I’ve received a few questions regarding my take on the unrealized gains tax so I thought I’d put pen-to-paper (keyboard-to-document?…whatever) to pen (key?) my thoughts.
If you couldn’t have guessed by the title, I’m not a big fan of what’s being proposed.
My Political Biases
Before I dive in, I want to be clear about my political bias: I HATE politics.
Politics is just a sport for dorks. One half of the country roots for the blue tie, and the other half roots for the red tie. If your team wins, it’s a totally legitimate victory, but if your team loses, it’s not because they played poorly—it’s due to some grave injustice brought on by a corrupt system. The “referees” were bought and paid for, and the “game” was fixed from the start.
So, if you think I lean one way or another politically, you’re mistaken. My conservative friends think I’m a liberal, and my liberal friends think I’m a conservative. Politically speaking, I like where I am.
You might wonder why I’m wading into these political waters given my disdain for the subject. Well, it’s to discuss a hot political topic—the unrealized gains tax. While I hate politics, I love investing, and this controversial tax proposal happens to be at the intersection of both.
I’m not going to sugarcoat it: Democrats say Republicans are an existential threat to democracy. Given these tax proposals, Republicans can say Democrats are an existential threat to our economic system. The ramifications of an unrealized gains tax, if enacted, are truly that dire.
But before we talk about why, let’s first discuss exactly what’s being proposed and how an unrealized gains tax would work.
Outlining The Unrealized Gains Tax Proposals
There are two unrealized gains tax proposals being floated around in Washington. From ITEP.org,
Proposal #1: Under Sen. Wyden’s proposal, very wealthy people would pay income tax annually on unrealized gains on publicly traded assets like stocks, which have a value that is easy to track each year. This approach is often called mark-to-market taxation. For other assets, which have values that are not easily determined, wealthy individuals would defer paying income tax until selling the asset (as under current law), but the tax due at that time would be increased to offset the benefit of the deferral. This approach for non-tradable assets is not technically mark-to-market taxation, but if structured well it can have a very similar effect on wealthy taxpayers.
Proposal #2: The President’s Billionaires’ Minimum Income Tax. Instead of mark-to-market taxation, very wealthy people would be required to pay a minimum tax equal to at least 25 percent of what we could call their “true income,” including both traditional taxable income and unrealized capital gains.
So, if you’re worth more than $1 billion dollars or have three consecutive years of making more than $100 million dollars in the first proposal or have a net worth exceeding $100 million dollars in the second. You would be subject to an unrealized gains tax.
Under both proposals, your public market portfolio’s unrealized gains would be subject to taxation each year. Using the President’s proposal as an example, if your stock has a value of $10 at the beginning of the year and it closes at $14 at the end of the year, at least $1 would be owed in taxes.
Private assets are valued differently under each proposal and while proposal #1 makes more sense relative to proposal #2, it doesn’t matter. Taxing unrealized gains is a bad idea.
To explain why, let me lead off with an important question.
The Question: Who is better at managing money, the federal government or capitalists?
I mean…come on now. Do I really have to answer that?
Point #1: An unrealized gains tax would exacerbate our federal government’s atrocious financial behavior.
The belief that the federal government spends money effectively and invests capital efficiently baffles me.
I would happily pay more taxes if the funds actually reached the individuals who needed them most. Investing more in disadvantaged communities to give them a shot at a better life? Increasing policing to enforce the law in these poor neighborhoods? Universal healthcare? Absolutely, I’m a fan. If there were measurable outcomes proving that my tax dollars were being used effectively, I’d be more than happy to write that check to the government every year.
Unfortunately, there’s no such proof, despite the massive amount the government spends each year. If you told me that even a dime out of every tax dollar actually helps people in need, I’d call you a liar. Because of this, I want to pay as little in taxes as possible and instead use my brainpower to help others directly while tipping service workers well in the process.
Republicans, Democrats, it doesn’t matter. The federal government doesn't responsibly manage their finances and politicians have zero incentive to change their behavior.
