The Supreme Court on Thursday upheld a provision of the Trump tax cuts that taxed American shareholders of U.S.-controlled foreign companies on otherwise untaxed company earnings. The case, Moore v. United States, generated interest for the potential implications it would have for a wealth tax — specifically, one based on taxing investment gains that have not yet been realized. Ultimately, the Supreme Court punted on this question, describing its decision as “narrow” and “limited.” The majority opinion by Justice Brett Kavanaugh neither opened the door for such a wealth tax nor slammed it shut. The concurring and dissenting opinions, however, made it clear that there are at least four votes among the conservative justices to constitutionally limit taxes to income that has been realized.
However the justices might ultimately rule on such a matter, it doesn’t change the fact that the idea of taxing unrealized gains is a bad one that should be rejected on the merits.
Under the current system, Americans pay taxes on investments when they sell or earn interest on them, not merely when their value goes up. This is a source of consternation on the left, because those who are mega-rich don’t need access to all of their wealth at once. As long as they hang on to their investments, their net worth can swell without being subject to taxes on any paper gains. For instance, Warren Buffett is a “buy and hold” investor who has his money tied up in Berkshire Hathaway stock, so only a relatively small portion of his estimated $133 billion of wealth is subject to taxation each year.
To the Left, and President Biden, this wealth is a giant honeypot waiting to be tapped. It is a central part of their plans to transform the United States into a European-style social-welfare state while pretending it won’t require European-style taxes on the middle class.
But a system in which the government taxes unrealized gains would be unfair, unworkable, and economically destructive.
Investments are taxed when their gains are realized because they can fluctuate wildly. For instance, in May 2021, an investor could have bought Tesla stock for under $200 and, by November, that investment would have doubled to more than $400. But by January 2023, the stock had cratered — to $113. Depending on the timing of purchase and the tax deadline, an investor could pay taxes on unrealized gains based on the runup of the stock, only to ultimately take a bath on the stock after having paid taxes on it.
Under the current system, investors who sell not only have to pay tax on gains but get to deduct losses. Under a new system, would the IRS allow billionaires to deduct unrealized losses?
In the scheme of things, however, valuing stocks is relatively easy given they are traded in high volume on public markets that have real-time prices. Wealth, however, is often tied up in investments with values that are more subjective. For instance, how will IRS agents accurately evaluate the real-time value of a piece of real estate, business income, or venture-capital holdings? How will agents value works of art?
Beyond this, there are the economic consequences. The current system not only waits until gains are realized to tax them, but it offers a lower rate on gains from investments that are held for over a year. This helps facilitate more stable markets and fosters investment in businesses that fuel the economy.
If unrealized gains are taxed each year, investors would be much more likely to buy and sell assets more quickly, leading to more market volatility that would punish smaller businesses seeking capital as well as Americans who have their savings tied up in markets. If critics of “vulture capitalism” and the like think that companies are already too obsessed with their short-term stock price, they haven’t seen the half of it.
A wealth tax would require a vast expansion of the IRS staff and its intrusion into taxpayers’ lives. It would be a boon for accountants, but it would distort economic incentives.
The idea of taxing unrealized investment gains needs to be killed in the crib before the Supreme Court even gets a chance to weigh in on whether it is constitutional.