Unreal(ized) Gains Tax: an Economic Earthquake in the Making

Commentary

The Internal Revenue Service (IRS) would first need to impose an annual (or periodic) valuation requirement on a wide range of assets. For some assets, like securities and derivatives, that calculation would be burdensome but at least possible. On others, in particular where valuations are subjective or liquidity is low, there would be considerable debate over the value upon which the tax assessment should be based. This would be the case with assets ranging from real estate to collectibles to intellectual property. The IRS would need to be granted sweeping appraisal powers or the authority to hire/appoint nominally-independent consultants to handle the assessments associated with the massive broadening of assets subject to the new tax.

In light of the vast capital stock in the corporate and high-net-worth world, reporting obligations would increase several-fold. Ironically, the Constitutional guarantee of property rights has facilitated the massive accumulation of assets to which the Beltway bandits now seek to help themselves. Targeted taxpayers and their firms would be required to report the details of all of their assets annually, including their estimated market values, at their own expense. The compliance costs and reporting obligations would expand tremendously as compared with the current tax liability on sales transactions alone. Drawn into this process would be third-party entities such as financial institutions, insurance appraisers, art galleries, franchisers, marketing firms, auction houses, copyright and trademark registries, pawn shops, and countless other intermediaries involved in asset purchases, sales, and transfers. Even your local comic book store or baseball card shop will be enlisted to provide valuations and make detailed, periodic reports on customer activity to tax authorities. Most of us, at this point, will have been conscripted by the IRS.

The audit and enforcement arm of the IRS would need a sizable beefing up as well. Tax collectors would gain authority to audit and investigate taxpayers’ holdings, financial records, property titles, and transaction details, especially for illiquid or hard-to-value assets. Expanded powers would follow to enforce the tax on offshore or foreign-held assets, likely with the kind of international cooperation agreements like those currently advancing global minimum corporate or wealth taxes. New penalties for non-compliance will cover such violations as under-reporting asset values, failing to disclose assets, or underpaying taxes on unrealized gains, with penalties to include monetary fines, asset seizures, and criminal charges.

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A new and highly complex realm of taxation would also need new mechanisms for dispute resolution for taxpayers to challenge valuations they find inaccurate or unfair. Legal challenges, in turn, would necessitate greatly increased capacities for both judicial and administrative review processes. And because squeezing tax revenue out of illiquid assets inevitably causes liquidity shortfalls, a new array of deferral options or installment payment plans would have to be drawn up and administered. Over time, forced sales—whether legally ordered or made to avoid running afoul of the tax man—are likely to depress asset values of all types.

Government agencies far outside of the IRS would have to build information-sharing and coordination networks for tax authorities aiming to track ownership and asset valuations. Increasingly close collaboration between the Treasury Department and financial regulators, motor vehicle departments, patent offices and beyond would be needed to cross-reference and share information. Monitoring overseas assets and high-net-worth individuals would expand tax treaties and new data-sharing with foreign governments.

All of that will generate a flood of data from annually tracking and valuing assets, so advanced technology and data-collection infrastructure would follow in short order. Real-time systems would monitor the disposition of financial assets, real estate, intellectual property, and other possessions. For liquid assets like stocks and bonds, automated systems will likely be developed to assess and tax unrealized gains as they occur.