Our elected officials are naturally biased toward short-term thinking. They’re primarily incentivized to win their next election, which leads them to focus on immediate gains rather than considering the long-term consequences of their actions. Case in point: the federal government has been running budget deficits for the most part since the U.S. dollar became a fiat currency in 1971. Fast forward to today, and the United States is saddled with over $34 trillion in debt. That’s $34,000,000,000,000.
And what do we have to show for it?
Moreover, every valid criticism of crony capitalism can also be directed at our corrupt federal government. Politicians routinely ignore the public’s wishes to serve their own interests instead. For example, Congress continues to vote in favor of sending billions to support overseas conflicts, despite polls clearly showing that the majority of the population opposes these actions. As the primary financier of geopolitical conflicts, the U.S. possesses significant negotiating leverage to bring both sides to the table and end these wars, sparing countless future lives. But Congress won’t act, as there’s too much self-interest involved. It probably won’t surprise you that the top three counties by median household income in the United States are located near Washington, D.C. (Loudoun County, Falls Church City, and Fairfax). What do they have in common? Many of their residents are employed by defense companies like Raytheon and Northrop Grumman. Additionally, lobbyists with deep pockets routinely prioritize their own interests over those of the American population, ensuring that nefarious actions continue.
So sure, capitalism has its issues, but politicians are massive hypocrites for not looking in the mirror. People who live in glass houses shouldn't throw stones.
So, getting to the unrealized gains tax specifically and given everything I’ve laid out, I have zero confidence that our elected officials would be able to responsibly handle the swings in tax revenue that would come from an unrealized gains tax. It’s reasonable to conclude that they would massively increase spending during stock market booms and not cut back during stock market busts.
After all, cutting back benefits would be politically unpopular, and since government officials want to get re-elected, it’s more likely they would maintain spending at these higher levels instead of making cuts. Kicking the can down the road for future generations to worry about.
It’s easy to predict where this would lead. Relying on volatile markets to fund spending would likely accelerate the timeline before the country goes broke, especially if there's a prolonged bear market.
Point #2: Capitalists are better spenders and investors.
Entrepreneurs, like Jeff Bezos, are the primary unrealized gains tax targets in the political crosshairs. However, the targeted business owners are far superior capital allocators. If they weren’t, their businesses would go belly up and they wouldn’t be worth what they’re worth.
In addition, because entrepreneurs invest a significant portion of their personal wealth in their startups, they have substantial skin in the game to manage their finances well. They carefully perform cost/benefit analyses to determine how spending money today will benefit the business in the future. They seriously consider whether allocating funds to one area is better than another. They heavily weigh the risks, knowing that making a big investment today could jeopardize the survival of their business tomorrow if the bet doesn’t pay off.
Capitalism naturally biases participants to be more financially responsible and mindful with their spending. They think more long-term and weigh the consequences of their actions. Government officials, generally speaking, don’t.
Point #3: The private sector has created more value for the average American than the Government.
This might be a hot take, but overall, I believe entrepreneurs have done more to improve the standard of living for most Americans than the federal government. People often don’t fully consider the impact many of the largest U.S. companies have had on their daily lives. Think of Amazon and online shopping, Apple and the iPhone, OpenAI and ChatGPT—the list goes on.
Take Amazon as an example. Today, I have a one-stop shop online where I can easily browse for what I need and be confident that I’m paying a reasonable price. Many young people don’t know what life was like before Amazon, when you had to sift through mail-order catalogs, spend time driving from store to store to find what you were looking for, and never be sure if you were paying a fair price or getting ripped off. Amazon has solved these issues, saving me considerable time and money.
In contrast, many sectors tied to the government have deteriorated over time. College costs have soared, in part due to government-subsidized student loans, burdening graduates with massive debt and impairing their financial security at a time when their careers are most uncertain. Additionally, healthcare costs have skyrocketed, bankrupting individuals and families who face medical emergencies, especially when they’re retired and unable to generate income or have the assets to pay their medical bills. And if you’re in poverty, good luck.
