Paul L. Caron
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Tuesday, December 17, 2024

Sheffrin: Realization Makes An Intellectual Comeback

Steven M. Sheffrin (Tulane; Google Scholar), Realization Makes an Intellectual Comeback, 185 Tax Notes Fed. 1737 (Dec. 2, 2024): 

Tax Notes Federal (2022)The case for taxing unrealized capital gains is based on the Haig-Simons definition of income. In this definition, income equals consumption plus savings when savings includes both realized and unrealized capital gains. If asset prices change because of changes in future cash flows, Haig-Simons income can provide an appropriate guide for designing tax policies. However, asset prices can also change because of changes in interest or discount rates. There is a long and ongoing literature in tax policy that recognizes that asset price changes arising from interest or discount rate changes do not fit into the Haig-Simons framework.

Moreover, in those circumstances, taxes based on realized asset sales can provide a more efficient starting point for taxation. This theoretical result is crucial because modern financial research has provided considerable evidence that fluctuations in asset prices arise primarily from fluctuations in discount rates and not from cash flows.

Those insights provide support for the principle of taxing gains on realized sales, as we do today. We can understand the arguments using an intuitive framework, and then apply that to a recent proposal to tax unrealized gains.

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