By Finn Donnelly
In America, key issues such as wealth disparity and the federal deficit have become increasingly troubling. The populace has grappled with strategies to reduce inequality, implement ‘fair’ taxation on the extremely wealthy, and address national debt. As a result, taxation of unrealised capital gains has become a pressing issue that has sparked much controversy, confusion and division. With Joe Biden including the policy in his budget for 2025 and Kamala Harris backing the plan during her unsuccessful presidential campaign in 2024, it is clear that there is significant advocacy for a tax on unrealised gains. This article will cover the policy proposal and analyse its weaknesses.
The current capital gains tax code and proposed changes
Traditionally, capital gains are taxed when the gain becomes realised – that is when the asset is sold. In contrast, taxing unrealised gains would target assets’ increase in value, regardless of whether they have been sold. Advocates see this as a way to address inequality and ensure that ‘paper billionaires,’ who currently accumulate large unrealised fortunes, contribute to taxation. In its current format, the American tax code categorises capital gains and losses as either short-term or long-term. A capital gain is short-term if the asset had been held for one year or less when it is sold whereas long-term is when the asset had been held for longer than a year upon its sale. Short-term capital gains are taxed as regular income. The long-term gains are taxed differently and the rates for 2025 range between 0% and 20% depending on your income.
The most recent proposal of unrealised capital gains tax came from the White House’s 2025 budget and was backed by Kamala Harris during her unsuccessful presidential campaign in 2024. The proposal was a 25% tax on all unrealised capital gains accrued by individuals with a net worth of $100,000,000 or more. This was estimated to affect around 10,000 Americans and raise an extra $503 billion between 2025 and 2034. As an example of how this would work: Let’s say you bought a stock at $100 a share and by the end of the year its value has increased to $110, you would then have an unrealised capital gain of $10. Traditionally, you would not owe any taxes on this due to the fact that you are yet to ‘realise’ the gain (sell the asset). Under the Democrat’s tax proposal, you would owe $2.50 (25%) of the $10 gain to the IRS.
The question then arises: Would you pay tax again when you decide to sell the asset? No, you would not, but only if the asset price has not changed since the last time you were taxed. If the asset price has fluctuated since you were taxed, then you would owe tax or be owed a tax refund. To better understand how this would work in actuality; that same stock you had purchased at $100 and then paid unrealised capital gains tax on at $110 has been held for another year and eventually, you decide to sell the stock at $115. This leaves you with a realised gain of $15, upon which you would owe the IRS $3 (the 20% long-term rate) but since you already paid in $2.50 tax when the gain was unrealised you would only owe $0.50. This makes the unrealised tax a sort of cash advance.
Problems arise
The first issue that immediately jumps out is the system’s complexity, which would undoubtedly be a headache to enforce. The IRS is already overburdened. This proposed tax would mean that 10,000 individuals would have to evaluate the worth of their assets every year. This is simple enough for holdings that have a clear market value such as stocks, bonds and securities but becomes rather tricky when valuing real estate and private market investments which do not have an objective price. Furthermore, would the IRS be able to audit all these filings? To introduce another angle, if a taxpayer paid taxes whilst an asset was unrealised but upon its sale they realised a loss, then this taxpayer would surely be entitled to a tax rebate. When Germany adopted a tax on unrealised capital gains in the 1980s it was quickly abandoned due to the policy being fraught with economic issues. One such issue was that investor confidence fell and led to a broad decrease in total investment within the economy, which in turn impacted the efficiency of capital markets. Also, the tax was very difficult for administrators to impose. It is reasonable to expect that America would encounter similar challenges that the Germans had in the eighties.
The next problematic factor is liquidity constraints. How would the taxpayer pay tax an unrealised gain without selling the asset to generate cash? They would be forced to pull money from other investments or sell part of the asset to foot the tax bill. Therefore, investors would be pulling capital from the economy rather than keeping it in the market, as mentioned previously it was estimated that the tax would pull in an extra $500 billion in the period 2025-2034. This contradicts the argument that the common man should not be worried about tax on unrealised gains because this only affects the richest 0.01% of Americans. If this tax impacts overall investment in the economy, then in turn every single consumer would inevitably face the effects due to weakened capital markets and the value of their retirement funds going down.
Unrealised capital gains tax would initially apply only to the super wealthy, but history suggests such taxes often extend to lower income brackets over time. Once the tax settles, voters will eventually become desensitised to taxes on unrealised gains. In times of fiscal strain, if the government faces a deficit or lacks the funding to sustain its budget, it may extend this tax to lower-income groups. We’ve seen this before. Federal income tax was introduced in America in 1913. Upon its introduction, the tax was accepted by the people because it targeted only the super-rich. In fact, it only affected less than 4% of the population. By 1950 – two world wars and nine recessions later – 75% of Americans were now paying income tax. In times of desperation, Uncle Sam reaches deeper into consumers’ pockets to keep the country afloat, which often results in the merciless expansion of tax.
This ship is unlikely to ever leave the harbour.
A tax on unrealised capital gains is unlikely to pass. Certainly not in the next 4 years due to the republican stronghold in government. Even if the democrats had entire control of the white house, congress and the Senate, several democrats have come out and said they would not support it. Also, it must be said that the proposal of taxing unrealised capital gains was probably a populist popularity grab, therefore it is unlikely it would ever have been put in place even if Kamala had won in November.
Moreover, a tax on unrealised capital gains could be unconstitutional. The Constitution makes it incredibly difficult for the government to enact direct taxes. Congress was required to pass a constitutional amendment just for income taxes to become law. Experts and politicians will continue to debate this issue. However, if a tax on unrealised capital gains were passed, legal challenges would inevitably arise, and the Supreme Court would ultimately rule on the issue. It is highly likely that they would strike down the tax.
Closing statement
Despite the low likelihood of this tax becoming law, there is still clear support for taxing unrealised capital gains. Advocacy for this stems from those who – rightfully so- are frustrated by the super-rich avoiding their fair share of taxation and America’s colossal wealth disparity. However, it is important that people understand that a tax on unrealised capital gains is an inane and inefficient means of holding the ultra-rich accountable for their share of tax.
The views expressed in this article are the author’s own and may not reflect the opinions of The St Andrews Economist.
Photo by Kelly Sikkema on Unsplash