Kamala Harris has proposed a 25% “Kamala Tax” on unrealized capital gains, applicable to all those with more than $100 million net worth, while removing the differential between income tax and capital gains tax rates for the rest of us. Since the inflation her policies will inevitably cause would push us all into the $100 million net worth bracket in 4-5 years, I thought it worth examining the economic effects of her new policy, yet another attack on capitalism by a party that no longer believes in it, which will not yield significant net revenue.

The problem with any tax on unrealized gains is that most investment assets are highly illiquid and fluctuate wildly in price, which prices may not themselves be realizable. At one extreme, my modest portfolio of index-linked Treasury bonds (TIPS) (not amounting to $100 million, I should add!) would not be a problem. TIPS accrete in price according to inflation with only modest fluctuations, and they are very liquid, so I could sell a few to pay any tax bills. The Kamala Tax provision would however represent a net tax increase, as I would be forced to pay tax on the accreting price now, rather than in say 20 years’ time when the bonds matured.

Since the inflationary value increase in TIPS merely compensates for government-caused inflation (which is in any case underreported in government statistics) it is of course unjust that this increase bears any tax at all. Deferring the tax until the bonds mature lessens this injustice, while the Kamala Tax increases it, making TIPS relatively less attractive. Nevertheless, for TIPS the effects of Kamala Tax are not too severe.

For equity investments, the position is more complex. There are two difficulties. First, equity prices fluctuate sharply, so that their value at the end of the year may differ greatly from their value when the tax is due. Second, many equities are highly illiquid, so selling them to pay the tax becomes very difficult and costly.

There is a third problem: the tendency of equities to fluctuate to extreme values, becoming overvalued for many years in periods like the late 1990s or today and undervalued for equally lengthy periods in the 1930s-1940s and the late 1970s. The Kamala Tax will exacerbate these tendencies; a very strong market year will produce gigantic capital gains tax liabilities that have to be satisfied when the market may have fallen substantially, the sales to satisfy which will then cause the market to fall further. A “death spiral” could easily be created.

Conversely, in bear markets investors may be able to claw back previous taxes paid (given the persistence of market excesses in either direction, a tax carry-forward or carry-back for at least a decade would be needed). Indeed, if the Kamala Tax is introduced next spring, when the market may still be structurally hugely overpriced, it may not produce net revenue for a decade or more, as zillionaires declare tax deductions on unrealized market losses that wipe out their other profits.

The effect of the Kamala Tax on the market is even more troubling than its effect on investors. Because investors are liable to be zapped with large tax bills every time the market went up, their risk aversion in equity investment would be substantially increased. This would push them towards dividend stocks of very large companies whose price performance is sluggish and towards bonds rather than stocks. The result would be a much lower market valuation, and a much stronger preference for blue chips over tech and other small companies. Indeed, small new companies would find it very difficult to attract investor interest. Since they would also have trouble in the private markets as set out below, the Kamala Tax would be devastatingly bad for entrepreneurship and innovation.

The Kamala Tax’s adverse effects would be even greater in the markets for real estate and private equity, because of those asset classes’ illiquidity – illiquidity problems would also arise in markets for art, fine wine, etc. Real estate investment rests largely on leverage; there is not much cash around in most real estate portfolios. Furthermore, real estate appraised values are essentially guesswork – portfolios are written up according to the most recent comparable sales, but any attempt to sell a building quickly could well result in a sharp loss below the appraised value. Hence a sharp rise in real estate values in one year which led to tax liabilities in the following year would probably lead to bankruptcies as investors would be unable to sell assets quickly. Their creditors would foreclose, possibly profitably, if interest payments were missed or tax obligations declared past due.

In private equity investment, the illiquidity effect is even more extreme. Profits are made over the long term, and mostly depend on a few spectacularly successful investments, which offset the duds, while those with mediocre success do not affect returns much. At present, spectacularly successful investments attract tax only when they are sold; hence there are indeed games to be played in managing the portfolio to minimize tax liability and realize losses to match large profits. However, if an investment was “marked up” spectacularly, perhaps because of a successful sale of a similar investment from some other portfolio, there would be no way to sell it to meet a Kamala Tax liability.

In addition, many private equity investments are only evanescently successful. They attract a high valuation in one year based on special factors and then collapse. For example, the tech office space company WeWork attained a peak value of $47 billion in 2019, which would have attracted a Kamala Tax of $11.75 billion – completely impossible to pay when the company went public through a SPAC on a $9 billion valuation only two years later.

Generally, the effect of a Kamala Tax on the private equity market would be so severe that it would very probably close the market altogether in the U.S., although a residual business might remain funded entirely by foreign sovereign states and U.S. pension funds, which are exempt from tax. That smaller market would however contain only the doziest private equity investors, with none of the entrepreneurial ones that make private equity investment successful. It would therefore impose a severe adverse selection on new business formation, such that only the stupidest and most fashionable ideas got substantial funding.

In summary, the Kamala Tax would cause huge structural economic damage to the U.S. and yield relatively little revenue, or even negative revenue if (as is likely) it caused a stock market crash. Indeed, new methods of tax evasion would doubtless appear; for example, a billionaire might shelter his venture capital profits by buying a hugely expensive and vulgar yacht, since yachts always depreciate horribly once they are no longer new and glossy, hence providing a useful shelter.

I sympathize with Vice President Harris’s wish to zap the very rich; with 30 years of “funny money” interest rates they have benefited inordinately compared to the rest of us from soaring asset prices and their superior access to cheap leverage. However, the Kamala Tax is a grossly suboptimal way to achieve this end; it raises a tiny amount of tax compared to its huge economic damage.

A much better approach, as this column has advocated in the past, is to eliminate the tax deduction for charitable contributions, or cap it at a low flat level. This tax deduction totaled $215 billion in 2020, 45% of which was from taxpayers with incomes above $1 million – since nominal tax rates are higher at those incomes, the tax loss from charitable deductions of those with $1 million incomes (and benefit to wealthy taxpayers) must have been close to 60% of the total. Cutting these people off from their deductions would reduce much wasteful expenditure on charitable dinners etc. (40% of which should NOT be subsidized by lower-income people) and, even more important, would defund vast amounts of left-wing propaganda and election chicanery (the additional tax bill to George Soros alone would surely be in the billions)!

The distributive effect of abolishing the tax deduction for charitable contributions would be similar to that of the Kamala Tax, but its economic effect would be almost entirely beneficial, since it would not damage economic incentives of taxpayers at all (if it reduced their charitable donations and dinners it would leave them with more money to invest in economically useful activities) and it would de-fund the socially and economically damaging nonprofit sector.

Finally, I would remind readers that Silly Ideas are not the prerogative of one party only. President Trump’s crazy-realtor affinity for ultra-low interest rates is as damaging as the Kamala Tax and should be resisted by the Fed at all costs. Interest rates are still not quite high enough to bring down inflation; any cut by Jerome Powell on September 18 should be modest and doubly reversed on November 7 after the election, so that even if President Biden is given an appropriate send-off, monetary policy can be appropriately tight for the next President’s arrival on January 20.

John Cleese’s Ministry of Silly Walks was at least funny. A Ministry of Silly Ideas that produces the Kamala Tax would be merely tragic in its effects on American living standards.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)