In this year’s State of the Union address, President Biden once again touted his proposal to target the unrealized gains of wealthy individuals. Unfortunately, it has not gotten any less unworkable and economically harmful than the last time it was proposed.
Biden’s “billionaire tax” is a misnomer, as it does not apply exclusively to billionaires. The proposal would assess a 20 percent minimum tax rate on both the income and the unrealized capital gains of taxpayers with a total wealth of greater than $100 million (definitionally not “billionaires”).
Proposals to tax unrealized gains have become far more popular in recent years, as progressives seek new sources of tax revenue to fund further expansions of government. But there are good reasons why we don’t tax unrealized gains currently.
The first reason is that taxing unrealized gains violates principles of tax fairness. While it would be inaccurate to say that capital gains are worthless to a taxpayer until they are realized, we still instinctively recognize that the realization of those gains is the appropriate taxable event.
That’s because those unrealized, on-paper gains are just that until they are actually realized. Taxing an activity that does not provide a taxpayer with more cash on hand creates logistical issues not present with traditional income taxes — namely, some taxpayers may lack the cash to pay the taxes they owe, such as entrepreneurs whose start-up takes off rapidly. This can create situations where founders are forced to liquidate a controlling interest in their brainchild just to pay their tax bills.
But the arguably greater issue is one of logistics. Countries that adopted wealth taxes have tended to abandon them because the logistical issues proved more difficult to handle than the comparatively meager revenues were worth.
To begin with, Biden’s proposal requires an accurate accounting of an individual’s wealth to assess whether or not a taxpayer is subject to the tax. This would require a great deal of effort dedicated to valuing non-liquid assets — some of which would prove tremendously difficult to value.
Take a somewhat recent example, when Michael Jackson passed away. Jackson’s estate valued his image and likeness at just $2,105. The IRS, on the other hand, valued it at $434 million. That alone is more than enough to make the difference between a taxpayer being liable for “billionaire tax” or not. It took twelve years for a court to finally arrive at a ruling valuing Jackson’s likeness at $4 million.
Now imagine if IRS agents were responsible for valuing not only celebrity likenesses, but also privately-held businesses, artworks, and all the other assets that make up an individual’s net worth on an annual basis. Then imagine if the IRS then had to defend its valuations in court from an army of very wealthy individuals with the resources to engage in protracted court battles. The only winners would be lawyers.
And even if the IRS could get past the issue of determining who was subject to the tax, it would then have to deal with the even-more complex issue of determining liability and administration. A tax on unrealized gains would require all kinds of lookback periods, transition rules, and provisions for treatment of capital losses.
It’s also worth noting that past iterations of this proposal have required taxpayers to pay taxes on unrealized gains not only going forwards, but retroactively as well. In other words, in the first year it was in effect, taxpayers would be liable for taxes on all unrealized gains up to this point. That would create a massive tax bill on a great deal of non-liquid assets, one that would be likely to create all kinds of economic disorder as wealthy individuals sold assets en masse to raise cash for their tax bills.
Convoluted proposals to subject whole new categories of income and wealth to the tax base are presented as being simple, but the reality is that they are anything but. The administration should leave half-baked and unworkable tax policy ideas back on the drawing board where they belong.
