Unrealized gains taxes are a pointless hassle

There are much better ways to tax the rich. We don't need this one.

There’s this annoying thing that some Democratic politicians do in America. They want to toss out some economic populist red meat — a reasonable enough impulse — but they make it overly wonky and then get lost in the weeds. For example, suppose you want to tax the rich. That’s a very popular idea. It also happens to be a good idea — with interest costs going up and debt levels high, the U.S. needs to enter a period of austerity. That needs to involve some spending cuts and some tax increases.

OK so, we know how to tax the rich very effectively, without hurting the economy much if at all. Just raise income taxes on people with high incomes. This is what Bill Clinton did in 1993 during the last era of austerity, and tax revenue went from 16.7% of GDP to 19.7% of GDP:

(If anyone ever tells you that tax revenue as a percent of GDP can’t go up, just point them to the 1990s.)

Economists have established that income tax isn’t very harmful to the economy until you start getting to very high rates. The 39.6% rate of top income taxes in the 90s sure didn’t seem to make any rich people stop working. So if you want to tax the rich, income tax is a good tool.

Another alternative is to raise the capital gains tax. We also did this in the 90s, and it was fine:

Wikideas1, CC BY-SA 4.0, via Wikimedia Commons

Again, this is not particularly surprising to economists — or to anyone who just looks at the history of capital gains tax changes. (We should also eliminate the “step-up basis” loophole that wipes capital gains away when the asset owner dies.)

But then some wonky progressive intellectuals¹ got really upset over the fact that some rich people seem to be getting richer without paying any taxes at all. If the value of your stock goes up, you don’t have to pay capital gains taxes until you sell the stock. So all the rich people in America are sitting there, getting richer on paper year after year, without paying a dime in taxes (until some unspecified future date). That’s the way things have always worked — and the way things work in every other country — but if you’re a progressive intellectual who spends a lot of time thinking about the wealth inequality numbers, it seems quite unfair.

Like many ideas of Elizabeth Warren’s, for good or for ill, the idea of taxing unrealized gains made it into the standard canon of the Biden administration’s economic policy, replacing the wealth tax (which had potential legal problems). Biden won’t have a chance to actually pass an unrealized gains tax by the end of his term, but now Harris has taken up the idea. And predictably this is causing some debate.

On one hand, there are a few wonky econ reasons to support an unrealized gains tax, in an ideal world. And Harris has structured her proposal so that A) it would only hit a few extremely rich Americans (people with over $100M), and B) some of the problems with earlier iterations of the proposal have been fixed. But there are still a number of challenges and dangers to the proposal, which I’ll get to in a bit.

More fundamentally, it doesn’t make sense to go inventing completely new taxes — doing stuff that even Scandinavian social democracies have never done!² — when we have multiple perfectly good taxes that we used just 30 years ago and that we already know are safe and effective.

I also doubt the idea works as campaign rhetoric. Taxing the rich is very popular, but I doubt most American voters understand the difference between the unrealized gains tax proposal and any of the more normal, tried-and-true tax hikes that Bill Clinton did back in the 90s. Just say “I’m going to tax the rich” — there’s no need to get fancy. Also, as I’ll explain, there are some other boring normal policies that would get the benefits of an unrealized gains tax without the risks.

And the downside of this campaign tactic is that fancy, newfangled proposals like this tend to rile up both rich businesspeople and lots of wonky intellectuals (like me). You scare the donor class, and you get the chattering class talking about economic theory instead of about all the actually awesome things you’re trying to do, or about the crazy things your opponent wants to do.³

So anyway, let’s talk about the various reasons people like the idea of unrealized gains taxes, and about why the risks outweigh the benefits.

Why some people like unrealized gains taxes