Plans to Tax Unrealized Capital Gains Are Beyond Radical. They’re Ridiculous

H ow much in unearned wages will you pay taxes on next year? Better yet, how many yet-to-be-born children do you plan to include on your tax return? If these questions sound ridiculous to you, then you will understand exactly why proposals to tax unrealized capital gains are equally absurd.

Earlier this week, the president proposed a minimum 20 percent tax rate that would hit both the income and unrealized capital gains of U.S. households worth more than $100 million as part of his budget proposal to be released on Monday. But don’t let those seemingly simple parameters fool you — this tax would hurt everybody.

If the president’s “Billionaire Minimum Income Tax” were to be implemented, employment opportunities and wages for the average American would decline. What’s more, the plan to tax unrealized gains may face potential legal obstacles — most notably, the U.S. Constitution.

The proposal is essentially a rehash of a failed tax proposal offered by Senator Ron Wyden (D., Ore.) last year to offset some of the costs of the Build Back Better agenda. Unrealized capital gains are an increase in the value of your investment that you have not sold — these gains are not taxed because the value hasn’t been realized until you cash out the gains.

Here’s another way of thinking about the proposal: You buy a painting worth $1,000, and after one year the market price for the painting increases to $1,500. You won’t be expected to pay taxes on that $500 gain in value because you haven’t sold the painting. This is an unrealized gain.

Taxing unrealized gains aside, policymakers have long acknowledged that even taxing realized gains is inefficient and economically harmful. Previous Democratic administrations openly acknowledged the economic costs of capital-gains taxes. In the 1960s, President Kennedy noted how capital-gains taxes negatively affected investment and growth. Similarly, a Joint Economic Committee report in 1997 concluded that the capital-gains tax “is systematically biased against savings, investment, and work effort.” The Clinton administration agreed with that assessment.

Capital-gains taxation is one of the least efficient and most economically destructive forms of taxation that governments can implement. It leads to less growth, fewer jobs, and reduced tax revenue. 

Then there is the issue of calculating how many households have a net worth over $100 million. Finance website DQWDJ says there were around 34,507 such households in the U.S. as of 2021. How does the IRS plan to calculate the value of different assets and identify this group? One can only imagine how arbitrary, inefficient, and inaccurate this process could turn out to be.

All that said, unrealized gains represent changes in wealth, not income. In this sense, a tax on unrealized gains is a wealth tax. If the history of wealth taxes teaches us anything, it’s that they never work as intended and tend to be abandoned to alleviate the economic destruction they wreak.

Over the past century, 15 European countries have implemented a tax on wealth — today only three of those countries still have a wealth tax in place.

France repealed its wealth tax in 2017 after the prime minister admitted that it had led to an exodus of 10,000 to 12,000 millionaires every year. The French wealth tax (and subsequent exodus of the rich) reduced economic growth, and the yield from the tax made up little more than 1 percent of total tax revenue — hardly a worthwhile trade-off.

Sweden, often held in high regard by progressive policy-makers as a model country, had a wealth tax for almost a century before abandoning it in 2007. The Swedish tax was said to have had “virtually no effect” on government finances, but it had been blamed for years for a massive reduction in domestic investment. Germany too had a tax on wealth, which was eliminated in 1996 after being ruled unconstitutional.

Putting aside economic and historical arguments against wealth taxes, there is the question of whether the U.S. Constitution even grants Congress the authority to impose such taxes on wealth.

The 16th Amendment to the Constitution provides that “the Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.” In other words, a tax on wealth (such as unrealized capital gains) must be applied equally to all 50 states, according to the state’s population size. Mississippi, which makes up roughly 1 percent of the nation’s population, would have to produce roughly 1 percent of revenues raised by the tax.

Once you consider that seven U.S. states have zero billionaires, and California and New York combined have almost half (45 percent) of the nation’s billionaires, you can begin to see why a tax on unrealized gains on billionaires would be in violation of the 16th Amendment’s equal-apportionment clause.

For this reason, you can expect progressives to deny it’s a wealth tax.

Regardless of what we call it, however, policy-makers must recognize it for what it is: the most ridiculous tax proposal by a president in recent memory.