Impact of Taxing Gains

 

Taxing unrealized capital gains, particularly at a rate of 25%, could have several negative impacts, especially on retirement systems, including those for local government and state employees. Retirement systems often invest in stocks and other assets that appreciate over time. If unrealized gains—those that haven't been sold yet—are taxed, the total value of these investments will be reduced, potentially leading to lower returns for the funds that manage these systems. This reduction in returns could decrease the overall retirement benefits available to employees. Moreover, the taxation of unrealized gains might force these funds to sell assets prematurely to cover tax liabilities, increasing market volatility, reducing asset values, and making retirement systems more vulnerable to downturns. Retirement systems typically plan their cash flows based on expected contributions and withdrawals. If they are required to pay taxes on unrealized gains, this could disrupt their cash flow management, potentially forcing them to sell assets in a down market or take on debt to meet obligations. The complexity of tracking and reporting unrealized gains, particularly for large, diversified portfolios, would also increase administrative costs. These costs would ultimately be borne by the beneficiaries of the retirement systems, either through higher fees or reduced benefits.

Hillary Clinton’s idea of taxing 1% on all retirement systems to pay for healthcare is similar in that both proposals involve imposing a tax on the accumulated wealth of retirement systems. However, taxing unrealized gains is more complex because it involves taxing theoretical gains that may never be realized if the market fluctuates. Suppose an individual or entity pays taxes on unrealized gains and later experiences a loss. In that case, it raises the question of whether the government would reimburse the taxes paid on gains that never materialized. While current tax systems sometimes allow losses to be carried forward to offset future gains, this does not directly compensate for taxes already paid. The idea of being "paid back" by the government for losses after paying taxes on unrealized gains would pose significant administrative challenges and could lead to further complications. Critics of taxing unrealized gains argue that it is akin to confiscation of wealth. Since unrealized gains are not liquid and exist only "on paper," taxing them could force individuals and institutions to sell assets they would otherwise hold, potentially damaging long-term investment strategies, including those employed by retirement systems. In essence, taxing unrealized gains is seen by many as a significant overreach by the government, potentially harming both individual investors and large-scale retirement systems, which rely on stable, long-term investment returns to meet their obligations.