Year Of The Opposite - Travis Stoliker's Substack Podcast

I want to be very clear: I am NOT endorsing or opposing any politician or candidate. But this is an incredibly important topic and I am hoping that I can break it down fairly and dispassionately. I am also going to try my best to keep my personal views out of it. I look forward to hearing your thoughts, comments, corrections and questions. Here goes…

Year Of The Opposite - Travis Stoliker's Substack is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.

In plain English, what exactly is going on and why is the concept of taxing unrealized capital gains in the news?

The concept of taxing unrealized capital gains has become a hot topic, especially as the Biden-Harris administration pushes forward their unique tax policies.

In essence, unrealized capital gains are the increases in value of assets like stocks or property that haven't been sold yet. Under a new proposal, the idea is to tax these paper profits annually as if they were actual income.

This topic is making headlines because it's a major shift in how we think about wealth and taxation.

Traditionally, taxes are levied on income you actually receive—like your salary—or on profits you make when you sell an asset.

(Note: When I say “Asset” just think: your real estate, your stock, or maybe a business you own that you sell.) But now, the discussion has pivoted to taxing potential income before it’s even realized.

(Note: When I say “realized” in a financial concept it means selling an asset like a stock and converting the stock certificate into cash.) The stated goal behind this new and novel approach is supposed to ensure that the wealthiest individuals pay a fair share, addressing concerns over wealth inequality. However, as with any significant policy shift, it brings along a flurry of debates and concerns.The Biden-Harris administration has said: "Preferential treatment for unrealized gains disproportionately benefits high-wealth taxpayers and provides many high-wealth taxpayers with a lower effective tax rate than many low- and middle-income taxpayers."

What has been proposed and what is the history of the proposal to tax unrealized capital gains?

The proposal isn't just a fleeting idea; it’s embedded in the Biden administration’s fiscal plans. Officially introduced in March 2023, the proposal suggests a minimum tax of 25% on total income, including unrealized gains, for those with a net worth exceeding $100 million.

This isn't a new debate, though. The concept of taxing wealth rather than just income has been discussed for years, but it’s only now being seriously considered as a part of fiscal policy.

The reason this is coming up this week is that the Committee for a Responsible Federal Budget reported on the Harris campaign's stance. They stated: 'The campaign specifically told us that they support all of the tax increases on the high earners and corporations that are in the Biden budget." Here is the full policy and some important excerpts:

But doesn't this policy only apply to super rich people?

Yes, but the concern is that this is exactly how the income tax originally started. The idea of taxing only the super-rich isn't new; it mirrors the initial U.S. income tax in 1861, which taxed just 3% of the population making over $800. However, this tax was temporary, repealed in 1872, but its concept evolved, leading to the 16th Amendment in 1913, allowing for a broader income tax.

Critics worry that what starts as a tax on the ultra-wealthy could expand, much like the income tax did. Initially targeting the rich, the income tax eventually reached the middle class, with rates as high as 94% for top earners by 1944, showing how tax policies can broaden over time.

Even though this policy doesn't yet apply to everyday people, can you give me an example that a common person can relate to?

Sure, imagine you own a house. Over the years, the value of your house increases significantly, but you don’t sell it. Under a policy that taxes unrealized gains, you'd have to pay taxes each year on the increased value of your home—even though you haven’t actually received any cash from that increase. This could create a financial burden, especially if you’re cash-poor but asset-rich. Let’s try to use an example. Say you bought a house in East Lansing for $100,000 but due to some crazy economic events like the lead up we saw to 2007, the house in theory is worth $200,000. But you have no intention of selling your house because you just want to live in it.

Under this proposal, you’d have to pay a 25% tax on the gain of $100,000. Meaning you’d have to come up with $25,000 in cash to pay your taxes on the house. Where would you come up with that cash? Would you have to sell the house in order to pay the taxes? Maybe you did have $25,000 in cash, which you had intended to use to replace the roof on your house or remodel it. Now you would have to use that money to pay taxes.

And what if that $200,000 increased value was not real. What if we saw what happened in 2008 happen all over again and there is a market crash and now your house is again worth $100,000?

As you can see, this gets very complicated and very confusing, very quickly. To be very clear: This current proposal does NOT apply to your house or mine. I’m just using this example because it’s something we can all relate to.

Do other countries do this?

