The recent U.S. Supreme Court ruling that upheld Congress’ power to tax unrealized income has ignited a significant debate in economic circles. Economist Steven M. Sheffrin has joined this discussion with a pointed critique of proposals aimed at broadening the taxation of unrealized capital gains. This proposal lies at the heart of President Biden’s new billionaire income tax plan. Sheffrin’s analysis evaluates the economic justifications behind such taxes and raises critical concerns about their practicality and legal standing.
At the core of the discussion is the fundamental question of how the tax system should handle changes in asset values. Under current U.S. law, taxation occurs only when gains are realized through the sale of assets. However, Biden’s budget proposal for 2024 suggests applying a hefty 25% tax on unrealized gains for individuals with a net worth exceeding $100 million. This proposal is controversial, and Sheffrin challenges its validity by referencing over seventy years of economic research that suggests market fluctuations often reflect changes in interest rates and risk rather than real income growth.
Sheffrin argues that taxing these market fluctuations could warp investment strategies. When prices change solely due to market dynamics, taxing such shifts creates burdens on individuals without actual income to report. He states, “Taxing these market-driven price swings would distort investment behavior and impose tax burdens when no real income has been received.” This perspective is anchored in what is called the “volatility test,” a concept developed by financial economists who assert that much of the change in asset prices has little to do with genuine economic growth.
Sheffrin’s analysis highlights the potential drawbacks of relying on the Haig-Simons definition of income, which posits that income includes both consumption and changes in net worth. He contends that this theory does not hold up under scrutiny when applied to the complexities of real-world economics, particularly given issues of liquidity. He warns of the implications for billionaire taxpayers who may find themselves liable for taxes on assets they do not plan to sell, generating real financial pressure. “Requiring payment on non-liquid, temporary valuation gains is a legal and logistical nightmare,” he cautions.
Proponents of the Biden plan argue that without a tax on unrealized gains, the wealthiest Americans can defer their tax liabilities while lower-income citizens face regular tax deductions from their paychecks. However, Sheffrin refutes this notion, arguing simply that “the ability to borrow doesn’t create taxable income.” Loans are debts requiring repayment and ought not to be conflated with actual income, which speaks to the fundamental challenge of defining what constitutes “income” in an equitable tax system.
This tax contention echoes in the recent Supreme Court case, Moore v. United States, where the Court narrowly upheld a one-time tax on foreign earnings that had not yet made it to shareholders. While the ruling affirmed the legality of taxing unrealized gains in certain instances, the decision fell short of endorsing a broader wealth tax. Sheffrin highlights the precariousness of implementing such a proposal, noting that the Constitution mandates that direct taxes be more evenly distributed—a requirement many wealth tax schemes would struggle to meet.
The political ramifications of these proposals are also significant. Recent surveys indicate a deeply divided public sentiment surrounding new wealth taxes, particularly among older and blue-collar voters who express concerns over government expansion and potential future tax implications beyond billionaires. This sentiment aligns with Sheffrin’s argument that policymakers need to recognize the complexities surrounding timing, liquidity, and real versus illusory income when discussing taxation on capital gains.
Sheffrin asserts that extreme valuation-based taxes threaten to erode trust in the tax system’s impartiality. He warns that enforcing taxes on income not yet realized could lead to serious disruptions, stating, “If we make taxpayers liable for income they haven’t actually received—with taxes due whether or not they can afford them—we risk turning the tax code into a speculative instrument with devastating consequences.”
His conclusions are supported by substantial academic evidence, including work by notable economists revealing that taxing only realized gains aligns better with measures of economic welfare and fairness. This research shows that a taxation system based on unrealized gains exacerbates inequality and discourages productive risk-taking, thereby funneling capital into less effective but more tax-advantageous venues.
Tax professionals also warn of the practical challenges. Implementing a system that continually values assets across a range of categories, such as private businesses or collectibles, would necessitate significant expansion of IRS resources and expose the tax system to constant disputes over valuations. Sheffrin cautions that “this isn’t just a redistribution mechanism… it’s an administrative black hole.”
The implications of taxing unrealized gains extend beyond the ultra-wealthy. Small business owners and retirees with unsold assets may find themselves caught in a web of financial hardship, even though the initial proposal targets only those with net worths above $100 million. As critics argue, once the IRS establishes the framework to tax paper valuations, it will likely extend to more taxpayers. “Once the IRS builds the machinery to tax values on paper,” they contend, “it’s only a matter of time before that machinery applies to more Americans, not fewer.”
Ultimately, Sheffrin advocates for maintaining the existing realization-based tax model, which he claims upholds fairness and clarity while avoiding unnecessary risks. He argues that taxing temporary increases in asset values is fundamentally flawed from both an economic and political standpoint. “The case for taxing only realized gains,” he concludes, “is not just tradition — it’s sound finance.”
The response on social media, particularly from commentators like @CollinRugg, underscores a broader view that this policy direction may overlook critical economic truths that have persisted for generations. Whether decision-makers heed these warnings remains uncertain.
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