The Austrian Argument for Harris/Walz Unrealized Capital Gains Tax on those with Net Worth of $100m or Larger

Before I see what you guys think of this argument, I just want to state that in practice I oppose this tax for the same reason Milton Friedman said that in practice he opposes ALL TAX HIKES and will advocate for ALL TAX CUTS, political imperative. In a Liberal Democracy, politicians will always prioritize high time preference voters over long term interests, politicians will have no fortitude to resist the temptation to spend any additional tax revenue on any social program that they think will earn them votes. Therefore, the only way to shrink the size of government, is to cut taxes and starve the beast. The argument is built on two premises, Public Capital Markets Theory and Market Equilibrium Theory.

Public Capital Markets Theory

However, Friedman did argue in an interview with Peter Robinson Uncommon Knowledge that hypothetically the federal government revenue could be put to “better” use than the American people and be used to offer them more freedom and economic autonomy down the road if it was used for very specific purposes, namely paying down the National Debt. This is for two reasons.

Paying down the debt will reduce federal interest expenses, so American citizens will have to pay less taxes in the future to service this debt. This is for two reasons:

a) Less net debt means less interest expense, given the same level of interest rate

b) By decreasing the quantity supplied of outstanding T-bonds, they will become scarcer, raising their price, so interest expense on all remaining debt will decline. Instead of paying 5% on 30 trillion, we could be paying 4.2% on 20 trillion.

One could argue that the taxes expropriated from Americans to pay down this debt is a necessary evil to ensure that less is taken from them down the line.

Paying down the debt transfers capital from tax payers to bond holders. The taxpayers lose cash, the bond holders gain the cash, and they lose their bond (as the bonds either expire at maturity or are repurchased by the Federal Government). These bond holders are exclusively investors, and upon losing the ability to purchase the given bond quantity, will be forced to find investment elsewhere. Former T-bond holders will have three choices

a) Buy more bonds for a lower interest rate (as per point 1b)

b) Seek private sector investment, injecting investable funds into capital markets and lowering real interest rates.

Friedman argued that if the government could be fully trusted to pay down the National Debt with tax money, the economy would be richer and more prosperous in the long term than it would have been had that tax money never been collected in the first place.

But won’t taxing the rich investors reduce capital investment and hurt economic growth? Won’t these high taxes stifle growth and cause a stock market crash by forcing stock sell offs? The answer is no, and here’s why:

Market Equilibrium Theory:

Markets are in constant aggregate pursuit of their equilibrium, where all transactions and and capital allocations satisfy the individuals more than alternatives, otherwise people would trade. Of course the equilibrium is never reached, but the perpetual pursuit of this equilibrium by all rational actors acting in their self interest is what drives economic activity.

Pretend unrealized capital gains tax of 10% is levied on someone with a net worth of $500m, and 100% of their networth is in Microsoft (“MSFT”) which is currently trading at $500/Share. MFST increases 20% over the following year, creating an unrealized gain of $100m. The unrealized gains tax would require 10% of MSFT be seized by the Federal Treasury and sold off for cash. If MSFT is now $600, it must be because the market values the stock to be worth $600 given its predicted future discounted cash flow valuations. This means that even if the Federal Treasury sell-off of the stock pushed its market price down to $580, market arbitragers would quickly bit the stock back up, taking advantage of the opportunity to purchase a $600 asset for only $580, until the stock is back to $600.

Of course, for this to be true, there would have to be enough capital in the market to buy up these securities, otherwise supply may exceed demand, and the equilibrium price will decline, but as mentioned under the Public Capital Markets Theory, for every dollar received from selling the MFST stocks to the capital markets, the capital markets gained a dollar through Federal debt repayment. This money will albeit it would happen so fast you can just skip to the end and effectively nullify the steps between 1) and 10**)**

1) Risk-Free rate = 5%, Market Yield on Stocks = 10%

2) Government implements unrealized gains tax

3) Gates, Bezos, and Winklevoss Twins are forced to sell stocks to pay Unrealized Capital Gains Tax

4) Stock prices drop, raising the market yield on stocks to 11%

5) Proceeds are used to pay down National Debt

6) Decrease in supply of T-bonds lowers the Risk-Free Rate to 4%

7) Risk-adjusted Return for Risk-Free Assets (4%) and Equities (11%) are now in disequilibrium from aggregate investor risk-profiles (point 1)

8) X% of the former T-bond holders use their cash proceeds to buy stocks, Y% of remaining T-bond holders sell off their T-bonds for stocks, as the new 4% yield does not justify holding the asset.

9) Selling pressure pushes T-bond yield back to 4.5%, and stock purchases pushes equity yields down to 9.5%.

10) Market is back to equilibrium, but with a lower national debt, a more solvent America, and a lower real interest rate

You might be wondering why the new risk free rate and market yield for equities is now 4.5% and 9.5%, respectively? This is because with a lower national debt, there’s a significantly lower supply of risk-free T-bonds, so the remaining market players have to bit on a smaller supply of these bonds, lowering their yield. The lower yield will drive a certain percentage of investors out of bonds and into equities/private-investments to seek a higher return, and this influx of capital will manifest in lower real interest rates for the private markets.

Overall, everybody wins if, besides the people with over $100m, if the unrealized gains tax is implemented properly.