To get to the broader point, entrepreneurship and innovation are two of the United States' greatest economic competitive advantages. Our culture incentivizes creative problem-solving by exploiting market inefficiencies to generate profit, ultimately benefiting society.
Interestingly, the U.S. government benefits from private sector innovations (e.g., SpaceX and NASA) that it likely wouldn’t have been able to develop independently. Doesn’t this demonstrate that the private sector is more innovative and capital-efficient than the public sector?
To be clear, yes, a pure-profit incentive can be—and often is—exploited by a greedy, malevolent few. But that’s when the government is supposed to step in and regulate. It’s their job to punish these bad actors and pass legislation that prevents exploitative, rent-seeking behavior.
But do they do this? Nope. Instead, they’re often too busy hanging out with lobbyists, trading on inside information, attending fundraisers, and focusing on how to mislead the populace to win votes.
So, despite its many flaws (and there are many), our current economic system has been hugely beneficial to our well-being and is a major reason why the United States is the envy of the world. Taxing unrealized gains could drive entrepreneurs to start businesses elsewhere, greatly diminishing our global competitive advantage and benefiting foreign nations instead of our own.
Even worse, they may choose to launch their ventures in countries that are adversarial to the United States, like China.
So to answer the original question, “Who is better at managing money, the federal government or capitalists?” Answer: Capitalists
Hopefully, I’ve convinced you of three things: first, that the federal government is terrible with money; second, that successful entrepreneurs are better at managing money; and third, that these individuals create more societal value than the federal government.
This suggests that every dollar available for capitalists to invest creates more value for the average American than if that money were handed over to the government to waste. Therefore, we should prefer that capitalists have more money to invest rather than giving it to the federal government. An unrealized gains tax would shift money away from the former and give it to the latter, leading to significant economic opportunity costs.
Now that we’ve discussed the macro reasons why an unrealized gains tax is a bad idea, let’s delve deeper into the company-specific issues such a tax would cause.
The company specific issues created by an unrealized gains tax.
An unrealized gains tax would reduce the incentives for entrepreneurs to “think big” and “swing for the fences.”
As I’ve outlined, individuals with high net worth or income would be subject to an unrealized gains tax. Here’s the problem: such a tax would force successful entrepreneurs to reduce their business ownership and disincentivize further innovation once their wealth or income reaches a certain level.
Essentially, we’d be saying, “You’re free to innovate, but if you innovate too much and grow too big, we’re going to punish you.” This is silly. Using technology companies as an example—since technological innovation drives improvements in our standard of living and creates significant military advantages—an unrealized gains tax would weaken what makes our tech sector world-class, reduce our economic potential, and potentially leave us more vulnerable to external threats.
We want capital flowing towards big ideas. We want to properly align our top minds’ incentives toward swinging for the fences. An unrealized gains tax undermines both.
An unrealized gains tax would dilute the quality of firm ownership and raise potential governance issues.
Forced selling would dilute the average level of human capital in firm ownership. Since most company shares come with voting rights, this could lead to a scenario where shareholders, driven by a combination of ignorance, misinformation, and short-term thinking, vote against the long-term interests of the company.
For instance, forced selling of equity could make it easier for activist investors to acquire shares. If an activist investor gains enough shares, they could lobby for board representation and potentially negatively influence the company’s vision. They might also pressure shareholders to vote for proposals that benefit the activist's short-term interests at the expense of the company’s long-term goals and its stakeholders. This isn’t just a hypothetical concern—activist investors have pressured public companies in the past to take on debt to pay dividends to shareholders, increasing bankruptcy risk and reducing the capital available for new projects.
The bottom line is that we want the best and brightest minds to have the most control over the companies they create and manage. A successful, self-made, high-net-worth entrepreneur knows their industry better than a typical activist investor or the general public. And with a significant portion of their wealth tied to their business, they’re less likely to engage in short-term, “make a quick buck” strategies.