While some countries have experimented with taxing wealth, including unrealized gains, it remains far from a global standard. For instance, Norway's wealth tax indirectly affects unrealized gains as part of the overall wealth calculation, but it has sparked debates over unintended consequences like capital flight.

Similarly, France’s former wealth tax (ISF) faced criticism for driving wealthy individuals out of the country, leading to its repeal in 2017 and replacement with a tax focused solely on real estate. These cases illustrate the challenges and potential downsides of taxing unrealized gains, making the U.S. proposal a relatively novel and significant departure from how most countries handle capital gains taxation.

What would this mean for innovation and invention in America? What would this do to startups?

Innovation thrives on risk-taking and long-term investment. A tax on unrealized gains could potentially dampen the entrepreneurial spirit by imposing financial burdens on profits that exist only on paper. Entrepreneurs might become more cautious, fearing the tax implications of holding onto high-risk, high-reward ventures. This policy could stifle innovation by deterring the very risk-taking that drives breakthroughs.

Let’s be more specific about how this policy might impact startups. Many startups don’t generate profits in their early years. Take Amazon, FedEx, Snapchat, TBS, Netflix, Adobe, and Airbnb as examples—none of these companies made a single dime of profit for more than five years after they launched. Yet, during this period, the paper valuation of these companies soared like a rocket.

What does this mean in practice? It means that while these companies appeared successful on paper, they weren’t generating cash profits. The founders and investors were reinvesting every penny back into the company’s growth—hiring more people, building infrastructure, and ramping up advertising. Often, this reinvestment happens alongside rounds of fundraising at ever-higher valuations, based on the company's potential rather than its current profitability.

In plain English, the "value" of these companies on paper kept climbing, but there was no cash flow to match it. If this proposal were enacted, founders and investors wouldn’t just need to pour their personal cash into growing the business and paying employees—they’d also need to invest additional cash solely to pay taxes on unrealized gains. Would you sign up for that?I think an example might be useful here: We all know that restaurants are notoriously difficult and often unprofitable businesses. Now, imagine you’ve opened the dream café you’ve always wanted. You invest $100,000 from your 401(k) to build out your first location. Things are going well in your first year, so you decide it’s time to expand and open a second location. Like many entrepreneurs, instead of paying yourself, you choose to reinvest the business’s earnings into hiring the best employees possible. Then, you get an opportunity to launch that second location across town, but it’s going to take another $100,000 to make it happen.

After working an entire year without paying yourself, and having already invested your 401(k) savings into the business, you need to bring in a new investor to raise the additional $100,000. When the new investor comes on board, they value the company higher, so on paper, the value of your café increases. However, despite this increase in paper valuation, you, the founder, still haven’t earned a single dime from the company.

Now, because the valuation on paper has gone up (the unrealized gain), you and the new investor not only need to come up with the $100,000 to build the second location—you also need an additional $25,000 just to cover the taxes on that unrealized gain.

And let's not forget, startups are incredibly risky. What happens if the company fails? What if the founders are working on something as monumental as a cure for cancer? Would they, and their investors, continue to risk their money, time, and resources, knowing that a portion of it is being siphoned off for taxes on non-existent profits? Would you? Is this really what we want as a society—discouraging the very risks that lead to life-changing innovations?Again, to be very clear: This current proposal does NOT apply to your Cafe or mine. I’m just using this example because it’s something we can all relate to.

Since people can move, if this happened, wouldn't all the rich people just move and leave the United States?

Maybe. That is the problem with policies like this—they tend to have unintended consequences. Wealthy individuals have the resources to relocate to countries with more favorable tax laws. If implemented, we might see a migration of wealth out of the U.S., similar to what has happened in other countries with aggressive tax policies. This exodus could lead to a decrease in investment and philanthropy within the U.S., ultimately hurting the economy. And most importantly, this could ultimately reduce total tax income for the government which would completely defeat the intended goal of this policy.

Addressing some common misconceptions about taxes in the United States: “The rich need to pay their fair share”

There are some common misconceptions that are often stated that need to be cleared up. It surprises many people to learn that every year, between 40-55% of U.S. households pay $0 in federal income taxes. None.

Now let’s look at the top 1% of earners that are often talked about. The top 1% of earners bring in around 20-21% of all income in the U.S., but they pay nearly half of all federal income taxes​.

This isn’t to say that the system is perfect, but it’s a reminder that tax policy is already incredibly complex and there are many misconceptions.

Can you explain in a bit more detail how this would exactly work?

