The Unconstitutional, Unjust, and Destructive Tax on Unrealized Capital Gains

In my last TaxByte article, I singled out what I saw as the two worst tax increase proposals made recently by President Joe Biden. It was a target-rich environment, though. And so, looking again, I found another candidate for the worst of Biden’s tax proposals: the tax on unrealized capital gains.
 
It’s bad in three ways: it’s unconstitutional, it’s unjust, and it’s destructive.
 
The 16^th Amendment to the U.S. Constitution gives the federal government the power to tax people’s income. It doesn’t give the government the power to tax what might be income in the future. But Joe Biden ignores the Constitution. He would tax capital gains for wealthy people who don't sell their assets and get a gain. He would call it income even though it’s not. So his proposed tax is unconstitutional. 
 
It's also profoundly unjust, in two ways. First, it taxes gains but doesn’t give people a break on capital losses. Someone with a net worth of $200 million is subject to the tax if he has an unrealized capital gain of, say, $40 million. That person would pay millions extra in taxes. But what if, instead, he has an unrealized capital loss of $40 million. Would the feds treat the loss symmetrically and give the person a check for millions? I asked Garrett Watson, an economist at the Tax Foundation who has written on the issue. The answer is no.
 
You might argue that people who hold assets will tend to have capital gains over time. So the capital loss issue might not be huge. But what if, when the person sells the asset, it has lost value compared to its value when it was taxed? Then the feds would let the taxpayer recapture the overpayment on taxes. Sounds fair, right? Well, not quite. In a world with inflation, the person paid taxes today with dollars that are worth more than the dollars he will get back when he actually sells. If we have an average inflation rate of even 3 percent per year, and the person holds the asset for 10 more years, the dollars he gets back in 10 years are worth 26 percent less than the dollars he paid today.
 
The tax is also destructive. First, it takes money from people who have invested in productive assets. Second, it can force people who are cash-poor to sell those assets. The feds actually argue [see page 82] that that’s good because people hold on to assets for too long to avoid taxes. But there’s a better solution to that problem: cut the capital gains tax rate to zero. Then there would be no distortion at all.
 
Let’s just say no to Biden’s awful tax proposal.