An unrealized gains tax would greatly increase tax code complexities and decrease business and government resource efficiency as a result.
Individuals and institutions alike should strive to maximize the highest and best use of their time, money, and attention. An unrealized gains tax would guarantee that everyone’s resources are used sub-optimally.
The wealthy would spend more on hiring tax professionals, third-party appraisers, and lawyers to minimize their tax burden. The IRS would become bogged down in reviewing and disputing every valuation they receive, further wasting government resources. This might be good for CPAs, lawyers, business appraisers, and IRS agents if they choose to hire more staff, but it’s bad for everyone else.
Instead of focusing on business initiatives and growth, a business owner’s time and attention would be consumed by meetings to discuss tax strategies, debates on how to reduce the paper value of their business, and justifications of their business valuation to the IRS.
From a financial capital perspective, the increased costs of hiring more people to navigate the now even more complicated tax code would divert capital away from growing their current business or investing in other ventures.
An unrealized gains tax reduces resource efficiency for both the government and the private sector.
An unrealized gains tax would create significant liquidity issues for private business owners.
If an owner’s company is private, this could raise a myriad of liquidity issues. Private companies aren’t as easily tradable as their public counterparts, so raising the cash necessary to pay an unrealized gains tax could be challenging.
To maximize the selling price for private assets, you’d have to go through a lengthy transaction process. This involves marketing the asset to potential buyers, negotiating a selling price, undergoing inspections and audits, and finally drafting all the paperwork to execute the transaction. This process can easily take months (and years off your life). And that’s the best-case scenario. What if the buyer’s financing falls through or they back out?
Additionally, what if I were an unethical buyer and knew you had a large tax liability coming due? What’s to prevent me from dragging out the entire process and then, at the last minute when your tax deadline is near, lowering my offer? You’d be forced to either accept the lower offer or waste even more resources finding another buyer quickly.
It’s also not hard to imagine a scenario where it’s the end of the tax year, and a few months later, the economy goes into a recession. This could create a liquidity issue where the underlying asset is now worth less than it was at the end of the tax year. You’d be stuck paying taxes on the higher year-end value, not on what the asset is currently worth. If you have to sell assets to pay these unrealized gains taxes, you’re forced to sell at a low point. Compounding the problem, transaction volume and liquidity typically dry up during market distress, so private business owners may have to accept a substantial discount to raise the necessary funds.
Now, I know what you’re thinking—wealthy people could just borrow against the value of their assets to raise the cash to pay these taxes. Fair point, and many wealthy people already do this.
But what if their business already involves a high degree of debt, as is common in real estate? They may be unable to secure additional financing, creating a liquidity issue, or they may have to take on more debt than intended, creating significant problems if the asset value falls. If enough wealthy individuals take on debt to pay taxes and the economy falters, these increased debt burdens and subsequent defaults could cascade and negatively impact the broader economy. Look no further than the Global Financial Crisis as an example.
You can see how unrealized gains taxes can quickly become a significant issue. The liquidity mismatch between private asset ownership and cash taxes can create a host of problems.
Private business owners may be forced to sell their underlying business assets or ownership interests to raise money for taxes, distorting private asset prices.
Bad actors could exploit forced liquidity needs from sellers.
End-of-tax-year asset values can deviate significantly from their value when the taxes are actually paid, creating additional liquidity problems.
Private business owners might take out loans to raise money for taxes. This increased leverage could create issues if asset prices fall, potentially causing market crashes and exacerbating economic problems.
So, we’ve discussed some of the issues an unrealized gains tax would cause for both public and private business owners. Next, we’ll explore how such a tax could worsen inequality, but first, let’s talk about the differences between public and private market valuation.
Why massive capital would flow into private markets. Discussing private v. public asset valuation.
