One of the more controversial economic proposals to emerge from the progressive wing of the Democratic Party in recent years is the idea of taxing unrealized capital gains. Vice President Kamala Harris, among other prominent Democrats, has shown support for this policy as part of broader efforts to target wealth inequality and raise revenue from the ultra-wealthy. However, the idea of taxing unrealized gains has sparked intense debate, with critics raising serious concerns about its legality, constitutionality, and practical feasibility.
This blog post takes a critical look at Harris’ support for an unrealized capital gains tax, examining whether it is even possible to implement such a policy, and if doing so would cross constitutional or legal boundaries. It's hard to believe that a single voter would be in favor of such a ridiculous overreach, yet, here we are.
What Are Unrealized Capital Gains?
First, it’s important to understand what is meant by "unrealized capital gains." Capital gains refer to the profit an individual makes from selling an asset, such as stocks, real estate, or other investments. Currently, U.S. tax law only taxes capital gains when they are *realized*, meaning the asset has been sold and the profit is locked in.
An unrealized capital gain, by contrast, refers to the increased value of an asset that has not yet been sold. For example, if someone owns stock that has risen in value but they haven’t yet sold it, the profit they would earn by selling it is considered an unrealized capital gain. Harris and other proponents of the tax argue that this wealth should be taxed even if the asset hasn’t been sold, in order to prevent the ultra-rich from avoiding taxation on growing wealth.
Is the Unrealized Capital Gains Tax Legal?
One of the first questions surrounding Harris’ support for an unrealized capital gains tax is whether such a policy would even be legal under existing tax law. Under the current system, capital gains are taxed when they are realized, and the federal government has not historically taxed assets that have not been sold or converted into cash. Let's be very direct here - unless you sell an asset, there is no gain, so no tax nexus. Pretty simple to understand.
Implementing a tax on unrealized gains would likely require a significant overhaul of the Internal Revenue Code. Proponents argue that it is within Congress’ power to enact such a law under its broad taxation authority. However, legal experts are divided on whether taxing unrealized gains would be legally feasible without substantial changes to existing tax statutes.
The complexity of implementing such a tax also raises questions about its enforceability. Valuing certain types of assets, especially illiquid ones like real estate, art, or privately-held businesses, can be incredibly difficult. The Internal Revenue Service (IRS) would need to develop a framework for assessing the value of these assets annually, which would lead to administrative complications and a potentially massive bureaucratic expansion.
Is the Unrealized Capital Gains Tax Constitutional?
A more serious question is whether an unrealized capital gains tax would be constitutional. Article I, Section 8 of the U.S. Constitution grants Congress the power to levy taxes, but the 16th Amendment—which authorizes income taxes—has been interpreted to apply specifically to "realized" income or gains. The issue of taxing unrealized gains could face significant legal challenges, with opponents arguing that such a tax violates the Constitution’s definition of "income."
1. Direct vs. Indirect Taxes:
The Constitution distinguishes between *direct* and *indirect* taxes. Direct taxes, such as income taxes, must be apportioned among the states based on population. Indirect taxes, like tariffs, do not have this requirement. If an unrealized gains tax is classified as a direct tax, it could face constitutional hurdles, as it would likely not be apportioned among the states, making it vulnerable to legal challenges.
2. Supreme Court Precedent:
Supreme Court rulings have traditionally supported the idea that income must be "realized" before it can be taxed. The Court’s interpretation of income in cases like Eisner v. Macomber (1920) suggests that income must involve an actual receipt of cash or its equivalent. Based on this precedent, taxing unrealized gains—assets that have not been sold and no actual income has been received—could be considered unconstitutional. Any attempt to implement such a tax would likely face a protracted legal battle, potentially making its adoption highly uncertain.
Is It Even Possible to Implement?
Even if the legal and constitutional challenges could be overcome, the practical feasibility of an unrealized capital gains tax is highly questionable.
1. Valuation Issues:
One of the biggest challenges would be accurately assessing the value of unsold assets on an annual basis. While it may be relatively straightforward to value publicly-traded stocks, many wealthy individuals hold substantial portions of their wealth in illiquid assets like real estate, private companies, or fine art. Determining the market value of these assets each year would require frequent appraisals, which could be subjective and inconsistent. Moreover, this would create significant administrative burdens for both taxpayers and the IRS, increasing costs and complexity.
