Texarkana, TX 86° Thu H 94° L 75° Fri H 93° L 77° Sat H 92° L 74° Weather Sponsored By:

Democratic capital-gains tax not worth it

Democratic capital-gains tax not worth it

April 12th, 2019 by Noah Smith - Bloomberg View in Opinion Columns

Oregon U.S. Senator Ron Wyden recently proposed an interesting idea—taxing unrealized capital gains. There are advantages and disadvantages to this idea, which shares some similarities with a wealth tax. But ultimately, adopting this change probably isn't worth it.

Now, if you own stock or another asset, and it goes up in value, you pay tax if and when you sell it. As long as you don't sell, you don't owe tax. The tax rate is lower if you hang onto the asset for longer than one year, which is a way of encouraging people to hold on to assets—especially stocks—instead of trading them for short-term gains.

Wyden's proposal would tax assets as soon as the price goes up, rather than when the asset is sold. The logic behind this is simple—paper gains represent real wealth, since you could sell the asset and get cash any time you want. Waiting until the asset is sold in order to tax it allows the wealth to compound untaxed, which causes wealth inequality to accumulate.

In addition to eroding wealth as it builds up, taxing unrealized capital gains would cut down on tax avoidance. Investors and traders now try to skirt capital gains taxes by engaging in tax-loss harvesting—selling assets that go down, pocketing a tax credit that offsets future capital gains tax liabilities, and then buying similar assets to keep one's holdings roughly constant. There are rules that are supposed to prevent the selling and buying of identical assets for tax purposes, but these rules can often be evaded by simply buying similar assets instead of identical ones.

In addition to allowing wealthy people to avoid taxes, tax-loss harvesting represents a waste of resources from society's point of view. The time and effort of the smart people who game the tax system could be better spent doing something more productive. But if unrealized gains were taxed instead of realized gains, as Wyden wants, this kind of shenanigan would no longer work, and would thus disappear.

So taxing unrealized gains does have some appeal. But it also has major downsides. First, it would encourage an increase in trading. Investors now pay lower taxes if they hang on to an asset for longer than a year, but if taxes were independent of when assets were sold, this incentive would disappear. That would encourage more trading of assets back and forth—something that other Democratic senators want to curb. There are theoretical reasons to believe that much trading is wasted effort.

A second problem is that taxing unrealized gains would force asset owners to sell some of their holdings in order to pay their taxes. For some assets, like publicly traded stocks, that's no big deal, because their markets are big and liquid, with many buyers and sellers. But imagine the stock of a startup under a system like Wyden's. When the startup's stock appreciates in value because it accepts funding at a higher valuation, the founders, early employees, and early investors would probably have to sell some of their stake in order to make the tax payments. Finding a buyer would be difficult and time-consuming, and they might have to sell at a big loss, hurting the company's development.

For assets that can't be cleanly divided up, like houses, the difficulty would be even greater. Homeowners typically pay property taxes every year, requiring them to either have some other source of income or to borrow (expensively) against the value of their house. Taxing unrealized capital gains would add to this burden, making it more costly to own a home.

Taxing unrealized gains would also require illiquid assets to be frequently appraised or modeled in order to determine their value. This would create a cottage industry in lowball appraisals and models that understate asset values.

The problems associated with taxing illiquid assets are also hurdles for wealth taxation. They aren't insurmountable. But scrapping the current capital-gains tax code in favor of an unrealized-gains tax would sacrifice a system with many advantages in favor of one with a different set of advantages, and it's not clear the country would come out ahead.

Instead, there are better ways to modify the existing capital-gains tax regimen. Charging interest on untaxed gains—an idea proposed by economist Alan Auerbach in the 1980s—would limit the degree to which untaxed wealth could snowball. And limiting the number of asset sales that could be used to generate tax-loss carryforwards to help reduce taxes on future income could cut down substantially on gaming the system.

And of course, the most important reform would simply be to raise the capital gains tax rate. That would be unlikely to harm business investment.

Getting Started/Comments Policy

Getting started

  1. 1. If you frequently comment on news websites then you may already have a Disqus account. If so, click the "Login" button at the top right of the comment widget and choose whether you'd rather log in with Facebook, Twitter, Google, or a Disqus account.
  2. 2. If you've forgotten your password, Disqus will email you a link that will allow you to create a new one. Easy!
  3. 3. If you're not a member yet, Disqus will go ahead and register you. It's seamless and takes about 10 seconds.
  4. 4. To register, either go through the login process or just click in the box that says "join the discussion," type your comment, and either choose a social media platform to log you in or create a Disqus account with your email address.
  5. 5. If you use Twitter, Facebook or Google to log in, you will need to stay logged into that platform in order to comment. If you create a Disqus account instead, you'll need to remember your Disqus password. Either way, you can change your display name if you'd rather not show off your real name.
  6. 6. Don't be a huge jerk or do anything illegal, and you'll be fine.

Texarkana Gazette Comments Policy

The Texarkana Gazette web sites include interactive areas in which users can express opinions and share ideas and information. We cannot and do not monitor all of the material submitted to the website. Additionally, we do not control, and are not responsible for, content submitted by users. By using the web sites, you may be exposed to content that you may find offensive, indecent, inaccurate, misleading, or otherwise objectionable. You agree that you must evaluate, and bear all risks associated with, the use of the Gazette web sites and any content on the Gazette web sites, including, but not limited to, whether you should rely on such content. Notwithstanding the foregoing, you acknowledge that we shall have the right (but not the obligation) to review any content that you have submitted to the Gazette, and to reject, delete, disable, or remove any content that we determine, in our sole discretion, (a) does not comply with the terms and conditions of this agreement; (b) might violate any law, infringe upon the rights of third parties, or subject us to liability for any reason; or (c) might adversely affect our public image, reputation or goodwill. Moreover, we reserve the right to reject, delete, disable, or remove any content at any time, for the reasons set forth above, for any other reason, or for no reason. If you believe that any content on any of the Gazette web sites infringes upon any copyrights that you own, please contact us pursuant to the procedures outlined in the Digital Millennium Copyright Act (Title 17 U.S.C. § 512) at the following address:

Copyright Agent
The Texarkana Gazette
15 Pine Street
Texarkana, TX 75501
Phone: 903-794-3311
Email: webeditor@texarkanagazette.com