Believe it or not, the wealthy can afford to hire smart people to provide creative tax advice to minimize their taxes. They can also pay experts to manage their wealth in ways that maximize after-tax returns. And finally, they can pay top professionals to fight the IRS, allowing them to keep more of their money. If the benefit of reducing tax liabilities outweighs the cost of hiring these experts, wealthy individuals are more than willing to pay up. The taxes from unrealized gains would more than justify these hires.
Moreover, since the wealthy can pay more for these services than government agencies can, you can bet that the best and brightest aren’t working for the government. These private-sector experts are likely to outsmart the public-sector employees who write our tax code.
With that as a backdrop, let’s discuss valuing public and private companies.
Valuing your ownership in a public company is straightforward. Simply take your shares, multiply them by the share price, and you have your value. The large number of market participants, many of whom are trying to generate above-average returns, ensures that public markets are informationally efficient. Breaking news is quickly and accurately reflected in a company’s value for the most part, making a public company’s valuation objective. It’s hard to argue that a company is worth more or less than what the collective wisdom of the stock market suggests.
Private investments, however, are much more difficult to value. There isn’t a large number of market participants trading on news and information to provide an objective valuation for you. Because of this, a private company’s value is much more subjective and often requires hiring professionals to estimate it.
When there’s subjectivity in valuation, there’s more opportunity to inflate or deflate the asset value depending on the outcome you want to achieve.
If you’re trying to secure a business loan, you’ll present an optimistic story with financial projections that support your case. “My company is growing fast and has almost no risk. I’ll easily be able to pay back the loan.” If you’re negotiating the price of a house that’s been on the market for a while, you’ll emphasize everything wrong with the property to drive the price down. “This house is trash. You’re lucky I’m even making an offer.”
Private company valuation works the same way. It’s a dirty little secret in investment banking that much of the value they present on paper is inflated or deflated depending on what the client wants to see. While valuations must be somewhat grounded in economic reality, it’s easy to input favorable numbers into a model and spin a convincing narrative for why those inputs are valid. Off the top of my head, I can think of a few ways to decrease a private business’s value.
Reduce the total addressable market
Reduce revenue growth expectations
Increase expense expectations
Increase the required future capital expenditures necessary and minimize the expected return on capital on those capital expenditures
Increase the perceived riskiness of your company
Slap a fat illiquidity discount on the value you come up with.
I came up with those ideas in less than a minute, and I’m not even an investment banker. Imagine what a full-time professional could do.
All of this is to say that, because of the subjective nature of private asset valuation and the ability of wealthy individuals to hire top talent, an unrealized gains tax would naturally drive the wealthy to invest more heavily in private markets rather than public ones. They would seek to exploit the subjective nature of private market valuations to minimize their tax liability.
This significant influx of capital into private markets would have substantial consequences for everyday Americans. If you think inequality is bad now, just wait.
The wealth inequality issues created by an unrealized gains tax.
An unrealized gains tax would exacerbate the housing affordability crisis.
Many wealthy individuals, seeking to maximize their after-tax returns, would likely allocate more of their funds toward private real estate. A portion of this allocation would undoubtedly target single-family homes. If you’re an aspiring first-time homebuyer, you probably see where this is going.
As more capital flows into single-family homes, prices would rise, further shutting out first-time homebuyers and worsening our current housing affordability crisis. Big-money, all-cash buyers would drive up home prices and could easily pay over the asking price. Additionally, they could close quickly since they don’t need to secure financing, making wealthy individuals—who have no intention of living in the houses themselves—the preferred buyers. Meanwhile, a young person already stretching their budget to meet the asking price but needing to secure financing would be left in the dust.
Real estate is still the average American’s number one wealth-generating asset. Moreover, owning a home is a significant part of the American dream. Increased capital flowing into single-family housing would prevent first-time homebuyers from getting their foot in the door, further widening the gap between the haves and the have-nots and likely doing further damage to an already fragile American psyche.
But there are public markets. Besides, public equity markets have generated far more wealth than real estate anyways, so who cares, right? Well…
An unrealized gains tax would deter private companies from going public, encourage public companies to go private, and reduce the investment opportunity set for the average American.
