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Can we really tax wealth and unrealized gains?

It might surprise many people to know that very wealthy people pay a lot of taxes.

In California, for example, it's estimated that the top 1% of taxpayers pay 50% of the state income taxes collected. However, at the same time, it's no secret that the this same one percent pay far less in taxes than the average working person as a percentage of their overall income and/or net worth. And worst still, many taxes and fees in California are highly regressive, hurting low income people the most -- gas taxes, sales taxes, state income taxes, legal filing fees, and much more.

Because of this, there's a great deal of chatter about how to "tax the rich." One such proposal now being thrown around is to tax the unrealized gains on "assets." But is that really feasible or should we consider other options?

Marketwatch writer, Brett Arends, say that a wealth tax is very easy to do. See "Critics are totally wrong about taxing unrealized gains."

His argument is that we pay taxes and fees on all kinds of things like property tax, sales tax, etc., which are taxes on assets, so it should be easy. But in reality, it's a lot more complicated.

When it comes to income taxes or a tax on the sale of an asset or taxes on inheritance, the "value" of the thing being taxed is readily known at the time. But when it comes to all the other types of assets that are included in a person's net worth, it's another matter altogether.

For example, if we're talking about someone holding publicly traded securities.... stocks, bonds, and to some extent commodities in tradable forms, like gold, the values appear to be obvious. But then the question arises as to what value at what date and time.

The values of publicly tradable assets, commodities, and securities change by the day, the hour, the minute, and these days, by the millisecond. One day a person could owe taxes on a "paper" gain and the next day they wouldn't because the asset is suddenly trading at a loss.

So how do you establish a taxable value of their wealth?

And, consider an asset like stock options. How the heck do you value those? Ask anyone who has ever worked for a startup company and they'll tell you that one day you can be a paper millionaire and a month later be looking for a job because the company shut down and your options are worthless.

Meanwhile, when it comes to private capital investments (i.e., no public value established) and the broad spectrum of privately held assets, which constitute much of the "wealth" of the truly wealthy (over $100,000 million in investment assets not counting their personal homes) this would be extremely difficult, expensive, and time consuming to determine.

These assets include real estate of all types (e.g., undeveloped land, an island in the ocean, ownership or percentages in different classes of real estate -- residential, agricultural, commercial, industrial, etc.), artwork, jewelry, and collectibles, and intangible assets (e.g., percentage ownership in a privately held copper mine or venture capital investment), boats, planes, automobiles, and now even rocket ships!

How do you value those at any given moment in time and how do you track their value year after year? Appraisals on just one piece of artwork can take many months to determine and even then go for twice that or half that amount at auction.

An accurate appraisal of a wealthy person's assets could takes years to establish and then have to be updated every year to reflect fair value for tax purposes. And if the taxation date on assets were to be set at the end of the year, like income taxes are, one can only imagine how dramatically that would distort appraised asset "values" and the markets to compensate.

Finally, there's the additional problems that most truly wealthy individuals hold assets in the form of corporations and other types of legal entities that are located in other countries around the world. How does one accurately assess those without a thorough IRS audit, which can takes years to resolve?

The whole concept of taxing unrealized gains is so unwieldy and impractical and unlike anything in the history of tax law, that it seems infeasible from the get go.

One idea is the widely-supported proposal by billionaire Warren Buffett. The so-called "Buffett Rule" attempts to ensure that millionaires and billionaires pay a tax rate similar to that of middle-class families. The proposal is to implement a minimum tax rate of 30% on individuals earning more than $1 million annually, so that wealthy individuals don't to pay a lower tax rate than middle-class workers, such as his secretary.

This is certainly a more feasible method of estimating how much tax a wealthy individual should pay. And on its face, it is certainly more equitable. The only problem is that many truly wealthy people don't actually have much "taxable" income in any given year since much of the income is legally sheltered (e.g., real estate depreciation, tax credits, etc.) or doesn't come from income (e.g., loans on their assets or from their corporate holdings, etc.)

And finally there's the enormous problem of taxing unrealized gains on venture capital, private equity, and new startup business investments, which are the foundation of our entrepreneurial economy.

If the unrealized gains on these and all other types of high risk investments (major real estate development and technology, medical, and science R&D, etc.) are taxed, why in the world would anyone make those types of investments? Since these types of "risk capital" investments usually take many years (even decades) to make a profit, an annual tax on the value of those "assets" could reduce the investment to zero (i.e., 100% goes to taxes) even before the investment ever comes to fruition.

This would be economic suicide.

Don't get me wrong, I'm all in for taxing the obnoxious, know-it-all, super-duper rich, and I realize we're in the "chicken in every pot" time of the political campaigns so politicians are prone to promising everything for everybody, but the unfairness of our tax system will be a very tough nut to crack. As such, while we're figuring out how to do that, we might want to at least start doing something at the other end.

According to the IRS, approximately 40% of American households did not owe any federal income tax in 2022. Most of these households make less than $25,000 a year in taxable income (which effectively puts them below the poverty line) and all their payroll taxes are automatically reported to the government anyway.

Why do we even require such households to even file complicated tax forms and waste time processing those returns?

With all this considered, we may already have an easier way to accomplish the underlying goal of taxing high net worth individuals (over $100 million), which is to stop tax evasion.

Forget about taxing assets, just increase auditing

The IRS has recently been increasing the number of audits of high net worth/income individuals with surprising results. They quickly collected over $1 billion in unpaid taxes. And for every dollar spent auditing high-income / high net worth individuals, the IRS collects collects about $12 in additional tax revenue.

So based on these results, why not just increase IRS audits of the same high net worth group being targeted by a new wealth tax?

All the mechanisms needed to do this are already in place and the current tax code is sufficient to recapture significant lost tax revenues. This could go a long way toward addressing tax inequities. In any case, it's a more realistic place to start and it would produce more tangible results than trying to deal with the impossible complexities of trying to tax assets or net worth.

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