2. Volatility in Asset Prices:
The value of certain assets, particularly stocks and real estate, can fluctuate significantly over short periods of time. If someone is taxed on the unrealized gain of an asset that later drops in value, they may face significant tax liabilities on "income" that never materialized. This would not only be unfair, but it could also discourage long-term investment, as investors may be forced to sell assets prematurely in order to pay taxes on unrealized gains.
3. Liquidity Issues:
Taxing unrealized gains presents a liquidity problem for asset holders. Wealth is often tied up in investments, meaning the taxpayer may not have the cash on hand to pay taxes on unrealized gains without selling the asset. For example, a business owner whose company has increased in value may not have the liquid assets to pay the tax without selling part of the company. This could distort market behavior, forcing individuals to sell assets they otherwise wouldn’t, just to pay the tax bill.
4. Economic Consequences:
Critics argue that taxing unrealized gains could have broad negative economic consequences, particularly for investment and innovation. By penalizing individuals for holding onto investments that have appreciated in value, it could create a disincentive for long-term investment in areas like technology, real estate, and infrastructure. Additionally, this could drive wealthy individuals to seek tax shelters or move their wealth offshore, diminishing the policy’s effectiveness and ultimately reducing the potential revenue gain.
Criticism and Potential Alternatives
Opponents of an unrealized capital gains tax argue that the policy is less about solving wealth inequality and more about government overreach. Critics contend that rather than focusing on punitive measures aimed at a small segment of the population, policymakers should explore more effective ways to raise revenue or reduce inequality, such as:
- Closing Tax Loopholes: There are many legal avenues through which the wealthy can avoid paying taxes on realized capital gains, such as the "step-up in basis" loophole. Addressing these loopholes would likely yield more revenue without the legal and practical complications of an unrealized gains tax.
- Wealth Taxes: Some have proposed a more straightforward wealth tax, where individuals are taxed based on their total net worth rather than on unrealized capital gains specifically. While this proposal also faces constitutional challenges and implementation hurdles, it is considered more feasible than the unrealized gains approach.
- Progressive Income Tax Reforms: Adjusting the tax rates for high-income earners, increasing the top marginal tax rate, or introducing surcharges on extremely high earners could generate substantial revenue without the need for a radical overhaul of the tax system.
Let's Be Fair: Would The Law Allow 'Unrealized' Losses To Be Claimed?
When discussing the potential implementation of an unrealized capital gains tax, one of the key questions that arises is whether taxpayers would also be able to claim unrealized losses for assets that decrease in value. This is an important consideration because it introduces the concept of fairness and consistency in how gains and losses are treated under the tax code. Let's explore this issue in more detail.
Consistency and Fairness:
If the government were to tax unrealized gains—profits that exist only on paper—it would be logically inconsistent, and arguably unfair, to ignore unrealized losses. If a taxpayer is required to pay taxes on increases in the value of assets they have not sold, they should also be allowed to claim losses for assets that have depreciated in value but have not yet been sold. Ignoring losses would mean the tax system is only targeting gains, creating a lopsided and punitive approach.
For example:
- If an individual’s stock portfolio increases in value by $500,000 one year, they would be taxed on that gain even if they didn’t sell any stock. However, if their portfolio decreases in value by $500,000 the next year, fairness would demand that they be allowed to claim that unrealized loss to reduce their tax burden.
Failing to allow the deduction of unrealized losses would lead to a situation where taxpayers are taxed on theoretical gains but receive no relief when their investments lose value. This could create a severe financial burden on taxpayers and lead to widespread resentment of the tax system.
Valuation and Implementation Issues:
While allowing unrealized losses would be necessary for fairness, it would introduce significant administrative complexity. The IRS would have to deal not only with tracking unrealized gains but also with determining and verifying unrealized losses. This raises several logistical concerns:
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Asset Valuation Volatility: Asset values fluctuate regularly, especially in the case of stocks and real estate. Would the IRS have to revalue every taxpayer’s assets annually? For volatile assets, this could lead to taxpayers claiming losses one year and gains the next, introducing complexity in how taxes are calculated year-over-year.