Not everyone can invest in private equity or venture capital as you have to have a minimum amount of wealth and/or income to do so (i.e., you have to be an accredited investor). This limitation is already a significant factor in worsening inequality, but an unrealized gains tax would exacerbate the problem further.
An unrealized gains tax would disincentivize private companies from going public via an IPO (initial public offering), reducing the investment opportunities available to everyday Americans. They wouldn’t have the chance to invest in some of the fastest-growing companies because they don’t meet the wealth or income threshold to invest in private markets. Additionally, many public companies might opt to go private, further shrinking the pool of available public investments.
Since compounding interest is the major driver of wealth growth, and the wealthy are the only ones with access to the fastest-compounding companies, a reduction in public companies would further exacerbate wealth inequality. Fewer companies are going public as it is, and an unrealized gains tax would likely ensure that even fewer choose to do so in the future.
And there’s one more issue that drives home the point about worsening wealth inequality.
An unrealized gains tax would eventually gets nullified if legislation doesn't also address the step-up in basis provision.
If a proposal doesn't address the step-up in basis provision in our tax code, an unrealized gains tax is a serious short-term “solution” that ultimately does more harm than good.
For those unfamiliar with the step-up in basis provision: When you pass away, the cost basis of the assets your inheritors receive is generally adjusted to the market value of those assets as of the date of your death. In other words, the entire unrealized gain is effectively wiped away. For example, if you buy a stock at $1 and it’s worth $10, you have an unrealized gain of $9. However, if you pass away and your children inherit the stock, their cost basis becomes $10. There are no longer any unrealized gains to tax.
This illustrates just how short-sighted the unrealized gains tax proposals really are. While they may increase tax revenues for the current generation, once these wealthy individuals pass away and transfer their assets, there will be no significant unrealized gains left to tax.
Therefore, an unrealized gains tax would do little to close the wealth inequality gap after the current generation of wealthy individuals passes on. The next generation would still inherit vast sums of wealth and have more investment opportunities to compound their wealth faster than the average American. Oh, and the housing affordability crisis would likely worsen.
To summarize why an unrealized gains tax is a truly terrible idea.
Hopefully by now you can see why I think the unrealized gains tax is such a bad idea.
It would take money away from value creators (capitalists) and give it to value destroyers (the government).
It would speed up the timeline for when the U.S. inevitably defaults on its debt.
It would decrease innovation and lead to financial and human capital flight from the U.S. decreasing our country’s competitive advantages.
It would reduce the incentives for entrepreneurs to “think big” and “swing for the fences.”
It would dilute the quality of firm ownership and raise potential governance issues.
It would greatly increase tax code complexities and decrease business and government resource efficiency.
It would create significant liquidity issues for private business owners (and possibly create wider systemic economic issues).
It would increase the home affordability crisis.
It would deter private companies from going public, would encourage public companies to go private, and reduce the investment opportunity set for the average American.
It would eventually gets nullified if legislation doesn't also address the step-up in basis provision.
Final Thoughts
Look, I absolutely agree that capitalism isn’t perfect, and there are plenty of bad actors who negatively impact the lives of everyday Americans. I also agree that the government does help some people who wouldn’t have received assistance otherwise. But when you consider the natural cause-and-effect relationships that an unrealized gains tax would trigger, it’s easy to see how terrible and dangerous this idea is.
Here’s how our economy should work: Capitalists should be the creative problem solvers who improve the standard of living for Americans by seeking profitable opportunities, while the government should be the creative problem solvers who prevent unethical capitalists from lowering the standard of living through exploitation. The closer we get to this balance, the brighter our country’s future.
Capitalists shouldn’t use their power and wealth to influence the government, and the government shouldn’t be in the business of deploying capital and managing money. When these lines are crossed, current and future generations of Americans pay the price.
And unfortunately, from the looks of it, we’re going to be paying a heavy toll for years to come.
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