Taxing Capital Gains

A humane alternative to eating the rich

I’m seeing some flak about this issue, including on the left, all of which is uninformed. So I’m going to inform you. The background is some ignorant quacking about the Harris Campaign talking about taxing “unrealized capital gains.” An idiot writing for The Hill who used to work for the corrupt, bigoted Senator Conrad Burns of Montana (a former livestock auctioneer, now dead) calls the idea “insane” and “suicidal,” providing a raft of misinformation in the process. (No link. It’s too dumb.)

A less hysterical critique comes from the financial blogger “Downtown Josh Brown,” whom I have been reading for years. He is always informative and usually entertaining. I will take his complaint seriously.

Brown is most worried about the proposal’s impact on “independent” (really, centrist or conservative anti-Trump) voters. He reiterates the old saw along the lines of, this won’t actually affect many people, but it will offend many who would like to be rich enough for it to affect their “imaginary earnings.” We used to hear this regarding proposed repairs to the Federal Estate and Gift Tax, which repairs would indeed have affected a tiny segment of very wealthy families to a tiny extent. That tax, incidentally, is a shell of what it should be.

I’d like to note that Brown’s only objection to the merits of the tax is that it “wouldn’t help anybody.” But the Gov needs dough, with which it does a myriad of useful things. So yes more revenue would indeed help a lot of people. For the same reason, Brown’s political analysis is deficient. Yes, any tax increase will annoy some of those who aspire to great wealth, but so do the huge preferences in the tax code already afforded to the wealthy, especially recipients of capital gains, realized or not, aggrieve the common man and woman.

Brown offers a bigger rationale for laying off, that the aspiring masses are what has made the U.S. economy great. I’d say they are going to aspire in any case. What has also made the economy great is public investment and fuel for mass consumption, which any tax facilitates. With a normal election, Brown would be on the side of the Republican. Before the present weird situation (since 2016), this would be an important debate. Now we have sharks and childless cat ladies.

The actual Harris proposal, by the way, is for a modest increase in the rate applied to capital gains, which would still enjoy a preference relative to any poor slob’s wage and salary income, but a slight comedown from a Biden proposal.

Contra our overheated Hill columnist, actually the idea speaks to an old, well-regarded principle in the economics of taxation, that of taxing comprehensive income. Income was elegantly defined decades ago by eminent tax scholar Stanley Surrey as “consumption plus the change in net worth.” It is important to measure income properly, but the objective is for a broader tax base to facilitate the minimization of tax rates. It does not preclude the use of progressive, or graduated rates. In fact, it facilitates them as well.

Some confusion probably results from the terminology. Say you own a share of Apple stock that you bought for $200. If the market value of the share rises to $210 but you are still holding the stock, the ten bucks is an unrealized gain, also known as accrued income. If you sell and pocket the profit, it’s a realized gain. Under the principle of comprehensive income taxation, the ten dollars should be included in the tax base whether you sell or not. Suppose the stock goes down by ten bucks? Then ten bucks should be subtracted from your taxable income.

The way this would work in practice is that the change in your total assets between January 1 and December 31 is part of your taxable income. It can either go up or down, add to or subtract from your total taxable income. It does not involve tracking or reporting daily or weekly changes in asset values.

There are some reasons to worry about this practice, though fewer than there used to be. These days it is easy for the IRS to process reports from a broker to determine the impact on anyone’s taxable income. The sticking point is for assets whose values can change but are not easy to determine. With stocks, derivatives, and bonds, market prices are easily accessible. Determining market value is less simple with real estate (although its value is assessed annually for state and local property taxation), unincorporated business firms, and fancy collectibles that are not sold and thereby reveal a market price.

What taxing unrealized gains would not entail is affecting the vast majority of homeowners (I mean 95 percent) whose principal residences may have increased in value. No you would not have to raise the cash to cover the annual gain in the value of your house. Real estate of this type could easily be exempted from tax. For the super-rich, it would be practical to tax such gains, since they could raise the cash to pay the tax. Nobody in their right mind would propose to apply such a tax to most residential real estate. Nor would it be difficult to afford some concession to the storied family farm.

The income levels involved are not really the point. Most capital gains are received by the very top of the income distribution. We have a progressive income tax, so even if you’re a little old lady with 100 shares of Apple that went up over the course of a year, and your total income is sufficiently high, there is no reason that income should be taxed less than an electrician’s wages. If you really need to you can sell a share or two to pay the tax. If voters think little old ladies or farmers should not be taxed the same as everybody else, the law can be changed to reflect that. (It already does, actually.)

Under so-called “Modern Monetary Theory,” it is said that taxes do not finance public spending. They do, at least in terms of their political impact. So as I’ve written ad nauseum, including here and here recently, to get social-democracy we need to avoid punching holes in the tax base. A comprehensive income tax is not the only way for the government to collect revenue, but it is the one we have, and as the end of the 90s showed, it can be extremely productive. At that point, the Feds were in position to eliminate the national debt altogether. Alan Greenspan and George W. Bush took care of that.

Here is some wonky background from my old friend Jim Stanford, from our Northern neighbor.