A very Dumb and Dangerous Idea
If you drive capital out of a free market, Capitalism will cease to exist.
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The Biden administration has put forth a budget proposal for fiscal year 2025, featuring substantial tax hikes. Of particular interest are the proposed tax increases on realized capital gains and a new tax on unrealized capital gains. If Biden’s tax scheme were to materialize, it could destroy the U.S. economy.
Before I discuss Biden’s proposal, here’s a primer on capital gains and losses and how they are taxed today.
Let’s say you have a taxable account with Charles Schwab. On Monday, you paid $100 for a share of stock X. By Tuesday, your stock X was worth $120. If you sell your share at $120, you will have a realized capital gain of $20. You may be subjected to a capital gain tax on this $20 profit you made. How much capital gains tax you owe depends on your federal income and the length of your holding period.
Your $20 profit is a short-term capital gain because you held it for less than a year. Short-term capital gains are taxed at higher rates than ordinary income. If you hold your investment for longer than a year and then sell it with a profit, your profit is considered a long-term capital gain, which is taxed at rates of 0, 15%, or 20%, depending on your income (see IRS publication for details).
Similarly, if the price of stock X dropped to $90 on Tuesday and you sold it, you realized a capital loss of $10. The IRS allows you to use the loss to offset up to $3,000 of “ordinary” taxable income a year, i.e., wages. If you have over $3,000 realized capital loss for the year, you can carry forward the remaining unused losses to offset future capital gains and ordinary income.
Let’s say you didn’t sell your stock X on Tuesday. On Wednesday, the share price of stock X went up to $125, and you have unrealized capital gains of $25 ($125-$100=$25). You didn’t owe any capital gain tax because you hadn’t sold the stock yet, meaning your gain wasn’t realized and existed only on paper. On Thursday, the share price stock X dropped to $85, resulting in an unrealized capital loss of $15. You couldn’t use this unrealized capital loss to offset your taxable income either because you hadn’t sold the stock yet, so your loss existed only on paper.
If we use the daily closing share price of stock X as the data point, your unrealized capital gain or unrealized capital loss fluctuates daily as long as you keep holding your investment in stock X. Such wild swings in valuation will create administrative nightmares for both taxpayers and government agencies, and resulting in endless disputes with IRS. This is why taxing unrealized gains is a very dumb idea. The government essentially “penalizes investors for owning appreciating assets, regardless of whether they have realized any actual income from selling them,” according to Vance Ginn, an Associate Research Fellow with AIER.
Besides being dumb, taxing unrealized capital gains is also a hazardous idea. Capital is the lifeblood and oxygen of a free market economy. Most investors deny themselves instant gratification of their money and save diligently to accumulate funds. Driven by the motive of seeking profits and better returns, they funnel their funds into the hands of innovative and risk-taking entrepreneurs to produce goods and services that consumers need or want. Investors risk losing their funds if the business adventures they invested in fails—about 20% of startups failed in the first year, 50% within five years, and 65% within ten years, according to Investopedia.com.
Without risk-taking suppliers of capital, entrepreneurs are mere dreamers whose ideas will remain in their heads; we will have no antibiotics, internal combustion engines, iPhones, and many other things we have enjoyed in our lives and much progress that we have taken for granted. No wonder another name for a free market economy is “capitalism.” For those who think the government can provide capital and propel the economy forward, here is an excerpt from the Free Press’s Friday newsletter, TGIF:
“Amazon installed 17,000 electric vehicle chargers in just two years, making huge strides to electrify its fleet of delivery vans. Meanwhile, the Biden administration had Congress put $7.5 billion into building charging stations for America and two years later, it built only seven.”
The government that spends on other people’s money (taxpayers’ money) will never deploy capital as efficiently and productively as private investors and entrepreneurs.
Here is what his administration proposed for fiscal 2025:
Proposal 1. Hike the tax for Long-term capital gains and qualified dividends from 20% to 37% (40.8%, including the net investment income tax of 3.8%). The proposal would only apply to the taxpayer’s taxable income exceeding $1 million ($500,000 for married filing separately), indexed for inflation after 2024.
