Taxing Unrealized Capital Gains and an Inflation Nexus

by
John Klar

Among the various new taxes proposed by Kamala Harris’ presidential campaign are increased levies on capital gains and taxation of unrealized capital gains on wealthy Americans. Given recent history, this is particularly sneaky. The Biden-Harris team sparked rapid inflation, so now the Harris-Waltz duo wants to tax the phantom inflationary gain even before citizens holding assets as a shield against inflation have disposed of them. In other words, Harris plans to tax gains that don’t yet exist, which wouldn’t be possible without the inflation exacerbated under the Biden-Harris administration.

(Over)Taxing the Rich?

The Harris team rationalizes an assault on rich people’s capital to reduce the federal deficit, increase federal revenue, and “rebalance the tax code” so that the wealthy will “pay their share.” Targeting the rich is a standard slippery slope to justify government intrusions that will then be extended to more citizens and their assets.

Capital gains are generally a product of “real” growth due to increased demand or limited supply combined with inflation. As inflation escalates, the portion of gain on the disposition of capital assets attributable to sketchy Federal Reserve policy and not actual wealth also rises. The government artificially boosts asset values and then rakes off a percentage (28% under Harris’ latest proposals) of that artificial “gain.”

This is a moral hazard that has reared its ugly head before. Battling vicious inflation through the 1970s, the United Kingdom’s high capital tax rates stifled real economic growth. In a 1979 speech following the conservatives’ General Election victory, then-Chancellor of the Exchequer Geoffrey Howe condemned taxing phantom capital gains attributable not to real income growth but government-seeded inflation: “The objection to CGT [Capital Gains Tax] in its present form is that most of the yield comes from paper gains arising from inflation. The tax is, therefore, a capricious and sometimes savage levy on the capital itself.”

Accounting for Inflation

In an effort to achieve equity and counter the damaging effects on its economy and investment patterns created by government inflation of asset values that are then skimmed as “profits,” the United Kingdom introduced an “indexation allowance” which increased investors’ cost basis in assets by a factor linked to inflation. This worked for capital gains just as cost-of-living adjustments (COLA) shield Social Security and other benefits from erosion by inflation.

Kamala Harris’ effort to amplify a wealth-killing levy upon the inflation she and Joe Biden unleashed is far worse than the British experience – the British taxed realized, not unrealized, gains. The Harris proposal assaults unrealized gains on stocks or real estate that are still being held. This distorts markets enormously. How would an investor procure the cash flow to pay Kamala while the asset is unliquidated? How will the government account for subsequent drops in price at actual disposal? How are investors to purchase inflation-resistant assets – an effort to merely preserve, not grow, wealth?

The federal courts have long dismissed any efforts to tax unrealized income as patently unconstitutional. The Sixteenth Amendment provides that ‘income’ is taxable, but not the capital sources thereof: The difference is provided by what is called a “recognition event” – usually disposal in an arm’s length sale. By definition, the Harris plan seeks to pierce through real income and impose a levy on capital: the “source” of citizens’ income.

US Supreme Court Justice Clarence Thomas forcefully reaffirmed this fundamental constitutional precept in his 2024 dissent in Moore v. United States:

“’Income’ in the Sixteenth Amendment refers only to income realized by the taxpayer. The Amendment resolved a long-running conflict over the scope of the Federal Government’s taxing power. It paved the way for a federal income tax by creating a new constitutional distinction between ‘income’ and the ‘source’ from which that income is ‘derived.’”

Taxation of Unrealized Inflation

Harris’ proposed hidden “inflation tax” on capital gains is moral hazard enough without adding a policy that triggers premature recognition for “unrealized” income. In addition to cash flow and accounting/administration nightmares, this compounds the inflation/wealth drag problem exponentially. Imposing levies on inflation is economy-damaging and unfair; collecting them even before the asset is disposed of will crush free market investment strategies and wreak havoc on markets as investors seek to safely shelter capital from inflation.

Only so much debt can be monetized through “build back better” and “inflation reduction” – slogans that accomplish the opposite of what was promised, seeding inflation and dragging down real economic growth. The temptation to take even more to recoup declining tax receipts may be presented as beneficial but will prove to be a bureaucratic dragon devouring its own tail and the US economy with it. Taxing unrealized gains is a “capricious and savage levy on capital itself.”

Author

Share to...