One of the useful functions of markets is the determining of actual value.
What is something actually worth? This is a question asked millions of times every day by every kind of participant in the economy.
Very often, the seller of something has an inflated idea of its value, while a potential buyer may have a much different opinion. That’s why we say that the true value of something is determined by a willing seller and a willing buyer. That negotiation, whether it happens in person, on-line, or in the aisle of a retail store, results in a critical piece of information: What is that thing worth, in its current condition, in this place, at this moment in time? The answer is: Whatever a willing buyer and seller agree to.
That’s part of the genius of auction sites like eBay. We’ve probably all seen eBay sellers list something for a ridiculously high price, and it remains listed for weeks and weeks as the seller takes forever to come to terms with the fact that, because no one is bidding, he or she has overestimated its real value.
Conversely, these days homes are often selling above the asking price, which indicates that the seller has undervalued the property in the current market. What was the house worth? Whatever a willing buyer was willing to pay, and whatever a willing seller was willing to agree to.
Value cannot be accurately determined without a transaction between a willing buyer and a willing seller, and that’s just one reason why the tax on unrealized gains being proposed by some Democrats is such a terrible idea.
A gain is not “realized,” or actually gained, until and unless there is a transaction between a willing buyer and a willing seller. So an unrealized gain simply cannot be accurately valued, and how can you accurately tax wealth that cannot accurately be valued?
You can’t. And that’s one of the reasons why we have never even attempted to tax unrealized gains.
Whether we are talking about a house, a stock or bond, a shopping center, a piece of art, or anything else, there is no accurate valuation unless there is a market transaction. Lacking such a transaction, how would the taxable value of an unrealized gain be determined?
For securities, you could just choose an arbitrary calendar date, such as December 31. But that in itself would cause market distortions through tax-motivated buying and selling. For other less liquid goods, who would determine the taxable value? The Treasury Department?
There are other reasons why a tax on unrealized gains is unworkable, such as the fact that it is almost certainly unconstitutional. But the silver lining of this ridiculous proposal is that it gives us an opportunity to remember the significance of markets in determining real value through voluntary transactions.