The Democratic majority in Congress seems to be inching toward proposing a tax on unrealized capital gains, to be applied to billionaires. Bloomberg provides some details, and the proposal is being discussed quite widely in the press. Unfortunately, there is very little academic analysis of the likely effects of such a tax. One possible exception is an old paper by Alan Auerbach, from 1991, but this paper studies a scheme that would levy interest on taxes due on past accruals, to be paid at the time the gains are realized. This is not the current proposal, where accruals themselves would be taxed every year as they occur, even when not realized. Another assessment (not particularly kind to the proposal) comes from a finance professor at NYU, but it does not take the form of an academic paper, i.e. it lacks the rigor that peer-review imposes. Still, the effects that this blog post describes seem plausible. Billionaires will have to sell a portion of their holdings every year, meaning they will have less skin in the game (and this will have consequences for overall asset prices); they will face incentives to purchase hard-to value, easy-to-hide assets like art and expensive wines, they will face incentives to engage in more conspicuous consumption (yachts, airplanes, which depreciate over time), and to take their firms private (if there is a carve-out for privately held businesses - as there should be since these are often impossible to value). I also shudder to think of the litigation that will come out of this: billionaire by definition have plentiful resources, and it would make sense for them to devote even a small fraction of these resources to contesting the taxman's valuations. Lawyers and tax accountants will surely rejoice. Finally, as Elon Musk aptly reminded us today, taxes aimed at a very small group usually get extended down the income and wealth distribution eventually, as was the case with the Alternative Minimum Tax. The list of unintended consequences is long. I think implementing this untested idea would be reckless.
I also wonder why the proposal is limited to monetary capital. Why not extend it to human capital? The highly educated have invested resources to accumulating knowledge and skills in expectation of future gains. These gains are quite sizable, as David Autor's work on the college wage premium has shown. For example, I calculate the average lifetime monetary gain from obtaining a UCLA Anderson MBA degree to be in the vicinity of $2 million, in present value terms, compared to earnings that flow from the good undergraduate degrees that our students typically possess. This number is actually easier to calculate than the value of a billionaire's asset holdings! Should we tax that now, too, or wait until these gains are realized? Unrealized gains are notional gains. They are not income until the gains are realized, i.e. the asset is sold. If we are open to taxing unrealized income, the possibilities are endless: anything that could conceivably produce income in the future becomes taxable.
This discussion, of course, may be moot, since the whole package will most likely never become law [I hold to my prediction that nothing will pass].