Last year, a new tax debate surfaced in the halls of the Capitol. This new tax debate was mainly about unrealized capital gains tax. This means, imposing a tax on assets that have not been sold yet. Normally, an asset is only taxed once it is sold for a profit. And this is why it is called “capital gain tax.” The goal of such a proposal is to make the rich pay their fair share in order to reduce income and wealth inequality. Though, this kind of proposal isn’t new. Indeed, in 2020, Massachusetts Senator Elizabeth Warren proposed a progressive wealth tax as a means to reduce economic inequalities between social classes.
The wealth tax is quite similar to the capital gains tax. But they are not exactly the same. A wealth tax is a form of taxation imposed on an individual’s net wealth, or the market value of their total owned assets minus their liabilities. The particularity of the wealth tax is that it is applied to the entirety of the holdings of assets of a person on an annual basis. The assets to be taxed in a wealth-tax structure include cash, bank deposits, real estate, assets in insurance, pension plans, financial securities (stocks, bonds, and derivatives), and personal trust. On the other hand, capital gains are taxed based on the realization principle: Capital gains are only added to taxable income when assets are sold for a profit. The substantive difference between a wealth tax and a capital gain tax is that a wealth tax would fall on assets that generate capital gains and on other forms of capital income such as dividends, rents, and royalties.
The wealth tax was already implemented in many OECD countries and it generated undesirable outcomes. As a matter of fact, the number of European countries with annual wealth taxes has fallen from 12 in 1990 to just 3. For example, Ireland imposed a wealth tax and then repealed it in the 1970s. In fact, countries repealed their wealth tax for a number of reasons: (1) they raised little revenue, (2) created administrative costs, (3) it induced an outflow of wealthy individuals and their money, and (4) policymakers realized that high taxes on capital damage economic growth. In a nutshell, the wealth tax is a recipe for economic disaster. If the wealth tax was already a failure, what makes policymakers think that implementing a tax on unrealized capital gains would generate a more desirable outcome?
Source: Tax Foundation
During his 2023 State of the Union Address, President Biden brought back the idea of enforcing an unrealized capital gains tax on the wealthiest people in America (people with a net wealth of more than $100 million), which he calls the “Billionaire Tax.” Under the new proposal, households with net wealth over $100 million would be required to pay a minimum effective tax rate of 20% on an expanded measure of income that includes unrealized capital gains. If implemented, the proposed minimum tax on unrealized capital gains would look like this in the following table. According to the Tax Foundation, this proposal would take the tax code in the wrong direction by imposing a complicated tax on a narrow segment of high-earning households in a way that was never tried before. The proposal moves in the opposite direction of sound tax policy because it would be administratively costly, it would reduce savings, and its revenue potential is uncertain.
Taxing the ultra-wealthy for the purpose of redistributing wealth is not a sound economic policy. Wealth redistribution by government means leads to a decline in total income because it reduces the incentives of the producers and it reduces the incentive of the income recipients as well.