The Most Atrocious Tax of All (updated 18jun21)

‘A nation ignorant and free, that never was and never shall be.’  Thomas Jefferson

George Rebane

The country’s Democratic radical Left and Team Biden are prepared to expand asset taxes and introduce unrealized capital gains as another taxable form of ‘income’.  If they are successful, this will be the final nail in the coffin of American capitalism, the demonstrated most efficient way to generate and distribute wealth ever devised.

Income – The valuable return or yield from any kind of property, patent, service, etc. received in negotiable instruments, such as nominal dollars, that is spendable in an exchange for goods, services, or labor.  (Passive unrealized appreciation of any asset is NOT income.)

It boggles the sensible mind to hear that government has become so rapacious that it now wants to install a new, game-changing layer of taxes to perennially start taking more of what you have already earned and paid taxes on.  This atrocious taxing scheme comes in two parts.  They will apply one tax rate on the mark-to-market value of assets you already own, and another tax rate on your annual income augmented by the annual unrealized appreciation of those assets.  In other words, they will also perniciously count as income a fictitious amount of money that you never received or spent.

It is this malign definition of income that gave rise to the recent ‘news’ of billionaires paying miniscule tax rates of the order of 1% that came to light after their tax returns were hacked and distributed by the Left.  Where did such small tax rates come from when we know that the top 1% earners pay 40% of the nation’s income taxes?  The answer is easy when you slip in the new Democrat definition of income to include the appreciation of what they already own and have paid taxes on.  Using the accepted definition of income (see above), a wealthy high earner may pay at, say, a 30% rate on such income.  If his income last year was $10M, then his tax bill was $3M.  But if he was a billionaire worth, say, $10B, and his assets appreciated 10%, then Democrats want to call the unrealized $1B gain as ‘income’ and make his tax bill 30% of $1,010,000,000 or $303,000,000.  And if he only paid $3M, then the Left and their lamestream scream that billionaires tax rate is only 0.3% = 3,000,000/1,010,000,000.  And you can hear the envy chorus of the nation’s double dummies holler ‘Yeah, make him pay his fair share like I do!’

If the Democrats are able to pull off any of this, it will forever change the way people will garner wealth, invest in new enterprises, and save for family and the future.  To make sure that everyone understands the magnitude of such horrible taxes, let’s look at some more numbers.  Suppose you earned $1,000 last year, and your income tax rate is 20%.  You then got to keep $800 which you promptly invested.  A year goes by and your investment has appreciated 10%.  Say, the market value of your asset is then $880.  Now you file your tax return and it dictates that you have to pay 2% asset tax in addition to 20% on your income, which the government now decrees to include the $80 unrealized appreciation of your asset.  So on this asset alone, your total tax bill comes to $33.60 = 0.02*880 + 0.20*80.  Add this to the $200 tax you paid on the original $1,000 earned, and it totals $233.60 or a overall tax rate of 23.36% on a benefit you have yet to enjoy, and given the vicissitudes of the economy and markets, from which you may never benefit.

In any event, as we can see, you will have to come up with $233.60 out-of-pocket cash money within a twelve month period that goes to the government for the privilege of having earned and invested $1,000.  If you have to now sell part of that asset (or some other asset) to pay that bill, then one year on, the real value that this earned $1,000 has contributed to your total estate (net worth) is only $766.40.  And we have to take into account that you took a risk in making that investment which went to contribute to the workings and growth of a productive economy.

So, in the final analysis it is the earner who has to decide whether earning that marginal $1,000 is really worth the effort and risk if its nominal value a year from now will only be $766.40.  (And in this analysis we have yet to consider the added tax of government induced inflation – more here.)  But at this point we have to remind the reader that such a tax on a perniciously defined, unrealized appreciation as income will totally skew the long-term return on investments, and therefore change the risk/return calculations for investors since it is the investor who takes all the downside risk and the government helps itself only from the upside appreciation.

The question that comes to mind when I think of such a callous attack on our way of life, is how do our socialist elites even consider raising such a horrible new way of extracting tribute from Americans.  Such taxes inhibit raising investment capital, make it difficult to start and maintain small businesses, impose multiple taxes on paid taxes, and require arbitrary valuation of thinly marketed assets.  And don’t even consider the injustice of such policies on ‘death taxes’ which punish the ability of families to provide for their children and pass on an estate that has been built with after-tax monies.  The notion of government regularly robbing its citizens of their property by force is evil on its face.  As Frederic Bastiat demonstrated almost two centuries ago, no liberal country can long exist once it allows government to blatantly violate the property rights of its people, for the culling of rights doesn’t stop there.  (See the Bastiat Triangle of Rights)

Anyone paying attention knows that these types of taxes have been tried in Europe and elsewhere, and they been withdrawn after their devastating effect on their economies became apparent to all.  Given this experience and the obviously predictable impact of such tax policies, why does our government now seek to install this new tax code in the United States?  The only answer that makes sense to me is what we have been observing for years in these pages – America’s dumbth.  In the large, enough Americans pay little attention to national and international affairs (to them freedom and democracy are free), are terminally innumerate, and are under the sway of the lamestream’s socialist propaganda that they unquestioningly accept what comes out of Washington and their state capitals.  The truth of Jefferson’s ‘A nation ignorant and free …’ explains it all.

