So here’s the deal. The Democrats want to raise the estate tax. Republicans want to escape the annoying and counterproductive capital gains tax. How about we compromise on the following — Congress reduces the capital gains tax to zero but doubles the estate tax Americans would pay at death?

That, it turns out, would be the tax deal of the century, for American taxpayers, for the United States Treasury, and especially for the American economy.

America’s economic greatness — what John Steele Gordon called “The Empire of Wealth” — was built on the mostly steadily growing value of investment in America’s many enterprises and capital markets. Some fortunes started simply as a sole proprietorship that morphed, like Ray Kroc’s hamburger stand, into multibillion-dollar enterprises. Others grew from the Average Joe saving for retirement by investing in the stock markets, that created liquidity for the Ray Krocs and opportunity for Average Joe to own part of McDonald’s economic success.

Driven by the magic of compounding, such investments grow nicely, provided they’re not interrupted. One dollar compounding at 10%, slightly less than the long term performance that finance guru Roger Ibbotson attributes to the U.S. equity markets, will grow over 40 years, an average working life, to $45.26.

Then again, if one can outperform the market and compound a dollar at 15%, one would end up, after 40 years, multiplying his initial investment a whopping 268 times. That’s why compounding is called the Eighth Wonder of the World.

So far, so good. The problem comes when, in order to maintain the desired compounding rate, one has to move from one investment to another. IBM, say, starts looking a little tired. So one decides to move to Microsoft. When a person makes that switch, all the compounding gains accumulated up to that time are subject to the capital gains tax, which is 23.8% — for now. So after five years, a one-dollar investment compounded at 15% equals $2.01.

Yet now the investor must pay 23.8% of the $1.01 gain. That means he would be putting only $1.77 — not $2.01 — into the new investment that he hopes will grow at a higher rate. The IRS has effectively reduced the compounding rate from 15% to circa 12%. Over time, that makes a big difference.

So let’s look at the case of the average investor who can compound his investments at 10%. Without a capital gains tax, his nest egg after 40 years would be 45.26 times his original investment. However, if in order to maintain the 10% rate, he has to rebalance his portfolio every five years, seven times, and each time incur the 23.8% tax, he will wind up not with 45.26 times his original investment but just 23.34 times.

That’s roughly 50% of what he would have had without the capital gains tax. In other words, although the tax itself is “only” 23.8%, the penalty on one’s wealth, assuming five-year rebalancing, is closer to 50%, due to the periodic impact of the tax on the amounts remaining to be compounded. The 23.8% tax may not sound unreasonable, but a 50% haircut?

Because of the arithmetic of compounding, the loss of potential wealth is even greater at higher compounding rates. At a 15% annual return compounded over 40 years, the original investment increases a life-altering 268 fold. If the portfolio is rebalanced and capital gains taxes are imposed every five years, the multiple of the original investment shrinks to 110 fold. That’s a mere 40% of what it would be untaxed. So the 23.8% capital gains tax now costs the investor a staggering 60%.

And the loser is not just the taxpayer but the United States Treasury as well. For the government, it turns out, is like the spendthrift saver, raiding the piggy bank at regular intervals, via the capital gains tax, rather than allowing the savings to compound. The resulting reduction in wealth translates directly into a lower estate tax.

Take the 10% compounding case. Without a capital gains tax the estate would be worth 45.26 times the original investment. Assuming the current 40% estate tax, Uncle Sam would collect 18.10 times the original investment. If the estate were forced to pay capital gains taxes every five years, the terminal value would be only 23.34 times the original investment and the 40% death tax nets only 9.34 times, a mere 51% of the estate tax had capital gains not been taxed.

What if you add in all those taxes on gains paid along the way? The cumulative capital gains taxes paid over 40 years would be 4.22 times the original investment. So the total tax, capital gains plus estate, would amount to 13.56 times the original investment, still only about 75% of the estate tax without the capital gains interruption.

I won’t bore you with all the calculations assuming 15% compounding except to say with the higher compounding rate the discrepancy is much larger. Untaxed along the way, the current estate tax would yield 107.15 times the original investment. The cumulative capital gains taxes plus the estate tax on the diminished estate only provide 60.63 times the original investment, or about 57% of what the IRS would collect with no capital gains tax. Bad trade.

In addition to the absolute loss of tax revenue, there is collateral damage as well, because the capital gains tax makes investors reluctant to trade out of one position to invest in a more attractive one. This has been proven time and again when lowering capital gains taxes generated higher tax revenue as investors were more willing to take gains at the lower rate.

The illiquidity impact of the capital gains tax means suboptimal investing leading to lower economic growth as money doesn’t flow freely to its highest and best use. And a smaller economy over time, has negative implications, not just for wealth, but for wages. Since 1950 wages as a share of GDP have run between 43% and 50%.

So anything that increases GDP would inevitably increase wages (and, incidentally, government revenue from income taxes). That means that the wage earner would be among the biggest beneficiaries of the deal being proposed here, along with his silent partner, the Uncle Sam’s Treasury.

Remember, the original bargain was no capital gains in exchange for doubling the death tax. Under that arrangement, the death tax due at 10% and 15% compounding, respectively, would be 36.2 times and 214.3 times the investor’s original investment. That is, Uncle Sam would take in hugely more under our bargain compared to 13.56 times the original investment (at 10% compounding) or 60.6 times the original investment (at 15%) when the estate is taxed at the 40% rate with capital gains tax paid along the way.

Because of the enormous difference in wealth creation when compounding is not periodically interrupted, the deceased’s estate would be in the case of a 15% growth rate only about 20% smaller with an 80% estate tax rate than it would have been at the 40% rate for the estate tax combined with capital gains tax.

The Treasury, on the other hand, would enormously better off. And for those hung up on wealth inequality, they can say with satisfaction that 80% of that private wealth will be confiscated at death and redirected to the common good. That’s an outcome which would make Karl Marx and Elizabeth Warren smile, right along with the investor.

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Mr. Childs is a private investor based in Florida. His column on the wealth tax, “The Edict of Warren,” appeared in the Sun in February.