Newly-inaugurated President Biden is likely to take office and push for a flurry of new legislation. Yet while all eyes will be on Biden’s proposals for COVID-19 relief, healthcare policy, and undoing the 2017 tax reform law, two other dangerous ideas are flying under the radar.
The first of these is a proposal to implement a so-called “mark-to-market” regime for taxing unrealized capital gains. Currently, taxpayers pay tax only on “realized” capital gains — in other words, when the asset is sold and you bank a profit. Though its on-paper value might fluctuate during ownership, only when an asset like stock in a publicly-traded company is sold is the taxpayer liable for tax on the realized capital gain.
But a proposal championed by the incoming Chair of the Senate Finance Committee, Ron Wyden (D-OR), would change this. Under Wyden’s proposal, taxpayers over a certain income level or with qualifying assets exceeding a threshold would be expected to pay taxes on increases in the on-paper value of assets, even if the capital gain was unrealized.
A mark-to-market system presents many challenges that make clear why such a system hasn’t been implemented in the past. First and foremost, valuation of non-liquid assets can be complex. Assets such as stocks can be valued fairly easily, but others, like artwork or jewelry, may require appraisal. The administrative burden of ensuring accurate valuation of a diverse array of assets — and the opportunities it provides for gaming the system — may outweigh the revenue raised.
Another issue with the idea is that a mark-to-market regime would unfairly burden upstart investors. For example, many young businesses are “cash-poor” as they invest in fully establishing themselves. As a result, owning a share of such a company could generate a significant tax bill without the corresponding cash to pay it.
This could lead to some entrepreneurs being forced to sell part of it off prematurely in order to pay the tax bill arising from their unrealized capital gain. A “lookback period,” whereby an investor could delay payment of tax until the gain is realized but suffer a penalty as a result, eases the burden somewhat but also biases the system toward cash-rich investors and introduces more administrative complexity.
Lastly, any mark-to-market system would have to deal with capital losses. After all, an asset with a starting basis of $30 that grows to $80 over the course of one year would face taxes on a $50 capital gain under a mark-to-market system. But if that same asset dropped back down to a value of $20 the next year, the investor gained nothing — overall, they lost money! Any fair tax system would give that investor the ability to offset gains with losses, as is generally the case elsewhere in the tax code.
And a mark-to-market system isn’t the only half-baked tax idea coming out of the Beaver State. Congressman Peter DeFazio (D-OR) has introduced legislation for an idea backed by President Biden — a financial transaction tax (FTT). FTTs are often presented as a tax on Wall Street day traders, but the fact is that the harmful effects would be far-reaching.
FTTs violate one of the most basic rules of tax policy — that the same income should not be taxed multiple times. FTTs tax financial trades, placing another tax on top of existing taxes on capital gains and corporate income. Tax pyramiding obscures the impact of taxes on taxpayers while creating situations where taxpayers have to pay taxes on taxes that were paid during a previous stage.
And the poor design of FTTs are one of just one of their problems. By punishing investors, FTTs would effectively increase the cost of raising capital as well. This would make it more difficult for businesses to fund investments — something tax policy should be facilitating, not hampering. FTTs would also be distortive, arbitrarily targeting assets that are more frequently traded over less-frequently traded assets.
While a mark-to-market system and an FTT might be popular in the new Congress and could very well become law in some form, they’re far from good policy. While the headlines focus on flashier issues, taxpayers should beware efforts to establish complex new taxes that could prove expensive and harmful to the economic growth we’ll need to address the COVID-19 crisis.