[Addendum]  Here’s a bit more quantitative stuff to give you an idea of how drastic the one-two punch of inflation and taxing unrealized returns will be.  The first table below shows the annual real returns on an investment that appreciates at a nominal annual rate of rI (top gray row) and which is taxed at rate rT (lefthand gray column) in an inflation-free economy.  So, if your investment returns 10% that is taxed at 25%, then your actual nominal return is 7.5%.

The second table above shows the inflation-adjusted returns that give you the actual gain/loss of buying power when the annual inflation is 5%.  Now your 10% investment, taxed at 25%, increases your buying power by only 2.4%.  Adding the inflation tax makes your effective tax rate to be a devastating 76%.

Assuming the risk profile (probability of losing a given percent of your investment) remains unchanged as inflation increases, what kind of nominal return will you then demand before investing your funds.  The correct answer is ‘a helluva lot more than 10%’, which gives you an idea of what will happen to investment capital under such a tax policy.

[18jun21 update]  After more noodling and writing some code, I want to illustrate the stark impact that annual taxing of unrealized gains would have on typical long-term investments in a stock.  Investors know that future gains are the result of a probability game of varying annual results as the years pass.  If the above illustrated annual investment gains rI are taxed annually at rT for N years, then it can be shown that the resulting expected gain is given by

This little piece of math calculates the nominal N-year expected return of the taxed investment.  However, that’s not how seasoned and professional investors look at their prospects with such a security.  They realize that things will change and the stock will go up and down probabilistically.  With that in mind, they study their tea leaves and develop a necessarily subjective probability distribution (actually, density function) of how annual returns may vary.  A tool suitable for quantitatively representing such probabilities is the Extended MAB or EMAB (here) probability density function (pdf) which can be specified by five parameters that include the high/low range and most likely (mode) appreciation rates.  Once quantified, these subjective assessments can now support some very sophisticated risk analyses concerning a potential investment.

I made up a hypothetical stock with EMAB parameter set [rlow, rhigh, rmode, confidence, central probability of falling between rlow and rhigh] = [-10%, 20%, 10%, 0.67, 0.95].  I chose the annual tax rate to be rT = 30%.  Then I wrote a program that simulated the 10-year performance of this stock through a ‘Monte Carlo sampling’ process.  This called for sampling the stock’s EMAB for every year, and then calculating the resulting 10-year return.  This was repeated 10,000 times to generate a dataset of untaxed returns, and then again to generate another 10-year set with annually taxed returns.

These two sets of returns were then plotted as normalized pdf histograms shown in the figure below.  The horizontal axis is the 10-year return in a decimal format (e.g. 1.5 = 150%).  The blue histogram shows the result of a simulation run with no annual taxing of unrealized returns.  The tax rate is applied once at the end when, for our purposes, we presume the shares will be sold.  The expected return (thick black line) here is 55%, with a standard deviation (thin black lines) of 30%. 

The orange histogram shows the distribution of returns when annual gains are taxed yearly.  The 10-year return in this case is 45% (heavy dotted line), with a standard deviation (thin dotted lines) of 28%.  The annual taxing of unrealized returns has reduced the 10-year return by 18% from its once-taxed current policy.  And we all know in what pockets this missing 18% winds up.

The thick red line indicates 0% return, with losses falling to the left of it.  It is clear from the two distributions that the annually taxed investment bears the brunt of both lower returns and losses.

Comments

[fish]

We all knew this was coming! Just another stage in the progression of the disease.

[Scott O]

This isn't even about raising money for the operation of the govt.
The Dems can't actually make our country a better place, so now it's just the Dems showing their dim-witted constituents how they are 'sticking it' to those wealthy bastards. No one's life will be improved. Nobody will be raised out of poverty. The fed debt will climb ever higher. Tax specialty lawyers will be further enriched.
Money will continue to flee to where it will be better treated.
The folks at the IRS are ever obliging to the Dems.
"Certain tax documents need to be released? - Why certainly!"
We've already been through this once. If they ever get close to the person responsible that person will just plead the 5th and then retire with a handsome pension.
We are now in an openly corrupt fed govt. It can only go downhill from here.
Hey middle class America - did your house gain in value?
And it didn't do you any good and you had to pay more property taxes?
Now get ready to pay for that "unrealized" gain!
After this, the Dems can go after "unrealized" income!
Remember that overtime you turned down? Now you owe tax on what you could have made! And we can prove you could have worked a second job on the weekends but you just wanted to lay around the house. Now you'll have to pay taxes on that, too!
Hey - this is fun. Wonder what else we can get you for?
Cue the Beatles - "Mr Taxman".
https://www.youtube.com/watch?v=l0zaebtU-CA

[Dave Cranfield]

Up next, VAT?

[scenes]

I have to admit that it's a rather peculiar bit of red meat to throw to the mob. Let's say it happens. How do you (a) determine 'unrealized gain? It sure isn't the price of the last share of Amazon sold on the market X Bezos holdings of shares as they're not all worth the same amount...and (b) does the government pay *you* when the price of an asset goes down?

Honestly, if they actually manage to successfully go after the kulaks, The iron triangle (rich, bureaucrats, activists) will be broken and we're on to a new chapter in Year Zero.

Perhaps the White Supremacist hotline that the Bidens are planning to set up can be expanded to include reporting on your neighbors' hidden stash of something valuable. Oh well, "the way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.- sez some Russian guy.