Taxing unrealized capital gains? The mind boggles

Taxing unrealized capital gains? The mind boggles
Editorial: Democratic Party's proposal represents a fundamental shift in how people are taxed.
SEP 10, 2024

Tax fairness – the concept of taking more from those who can pay more – has been a source of political contention for years. The issue, unsurprisingly, has been thrust back into the spotlight during the US election campaign as the two candidates, Vice President Kamala Harris, of the Democratic Party, and Donald Trump, of the Republican Party, attempt to outline their respective visions for the country.

Trump, of course, is broadly pro-tax cuts, while Harris believes big corporations and the ultra-wealthy should pay more. To that end, she has voiced her support for a “billionaires-minimum tax,” originally proposed by President Joe Biden, which targets individuals with wealth exceeding $100 million by requiring them to pay a minimum tax rate of 25 percent on a combination of their income and unrealized capital gains.

The number of people this affects is small, but the concept of taxing unrealized capital gains represents a fundamental shift in how people are taxed. Instead of only taxing income earned, it introduces a “wealth tax” on paper gains that may or may not materialize.

The mind boggles with the potential implications.

To avoid being hit hard, or to cover their obligations, the top earners would likely attempt to reduce their bill by selling shares or assets, potentially destabilizing firms and increasing market volatility. There is also the risk that the ultra-wealthy would prefer to deploy capital outside of the US, diminishing the economy.

Then there is the administrative burden of the tax proposal. How are businesses and land, for example, valued? It invites disputes. What happens if an asset suddenly drops in value, and you’ve been paying tax on the unrealized gains for years? Payments, according to reports, would be credited against future capital gains tax liability on the asset when sold – but that’s of little consolation if the value has plummeted by time of sale.

Advisors who spoke to IN recently expressed concern that the “billionaires-minimum tax” is a slippery slope toward taxing more people on assets they still own. Would that mean taxing unrealized gains on people’s homes? What if the person has no plans to move? How would that affect their retirement? Such a prospect seems unlikely, but the principle applies – and looks fraught with danger.

Taxing unrealized gains also raises liquidity issues. What if a client is property rich but relatively cash poor and can’t afford the tax bill? According to the non-partisan Tax Foundation, this can be paid in equal installments over nine years. Again, though, the burden on taxpayers is raised considerably.

By adding more liability and complexity, the “wealth tax” does little to incentivize saving and entrepreneurship, pillars of “getting ahead” and creating wealth. Of course, a lot needs to happen for this to pass into law, but the principle of taxing unrealized capital gains appears overly complex and counterintuitive.

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