allows investors to forego any tax on investments if they hold the asset until they die. This not only costs the Treasury needed revenue and decreases tax progressivity, but also causes investors to hold otherwise poor investments until death to avoid a tax. This ultimately hurts our economy because capital is not directed to its most beneficial use.

The Biden Forum has addressed issues of inheritance taxes before. In particular, Boston College Law School Professor Ray Madoff advanced a proposal that would eliminate the estate tax, but subject inheritances to the income tax while concurrently eliminating the stepped-up basis loophole.