Capital Gains: Realization
Capital Gains: Realization Does Not Matter
– by Steve Roth
You’re looking at your asset portfolio and decide to sell or buy some ETF shares. Click.
The transaction is a dollar-for-dollar asset swap between you and your counterparty, at current market prices: M assets (bank deposits) in exchange for ETF assets, and vice versa. Equal dollar amounts in each direction.
The transaction has zero effect on either party’s total assets or net worth; they’re both unchanged. Likewise for the whole household sector or “national wealth”: no change to assets or net worth.
Of course: the seller may may have to pay cap-gains taxes, depending on what they originally paid for the ETF shares. But that’s immaterial to the basic wealth accounting. There’s no net asset transfer between individuals or groups that they’re part of (high-wealth groups to/from low-wealth groups, for instance).
Each party is just adjusting their asset-portfolio mix. It’s the constant everyday churn of portfolio turnover. In the economic picture (vs. an individual seller’s narrow tax-focused view), that’s the whole story.
So every time you think about capital gains in the big national-accounting picture (vs. individuals’ portfolio juggling), realize this reality: Realization Doesn’t Matter. Accrual and accumulation are what matter. You can watch that happening second by second on your brokerage website, as your assets get marked to market.
I have great respect for Steve’s work and his understanding of economics. The only issue I have with this post is the graph should be on a logarithmic scale. This would normalize gains on a percentage basis. A linear scale makes recent gains look larger.
Mark:
Of course you are correct. I doubt he gave it a thought. I would have missed such also. I have not written on manufacturing and supply chain in a long time. Just been too busy here.
I understand your point and the value a log graph would provide, but sadly, most people don’t understand that.
The perhaps larger issue is that the graph “should” be presented in “real,” inflation-adjusted terms. Arguably also valuable, but the goal here was very much KISS…
I am assuming you are arguing for an unrealized asset capital gains tax, otherwise no reason to try to define an accounting identity. So assuming this then:
If the market goes down will the government issue tax credits? What happens when something is not marked to market? Say for instance if you own a farm, a rental home, your personal home? Do you have to pay a realized capital gains on these assets also? For some individuals, selling might make them lose control of an asset which might affect the value.
If there are exceptions for non-traded or non-publicly traded assets, then many assets would go private. I think that a better mechanism is an estate tax with no way around it. I agree that this would be unlikely but just as unlikely as an unrealized capital gains tax.
@Pre,
I’m not sure I understand most of your comment, but I fully support taxing estates as income from the first dollar.
There are ways to pass on some or all of your wealth to your kids as tax-free gifts while you’re still alive. If you wait until you’re dead, it’s a financial transfer and we tax those.
Agree, but not the first dollar. Smaller bequests and gifts actually reduce wealth inequality. The current exclusion, “unmarried individuals may exempt $13.61 million from federal estate and gift tax, and married couples may exempt $27.22 million,” is insane.
(This also obviates the need to tax accrured-but-unrealized holding gains, a tax that I have no problem with on its face, but it’s administratively problematic.)
@Steve,
You can give each of your children $18K tax-free already. If you’re married, your spouse can also give them $18K each year tax-free. The amount increases each year. I’m fine with that. Above and beyond that, tax it.
Pre:
I suggest you take Steve’s comment to you to heart. Others might have deleted you, He is being polite.
>I am assuming you are arguing for an unrealized asset capital gains tax, otherwise no reason to try to define an accounting identity.
No absolutely not. (Not here at least.) Reread.
The reason is simple: insanely and increasingly concentrated wealth (and so power) is The Great Economic Satan. And you simply can’t explain the sources of that concentration in numeric terms unless you’ve got an accounting identity that does that.
Very simplified: Household “Personal” Income + Holding Gains income (total return on assets) – Taxes & Consumption Spending = ∆ Assets/NW
You can apply that identity to the aggregate household sector, and to different income/wealth classes. Top 20%, bottom 20%, whatever. They accumulate their wealth (such as it is) in v different ways. Curious?
I think it’s important to explain and understand the sources of wealth concentration in numeric terms. You?
I always thought the cost basis for inheritance should be 0 and not the fair market value at the time of death. Consider this argument: if your parents passed with net debt should you be responsible for that debt? If you are not responsible for their debts what entitles you to their wealth? Since you did not earn the wealth your cost basis should be $0. No tax would be due until the sale of the asset at which time all of the unrealized gains would be taxed.
To all:
Discussions of cap gains always and everywhere get immediately hijacked and sidetracked into tax policy issues. eg PreCambrian’s first sentence: “I am assuming you are arguing for an unrealized asset capital gains tax…”
That’s not what the post is about. At all. See the fourth paragraph: “that’s immaterial…”
Can I ask that you scan through the post again and focus on the points it makes? It’s about understanding and explaining the insane and increasing wealth concentration we’ve seen since the 70s/80s, esp since 2000. Thx.