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Illiquid Assets: For illiquid or hard-to-value assets, such as private businesses, real estate, or art, determining whether an unrealized loss has occurred could be highly subjective. The IRS would need a standardized system for appraising the value of such assets, but this could lead to disputes between taxpayers and the IRS over asset values, especially if a loss is claimed.
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Market Fluctuations and Timing: In a system where both unrealized gains and losses are taxed, market timing becomes a critical issue. For instance, if the stock market experiences a temporary dip at the end of the year, taxpayers could claim significant unrealized losses, only for the market to rebound in January. Would these losses be reversed, or would taxpayers receive permanent tax benefits from temporary fluctuations?
Potential Abuse and Gaming of the System:
Allowing taxpayers to claim unrealized losses could also create opportunities for tax avoidance or manipulation. For example, taxpayers could deliberately choose to hold onto depreciating assets longer in order to claim larger unrealized losses while deferring gains on other appreciating assets. This could lead to strategic asset management that focuses more on minimizing taxes rather than making sound investment decisions.
In addition, sophisticated taxpayers with access to tax advisors and financial planners could take advantage of annual market volatility to "cherry-pick" unrealized losses while postponing the realization of gains, thereby lowering their overall tax liability. This could lead to distortions in the tax code that benefit the wealthy, undermining the original purpose of the unrealized capital gains tax, which is to increase tax revenues from the ultra-wealthy.
Could Unrealized Losses Exceed Unrealized Gains?
Another issue to consider is the possibility that a taxpayer’s unrealized losses could exceed their unrealized gains in a given year. If taxpayers are allowed to claim unrealized losses, would they be able to carry forward these losses to future years, much like they can currently carry forward realized losses? If so, the government could end up in a situation where unrealized gains are fully offset by past unrealized losses, effectively negating any revenue from the unrealized gains tax.
For example:
- In a year where an investor’s portfolio experiences a significant drop in value (say, due to a market crash or economic downturn), the investor could claim large unrealized losses. If, in the following years, their portfolio recovers, they might still avoid paying taxes on any gains because of the previously claimed losses. This could make the unrealized gains tax less effective as a revenue generator.
Theoretical and Practical Problems with an Unrealized Loss Provision
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Complex Record-Keeping: Taxpayers would need to maintain detailed records of the value of their investments year-to-year, tracking fluctuations in unrealized gains and losses. This would add a significant administrative burden to both taxpayers and the IRS, complicating tax filing and increasing the likelihood of disputes over asset valuations.
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Difficulty in Creating Clear Guidelines: Establishing clear guidelines for what qualifies as an unrealized loss—and how it is calculated—would be challenging, especially for illiquid or hard-to-value assets. The potential for misreporting or discrepancies between taxpayer estimates and IRS valuations could create further complications and legal battles.
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Increased Volatility in Tax Revenues: If both unrealized gains and losses are taxed, the government’s tax revenue could become highly volatile, depending on market conditions. In years when markets perform well, tax revenues would spike due to gains. However, in years when markets decline, taxpayers would claim large unrealized losses, leading to reduced tax revenues or even net losses for the government. This could make budget planning and fiscal policy more unpredictable.
Conclusion: A Policy Riddled with Issues
Kamala Harris’ support for an unrealized capital gains tax faces significant legal, constitutional, and practical challenges. Taxing wealth that has not been realized through a sale violates traditional notions of income tax law and could be considered unconstitutional based on current Supreme Court precedent. Even if these legal hurdles were overcome, the complexity and unintended consequences of the tax—such as asset valuation difficulties, liquidity issues, and potential market distortions—make it a highly problematic policy to implement.
Rather than pursuing an idea fraught with practical difficulties and legal uncertainties, policymakers should focus on closing existing tax loopholes, reforming the income tax system, and encouraging fair and efficient ways to address wealth inequality. The pursuit of an unrealized capital gains tax may sound like a bold move to target the ultra-wealthy, but in practice, it could end up doing more harm than good, both to the economy and to the fundamental principles of the U.S. tax system.
This is just another example of corrupt politicians creating new problems that will continue to deteriorate our Constitutional Republic - which is already on life support. We need all taxpayers to exercise critical thinking and actively stand up and speak truth to power.