That would change, however, under a proposal that Democrats are considering that would tax unrealized gains each year as if the underlying asset had been sold. Forbes estimates that Tesla founder Elon Musk’s net worth rose by $126 billion last year as his company’s stock price soared, but he surely paid almost no tax on that because he never sold the stock. Biden’s plan would tax all of that rise, netting the federal government about $30 billion. Do the same for all the nation’s billionaires, and the feds could pull in loads of cash without disturbing their lavish lifestyles.
If that sounds too good to be true, it’s because it is. To start, not all assets are as easy to value as publicly traded stocks. Privately held companies, such as Charles Koch’s Koch Industries, are notoriously difficult to value. Rare but valuable items are even more difficult to fix an annual price. Someone who owns a Leonardo da Vinci or Picasso artwork likely paid more than $100 million for it at auction, but it’s almost impossible to assess what a unique work of art would sell for at the end of each tax year. Billionaires are precisely the people with the motive and the means to hire the best tax lawyers to fight the Internal Revenue Service at every step of the way, surely subjecting each tax return to excruciatingly long and expensive audits.
Then there’s the question of what to do with capital losses. Expensive assets can go down in value, too, and billionaires would rightly insist that the IRS account for those reversals of fortune. This would lead to some politically uncomfortable acts if, say, a market downturn coincides with the end of the tax year, as happened during the Great Recession. The U.S. stock market declined by roughly a third in 2008, with the low point at year’s end — exactly when valuations for an unrealized gain tax would be determined. This would have led to billionaires marking up massive amounts of unrealized losses. Would the IRS have to issue multi-billion dollar refund checks to return the billionaires’ quarterly estimated tax payments from earlier in the year? No president will want to be in charge when their IRS has to give billions of dollars back to Warren Buffett or Bill Gates.
The Constitution may not even permit taxation of unrealized gains. The 16th Amendment authorizes taxation of “income,” and the definition of that seemingly simple word has spawned a long history of complicated case law. Whether something is defined as income often has to do with whether a person has complete control over a source of money that can then be used in trade to purchase or invest as one sees fit. Unrealized gains don’t fit under that rubric because the wealth is on paper, not in the hands of the owner to use as she wants. In 1920, the Supreme Court ruled that stock dividends or splits can’t be taxed because they are not income. That is just one example of a torturous series of cases that the Supreme Court would inevitably have to consider to determine if Congress even has the power to tax unrealized gains.
If Congress does have that power, however, it will only be a matter of time before lawmakers apply the tax to ordinary Americans. Anyone who owns a house or has a retirement account has unrealized capital gains. Billionaires get all the attention, but the real money is in the hands of the broader public, as the collective value of real estate and mutual funds dwarfs what the nation’s uber-wealthy hold. The government would love to get 25 percent of your 401(k)’s annual rise, and our nation’s massive annual deficits and cumulative debt means it will need that money sooner rather than later.
Taxing unrealized capital gains will unlock a Pandora’s box of problems. Better to keep them under lock and key.