The Single Best Argument Against Taxing Unrealized Capital Gains
The single best argument against taxing unrealized gains is the liquidity issue.
Unrealized Gains Lack Cash Flow: When gains are unrealized, the asset owner hasn't actually received any cash. Taxing these gains would require the owner to pay taxes without having the corresponding liquidity. For example, if someone owns stock that has appreciated in value, but they haven't sold it, they would need to come up with the cash to pay the tax, even though they haven't received any actual cash from the investment.
- Forced Sales: To pay the tax, individuals might be forced to sell assets to generate the necessary funds, which could disrupt long-term investment strategies or lead to market instability.
- Market Impact: If many investors need to sell assets to pay taxes on unrealized gains, it could create downward pressure on the prices of those assets, leading to broader market impacts.
- Valuation Challenges: Determining the precise value of certain assets, especially illiquid ones like real estate or private equity, can be difficult. Fluctuations in market value could make it challenging to assess the correct tax amount.
- Unfair Burden: Taxing unrealized gains could place an undue burden on investors who may have substantial paper gains but limited actual income, such as retirees or long-term investors.
In essence, the liquidity issue underscores the practical and economic challenges of taxing unrealized gains, making it a strong argument against such a policy.
Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC.