Ron Wyden’s Plan to Drain Investors

A new Democratic idea to grab revenue: Tax unrealized capital gains.

WSJ Editorial. Excerpts:

"In a December working paper for the Federal Reserve Bank of St. Louis, two economists looked at what happened in South Korea when a 24% capital-gains tax on certain large firms was switched to a 10% rate. Compared with unaffected companies, “the affected firms increased investment by 36 percent and capital stock by 9 percent within three years.”

A lower tax rate is also a matter of fairness. If investors have capital losses, they aren’t allowed to deduct more than $3,000 a year. There’s no inflation adjustment either: If $100 of stock bought in 1999 is sold for $150 today, the difference is taxed even though much of it is an illusory gain caused by dollar erosion. Many people who have capital gains are “rich” for a year, after a lifetime of letting an investment build value before they sell.

Capital gains aren’t taxed like salaries, in other words, because they’re different from salaries. Mr. Wyden’s plan would treat capital gains as ordinary income and deliver a gut-punch to investors and the economy. Mr. Wyden also proposes an annual “mark to market” scheme, which would spread the tax over the lifetime of the investment. As an asset rises in value, its owners would pay tax each year on the incremental gain.

This would create an enormous new accounting burden. Mr. Wyden may say that his mark-to-market rule will apply only to the top 1% or 0.1%, but it would still be a bonanza for tax attorneys. How will people in the top 2% know whether they’ve passed the threshold, and how far will they go to avoid it?"

"A deeper problem is Mr. Wyden’s plan would tax gains that exist merely on paper. Imagine a doctor investing in stocks in a taxable brokerage account. In good times he’ll have to divert money to pay the annual tax, since the unrealized gain isn’t in his bank account. Then what if the market crashes as he retires, erasing the gain—or turning it into a sudden loss? Could the doctor call the IRS to get a refund for years of taxes?

And what about illiquid investments, such as private companies or real estate? As with Ms. Warren’s suggested wealth tax, no one knows how Mr. Wyden would go about valuing them."