In recent years, progressives have been pushing harder for taxation of unrealized gains, either through wealth taxes or “mark-to-market” taxation. Though there are numerous economic reasons why proposals to tax unrealized gains are wrongheaded, one should merely need to imagine how chaotic administration of such taxes would end up being to know they are an idea best left on the cutting room floor.
As I’ve noted in the past, a major issue that any proposal to tax unrealized gains would need to address is what happens when those unrealized gains disappear after they’ve been taxed. That’s particularly an issue for volatile assets — in the most recent example, cryptocurrency.
Over the past week in particular, the value of the most prominent cryptocurrencies have plummeted spectacularly. Trading above $34,000 on Monday the 9th, Bitcoin fell below $26,000 on Thursday the 12th, though it has since recovered to nearly $30,000 again. As recently as November of last year, Bitcoin was worth as much as $67,000. Doubtless by the time this op-ed is published, the price will have shifted significantly again.
After all, that’s the nature of cryptocurrencies. Even the “stablecoins” that are pegged to the value of another currency have felt the hit — TerraUSD, meant to follow the value of the dollar, dropped to a third of the value of the dollar twice on Wednesday the 11th. In the wake of this crash, its sister coin Terra Luna, trading at a value of about $82 a week ago, dropped to just below a cent.
In total, the cryptocurrency market lost over $1 trillion in value over the past month. In a single 24-hour period, the market lost $200 billion. That value doesn’t go somewhere else, it’s just gone — at least until the market is able to recover.
That’s a tough break for people with a great deal of exposure to the cryptocurrency market, but it would have been far tougher had they already had to pay taxes on gains that have since been wiped out. After all, someone who bought Bitcoin at its value of about $30,000 in July of 2021 would have ended the year with about $17,000 in unrealized gains per Bitcoin — “gains” which have since disappeared.
Practically, there’s only two options for drafters of taxes on unrealized gains. One option is that they don’t attempt to account for capital losses, creating an unfair “tails I win, heads you lose” situation for taxpayers and making investing a great deal more hazardous.
The other, and far more likely option, is that they do account for them through refunds when losses are wiped out. However, that would create situations where millionaires receive large refund checks from the government during economic downturns — situations that their own progressive constituents would doubtless decry as proof of the tax code favoring the rich.
At a more macro level, the latest episode for cryptocurrency is a reminder that taxing unrealized gains would make government revenues far less predictable. While tax revenue is already tied to the health of the economy, it’s not to the extent you might think. Even during 2020, when businesses and workers were made to hibernate by lockdown orders, federal revenues declined from their pre-pandemic projection of $3.6 trillion to $3.4 trillion. That’s not nothing, but hardly disastrous for budget-planning purposes.
On the other hand, a tax on unrealized gains could shift from making the government money to costing it money if the downturn is bad enough. Including assets such as unrealized gains from volatile assets such as cryptocurrency in the tax base makes this all the more likely.
Rather than trying to play whack-a-mole dealing with all the administrative issues that pop up with a tax on unrealized gains, Congress should recognize it’s just a bad idea. There are other ways to raise revenues that don’t create nearly as much confusion, hassle, and unfairness for taxpayers.