Here’s where it gets technical. The unrealized gains tax would function as a prepayment on future realized gains taxes, meaning you wouldn’t pay taxes twice on the same gain. If you eventually sell the asset for less than its taxed value or incur a loss, you could get a refund. This system aims to prevent people from being taxed on income they never actually receive, but it also adds layers of complexity.

For example, if you’re illiquid—meaning most of your wealth is tied up in non-tradable assets—you might only have to pay taxes on liquid assets, but there’s a catch: you’d face a deferral charge of up to 10% on the gain of your illiquid assets. And if you pass away, your estate pays the death tax, with any overpaid unrealized taxes refunded to the estate.

Can this policy actually be implemented by the President?

No, not directly. While the President can propose tax policies, it’s ultimately up to Congress to pass them. Given the contentious nature of this proposal and the significant legal and logistical hurdles, its implementation is far from guaranteed. It’s a complex policy that would require broad support and careful crafting to become law.

How would this tax interact with state-level taxes?

State tax systems often mirror federal rules, so if a federal tax on unrealized gains were implemented, states might consider adopting similar measures. However, this could lead to conflicts between federal and state tax policies, particularly in states with lower or no income tax. Additionally, the combined burden of federal and state taxes on unrealized gains could increase the overall tax rate on affected individuals.

How would this policy affect retirement accounts and other tax-advantaged savings vehicles?

At this point, the proposal does not specifically target retirement accounts like 401(k)s or IRAs, which traditionally benefit from tax deferral until funds are withdrawn. However, if the policy were to extend to such accounts, it could complicate the tax treatment of these savings vehicles and potentially undermine their tax-advantaged status. Clarifications would be needed to determine how, if at all, these accounts would be affected.

How do you determine how much tax to be paid? Who determines the value of an unrealized capital gain? For example: how do you know how much a business is worth for sure if you haven't yet sold it?

The tax on unrealized capital gains is based on the value of your assets at the end of each year. For stocks, it’s easy to figure out because their market value is clear. But when it comes to assets like a small business or real estate that haven't been sold, it gets tricky.

For these types of assets, the value would have to be estimated, often through appraisals. This is where things can get complicated and subjective. For example, valuing a business that hasn’t been sold yet involves guessing what someone might pay for it based on current market conditions and future earnings.

To illustrate how hard it is to value something accurately, just think about how often you’ve seen wildly different "Zestimates" on Zillow for houses, including your own. This same kind of uncertainty can apply to other assets, making it difficult to determine an exact tax amount.

The policy might include safeguards to adjust for big swings in value, allowing for tax credits or refunds if an asset’s value drops after you’ve already paid tax on it. But the details on how this would work aren’t clear yet, and it’s something that would need to be carefully handled to avoid unfair taxes based on inaccurate valuations.

Addressing some of the myths that are being said about this policy:

There are several myths or misconceptions often cited which might not hold up under scrutiny:

Myth: Taxing Unrealized Gains is Fair Because Wealthy Individuals Use Unrealized Gains for Borrowing:Reality: While it's true that wealthy individuals can use the value of their assets as collateral for loans, this doesn't mean they've realized income. (IE: sold their asset for cash.) The value of the underlying assets can still fluctuate, and if the asset's value drops below the loan amount, the individual might still owe on the loan despite having no income from the asset. Taxing unrealized gains could lead to situations where individuals owe taxes on "income" they never actually received.

Myth: It's Just Like Taxing Income or Profits:Reality: Taxing unrealized gains is fundamentally different from taxing income or realized profits because it's based on potential wealth, not actual wealth. This could lead to scenarios where individuals or entities are taxed on wealth that might never materialize if the asset's value decreases.

Myth: This Will Only Affect the Ultra-Wealthy:Reality: While the proposal might target the ultra-wealthy, there are always unintended consequences when imposing any tax policy. This may result in an increase in sales of businesses, or a decrease. It could lead to people moving their money out of the country, or potentially people completely migrating out of the country. The consequences could be far-reaching and unintended, as seen in France and Norway.

As always, please remember, these are never lectures. They are reminders to myself and I want to hear and learn from you.

What do you think? Is this proposed policy a good idea? What did I get wrong? Please let me know so that I can improve.

If you got value out of this, please do me a favor by sharing or subscribing. It means a lot to me.

Year Of The Opposite - Travis Stoliker's Substack is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.