The time for sound economic thinking is now. Reading the economic policy news is a daily head-spinning experience. Price-gouging, “greedflation,” $25K government cash subsidies for new homebuyers, eliminating taxes on tips,expanded child tax credits, and taxing unrealized capital gains top the list. All these proposals may sound good, in theory, because politicians erroneously argue that we can use the government to generate the outcomes we want with the flick of a pen. But reality is a harsh teacher.
Vice President Kamala Harris wants to tax unrealized capital gains to generate more government revenue, and because we have a spending problem, we also have a revenue problem. After all, if we expand the child tax credit, invest more in schools and infrastructure, and give new homebuyers $25,000, we’d better have some cash on hand. It’s worth remembering that the government has the monopoly on the use of force and can only gain revenue by taxing, borrowing, or inflating. There is no money tree behind the White House, no unlimited stash of cash whereby we can indulge our policy whims.
The Biden administration’s proposal to tax unrealized capital gains, endorsed by Harris, is part of a $5 trillion tax package. This proposal, if approved, would impose taxes on capital assets like stocks, bonds, digital assets, and property that have grown in value but have not been sold; thus, they are “unrealized.” The plan proposes a minimum 25% tax, not to exceed 40% of the amount by which the taxpayer’s net worth exceeds $100 million. It would apply to those with income and assets worth over $100 million, about 10,000 people, called centi-millionaires (yet it’s known as the billionaire’s tax). If this legislation is enacted, it will result in top marginal tax rates on long-term gains and dividends of 44.6%, the highest rate in U.S. history. This would erode economic freedom, resulting in less dynamism and economic growth.
The U.S. boasts the most centi-millionaires by a wide margin—about 9,850; second place goes to China, with a mere 2,400, which is a tragedy when you consider that China’s population is over four times that of ours. Over 60% of American centi-millionaires earn entry into this exclusive club by starting their own business or investing in business start-ups; some inherit their money from their parents, who started businesses. It should be noted that the U.S. ranks #5 in Economic Freedom in the World, whereas China ranks #111. The reason? The United States fosters entrepreneurship and economic growth with a mostly free-market economy and by adhering to the rule of law. It’s why millions of people want to make America their home. It’s the world’s most entrepreneurial country due to its friendly business and investment climate, including access to capital. Yet that access to capital will be significantly reduced if we tax people on income they have not actually acquired. This will reduce employment opportunities and depress wages for Americans.
Taxing unrealized gains is punitive without cause and will not generate its stated outcomes. Politicians have incentives to focus on the benefits of their policies, downplay the costs, and often think they can play God, directing the economy at their will. Moreover, election season is when politicians become Santa Claus; “free” goodies abound. Yet economic thinking insists on thorough cost-benefit analysis and the need to ascertain the unintended consequences of each policy. Nineteenth-century French economist Frédéric Bastiat warned us about this. He writes:
In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause—it is seen. The others unfold in succession—they are not seen: it is well for us if they are foreseen. Between a good and a bad economist this constitutes the whole difference—the one takes account of the visible effect; the other takes account both of the effects which are seen and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favorable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, at the risk of a small present evil.
The first consequence may be favorable to the policymaker; the government can temporarily collect some of these unrealized gains. However, the evil to come is that investors will stop investing to avoid the tax, and capital will become less available. This is not an intended or desired outcome of the policy, but it’s so flagrantly obvious that anyone should be able to predict it. There’s a great deal of “bad” economics at work in this policy proposal. Maybe Harris’ now-viral rhetorical question, “Did you just fall out of a coconut tree?” should be asked of her.
If Americans find the U.S. economy less attractive for entrepreneurial investments, they will pursue them elsewhere, which over time will retard economic growth and lower standards of living. This tax would increase the burden on savings and entrepreneurship by punishing investment, which is the very thing that yields personal wealth and income growth. Moreover, thinking this tax can be isolated to the ultra-wealthy is foolish, because they invest in start-up companies; everyone will feel the pain.
Moreover, as economist Vance Ginn suggests, taxing unrealized gains is unethical and an economic fallacy, arguing that it lacks the principles of fairness and violates property rights essential for a prosperous society. It’s a penalty for owning any asset that appreciates when the owner has yet to realize a profit. If you purchase a home for $1 million, which appreciates to $1.5 million in a tax year, you would owe a minimum 25% tax on the $500,000 increase in value, even though you have not sold the asset. When you do choose to sell, you’ll be taxed again!
Harris asks us not to worry, however. After all, the tax falls on a tiny sliver of the already wealthy population with cash to spare. She reminds us that she only wants the rich to pay their fair share. Her 80-page economic plan is dubbed “The Fair Share Plan.” It’s a political trope as old as time. After all, who opposes fairness? She further claims she isn’t mad at anyone for achieving success. What a relief. This is from a vice president campaigning to become president who donned a $60,000 Tiffany necklace to visit our southern border—a place where impoverished people jump over walls yearning to be free. But I digress …
Sure, the rich have more money, but that doesn’t mean we should take it from them, nor does it imply that we can increase revenue or generate equality by taxing their wealth more than we already do. The U.S. currently has the world’s most progressive tax system. It’s a system, moreover, that’s losing Americans’ confidence—60% report that they pay too much in taxes and receive poor value in return.
Politicians and elected officials must address three questions when advocating a new policy: Is it ethical and sound? Does it violate the rule of law? Would it erode private property rights, the benchmark for investment and entrepreneurship? Regarding the taxing of unrealized capital gains, the answer to the latter two questions is yes, and mercifully, most agree. When polled, a whopping 75% dislike taxing gains before they’re sold; they do, however, favor taxes at the time of sale.
As for whether the policy is sound, we must determine whether the means will achieve the desired ends. In other words, does it pass the cost-benefit test? Answering that necessitates focusing on cost: lost investment with less access to investment capital. It will change how the wealthy manage their assets. Moreover, it will complicate an already cumbersome tax system. The U.S. tax code spans 2,652 pages; it reaches 9,000 pages if you include IRS regulations and statutes.
To add insult to injury, trader and investor Scott Melker also argues that the rich will take out more loans against their portfolios and never sell. He reminds us that the interest on those loans is tax deductible. Thus, the government will not accomplish its mission of raising revenue but will, you guessed it, bring in less revenue.
This policy’s advocates almost imply that monitoring and managing it would somehow be costless. Investor and Acton University lecturer David Bahnsen raises the question of how we will assess the value of illiquid assets each year, which raises yet another the question: Will we refund unrealized losses if we tax unrealized gains? It’s like living in an alternate version of the movie Minority Report, where we punish people before they commit a crime, but here we tax them on theoretical income. It’s a dystopian hellscape we should all avoid.
Politicians (of all parties) notoriously extol the benefits of their policy ideas without considering the potential and foreseeable costs. We would do better to respect private property, create an attractive investment climate that fosters small- and medium-size business start-ups, and spend less so we require less federal revenue. Taxing unrealized capital gains is an idea best forgotten.
