President Biden’s $7.3 trillion budget proposes a federal tax on unrealized capital gains, following Vermont and ten other states that have considered similar measures. This tax, which is unjust, likely unconstitutional, and economically harmful, should be firmly rejected.

What Are Unrealized Capital Gains?

Unrealized capital gains refer to the increase in value of an asset, such as property or stocks, that has not been sold. Taxing these gains means individuals would be required to pay taxes on the increased value of their assets even if they haven’t sold them and realized any income.

For instance, if you bought a stock for $100 and its value rose to $110 by the next year, you would owe taxes on the $10 gain despite not having sold the stock. If the stock’s value then dropped back to $100, the loss would not easily offset the previously taxed gain, creating a complex and potentially unfair tax situation.

Types of Unrealized Gains Taxes

According to Adam Michel of the Cato Institute, President Biden’s budget includes two main types of unrealized gains taxes:

1. Elimination of Step-Up in Basis: This makes death a taxable event, taxing unrealized capital gains over $5 million for single filers and $10 million for married couples.
2. New Minimum Tax: A 25% minimum tax on income and unrealized capital gains for taxpayers with more than $100 million in wealth, creating a parallel tax system.

Economic and Moral Arguments Against the Tax

1. Unfairness and Property Rights: Taxing unrealized gains penalizes individuals for owning appreciating assets without realizing actual income. This contradicts principles of fairness and property rights essential for a free society.
2. Economic Disincentives: The tax discourages investment and capital formation, crucial for economic growth. Investors may avoid investing in productive assets like stocks or real estate, leading to slower economic growth and misallocation of resources.
3. Innovation and Entrepreneurship: By reducing available capital, the tax stifles innovation and entrepreneurship. Start-ups and small businesses rely on risk-taking investors, who may be deterred by such a tax.
4. Personal Liberty: This tax infringes on individuals’ property rights and financial privacy, granting the government excessive control over personal assets and discouraging saving and investment.

Detailed Examination of Economic Impact

The economic impact of taxing unrealized capital gains extends beyond individual investors to the broader economy. By penalizing individuals for holding appreciating assets, this tax creates a disincentive to invest in growth-oriented opportunities. For example, investors might shy away from putting money into emerging industries or innovative technologies due to the fear of being taxed on paper gains that have not yet been realized. This hesitancy can slow down the pace of technological advancement and economic development.

The Legal and Constitutional Concerns

The legality of taxing unrealized gains is another significant concern. The U.S. Constitution grants Congress the power to tax incomes, but unrealized gains do not constitute income in the traditional sense. Legal challenges to such a tax are inevitable and could result in prolonged uncertainty and instability in the tax system. This potential for legal disputes adds another layer of complexity and risk for investors, further dampening economic activity.

Historical Perspective

Looking at historical precedents, the U.S. tax system has traditionally taxed income that is actually realized. The principle behind this approach is that individuals should be taxed based on their actual economic transactions, not hypothetical scenarios. Introducing a tax on unrealized gains would represent a significant departure from this principle, potentially setting a precedent for further intrusive and speculative taxation policies in the future.

Counterarguments and Reality

Proponents argue that taxing unrealized gains addresses income inequality and raises revenue for social programs. However, this tax fails to address the root causes of inequality and merely redistributes wealth, misallocating resources. Additionally, the anticipated revenue from such a tax is likely overestimated, as individuals will find legal ways to avoid it, resulting in reduced economic prosperity and lower tax collections.

Furthermore, the administrative burden of implementing and enforcing such a tax would be substantial. Valuing assets that are not regularly traded on public markets, such as privately held businesses or real estate, poses significant challenges. The cost and complexity of this process could outweigh the benefits, leading to inefficiencies and potential errors in tax assessments.

International Comparisons

Examining international examples, few countries have successfully implemented taxes on unrealized gains. Those that have attempted such measures often face significant pushback and economic challenges. For instance, in countries where similar taxes have been introduced, there has been a notable decrease in investment activity and capital flight, where individuals and businesses move their investments to more favorable tax jurisdictions. This global perspective underscores the risks and downsides of adopting such a tax policy in the U.S.

Conclusion

Taxing unrealized capital gains is an economically unsound and morally questionable policy. It undermines economic growth, stifles innovation, and infringes on personal liberty. Instead of imposing such misguided taxes, the government should focus on reducing spending, taxes, and regulations to promote investment and economic opportunity.Only then can we foster a truly free and prosperous society.