Proposal 2. Impose a minimum tax of 25 percent on total income, generally inclusive of unrealized capital gains, for all taxpayers with wealth (the difference obtained by subtracting liabilities from assets) greater than $100 million.
The Biden administration’s justification for these changes is – Equity!
“Preferential treatment for unrealized gains disproportionately benefits high-wealth taxpayers and provides many high-wealth taxpayers with a lower effective tax rate than many low- and middle-income taxpayers. Preferential treatment for unrealized gains also exacerbates income and wealth disparities, including by gender, geography, race, and ethnicity.”
The real reason is that the Biden administration’s excessive spending has dug a steep financial hole in the federal budget. Our national debt is nearly $35 trillion, or about $103,000 for every American. The United States government pays almost $2.4 billion in interest daily and is spending more on servicing debt than national defense. Historian Niall Ferguson warned, “Any great power spending more on debt service than defense is probably not going to be great for much longer.” Don’t expect the Biden administration to heed his advice. Rather than cutting government spending, the administration is making a desperate move to raise capital gain taxes and impose a new tax on unrealized capital gains.
Team Biden emphasizes that these higher taxes will affect only ultra-rich people. But don’t be fooled. When President Biden signed the misleading Inflation Reduction Act (IRA) in 2022, he promised that the IRA’s new Internal Revenue Service (IRS) funding would only empower the agency to crack down on wealthy tax evaders (those who make $400,000 or more a year), leaving the middle class alone. However, the recent IRS audit shows, “As of last summer, 63 percent of new audits targeted taxpayers with incomes less than $200,000. Only a small overall share reached the highest earners, while 80 percent of audits covered filers earning less than $1 million.” In other words, contrary to what President Biden promised, the IRS stepped up its audit scrutiny against small business owners and middle-income Americans.
Whenever Democrats claim they are going after the rich people, their policies always end up hurting the lower and middle classes. Why? For one, the Democrats always carve out loopholes in the law to protect their ultra-rich donors, so enforcers of the law have to target the lower and middle class. Secondly, America’s 748 billionaires’ total fortune is about $5 trillion as of September 2023. Even if there is no loophole and all 748 billionaires pay 40% capital gains on their fortune diligently and honestly, their tax dollars are still far from sufficient to fill the government’s $35 trillion deficit. The government inevitably will go after lower and middle-class Americans.
Heritage Foundation’s economist and research fellow E.J. Antoni also pointed out that raising capital gains tax and taxing unrealized gains could “create a larger incentive for lawmakers and federal policymakers to maintain high rates of inflation to guarantee larger tax revenues.” Keep in mind that inflation is also taxation because it “transfers wealth from savers to the U.S. government.”
Remember, “If you tax something, you will get less of it.” Taxing capital gains excessively, especially unrealized capital gains, is like draining the lifeblood out of our economy because investors will “have less incentive to invest in productive assets such as stocks, real estate, or businesses. This leads to a misallocation of resources and slower economic growth” (Vance Ginn).
If you drive capital out of a free market, Capitalism will cease to exist.
I work as an accountant for a bank, and we do the books for an investment firm. As you pointed out (and I know your background as a CFA gives you extensive knowledge on this) taxing URGL is, in my opinion, the single-worst economic policy that could ever exist. It is worse than a 70% flat income tax, a 90% flat income tax. As you illustrated, the uncertainty intrinsic in share prices would cause devastation to the economy at large that would result massive contraction to the GDP as well as huge job losses. This would destroy pension funds, forcing investment firms to charge exorbitant management fee rates to offset the tax. People who think this would only affect mega-corporations or the super rich have no understanding of how the market economy functions.
The “justification” for this, that being “equity,” (and not the good kind), is disgustingly immoral. Additionally, the slippery slope here is steeper than a cliff, with the government just itching to chip away at that $100m threshold. It will go down to $95m, $80m, $50m, and so forth. And how will they even define wealth? They say assets - liabilities, but they make no mention of liquidity. Rest assured, the powers that be will absolutely count the most illiquid of assets in their calculation, and use the absolute highest valuation when it comes to property values.
I am reminded of the tenth Commandment, where the Lord tells His people to not covet their neighbor’s possessions. This is not just economically idiotic, it is immoral. As always, you wrote a great article, Helen, but what terrible news.