Unrealized Gains Tax: A Potential Economic Catastrophe
A New Proposal in the US Fiscal Year 2025 Budget
The United States Fiscal Year 2025 Budget includes a proposal to tax unrealized capital gains, marking a potentially devastating shift in US government revenue collection. This is just one of several proposed tax increases, but its implications could be far-reaching. It could cause significant distortions in the US economy, potentially leading to the destruction of businesses, altering how firms operate, driving capital offshore, discouraging investment, and drastically reshaping the American business landscape. Essentially, taxing unsold financial assets, ownership stakes, fixed investments, intellectual property, collectibles, and other forms of wealth could act as an economic earthquake, disrupting the capital markets that fuel innovation.
Implications of a Shift in Revenue Generation
The United States has a vast number of privately owned businesses, far exceeding the number of publicly traded ones. The latter, trading on exchanges and other market centers, can be easily valued using market capitalization and a few other financial ratios. However, determining the value of the other 25 million companies, most of which are closely-held, is a much more complex process. Therefore, imposing taxes on unrealized capital gains would necessitate a massive expansion in the size and scope of the US government’s taxing power, surpassing even the imposition of income and employment taxes.
The Role of the Internal Revenue Service (IRS)
The IRS would need to impose an annual or periodic valuation requirement on a wide range of assets. This would be a burdensome task, especially for assets where valuations are subjective or liquidity is low. In such cases, there would likely be considerable debate over the value upon which the tax assessment should be based. This would apply to assets ranging from real estate to collectibles to intellectual property. The IRS would need to be granted extensive appraisal powers or the authority to hire independent consultants to handle the assessments associated with the broadening of assets subject to the new tax.
Increased Reporting Obligations and Compliance Costs
The new tax would result in a significant increase in reporting obligations. Taxpayers and their firms would be required to report the details of all their assets annually, including their estimated market values, at their own expense. The compliance costs and reporting obligations would expand tremendously compared to the current tax liability on sales transactions alone.
Expansion of the Audit and Enforcement Arm of the IRS
The IRS would also need to significantly expand its audit and enforcement capabilities. Tax collectors would gain authority to audit and investigate taxpayers’ holdings, financial records, property titles, and transaction details, especially for illiquid or hard-to-value assets. Expanded powers would be necessary to enforce the tax on offshore or foreign-held assets, likely through international cooperation agreements like those currently advancing global minimum corporate or wealth taxes.
Impact on the Economic Landscape
The proposed tax could have significant implications for the economic landscape. Investment interest in firms with substantial fixed capital holdings or long-term appreciating assets, such as real estate, utilities, transportation, and telecommunications, would likely diminish. Companies in volatile industries, such as those with commodity market exposure, are also likely to decline in attractiveness due to the risk posed by unforeseen fluctuations endangering the ability to meet tax obligations.
Why is this Proposal Being Considered Now?
There are several reasons why proposals for an unrealized capital gains tax are being considered now. One reason is the mounting clamor over wealth and income inequality, which has intensified since the pandemic. Another reason is the awareness of widening deficits and unsustainable debt levels among US government entities. The proposal to tax unrealized capital gains may also serve as a trial balloon, softening public opinion and making moderate tax proposals in this direction seem more acceptable by comparison.
Looking Ahead
There are many questions surrounding this proposal. How would capital losses be handled? Won't the imposition of this new tax suddenly result in a statistically implausible burst of individuals and corporate entities worth less than $100 million? And won't short-term speculation increase precipitously after the government imposes a de facto maximum holding period?
Bottom Line
The proposed tax on unrealized capital gains could have profound implications for the US economy. It could discourage long-term investment, spur reactive liquidation of assets, and penalize growth. The distortions created by such a tax could cost the national economy far more than could be gained from valuations, and nowhere near enough to touch the national debt. Like all heedlessly extortionate government policies, this one would almost certainly grow over time, incrementally taking more from productive investment and the pockets of citizens it ostensibly serves.
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