All of you nerds out there who studied the theory of taxation in college, you are in for a Christmas treat with this article.
The rest of you: come along for the ride—the story in this article is far too important to be left to the nerds and the experts. After all, it is about taxes.
Over the past several months, there has been an intense political debate over fair taxes on both sides of the Atlantic Ocean. In America, it was centered around an idea that Kamala Harris, the Democratic Party’s presidential candidate, tried to win voters with. She proposed a tax on so-called “unrealized capital gains”.
On the European side—or at least in Britain—Prime Minister Keir Starmer ignited the tax-fairness issue by proposing a significantly higher inheritance tax on farms.
Both these tax ideas are bad in their own way, but they have an even worse common denominator that makes them bad—both economically and, from a conservative viewpoint, morally.
Before we dig deeper, though, it is important to note that Kamala Harris officially wanted to limit her tax to very wealthy taxpayers:
The proposal would impose a minimum tax of 25 percent on total income, generally inclusive of unrealized capital gains, for all taxpayers with wealth (that is, the difference obtained by subtracting liabilities from assets) greater than $100 million.
This threshold was often forgotten in the presidential debate, which proponents of Harris’s tax idea were quick to point out. However, there is a good reason to debate her tax idea as if it did not come with any threshold. Any limits on a tax, including at what income it starts applying, can easily be changed over time; once a tax is in place, it is basically a technical matter to extend its reach.
That is exactly what Prime Minister Starmer and his government seem to have had in mind: a debate over technical adjustments to an already existing tax. On the surface, it might indeed look that way, but as Paul Kelso with Sky News explains in his overview of the tax, the British tax system provides farmers with two types of full inheritance tax relief:
Agricultural Property Relief (APR) covers land and farm buildings, and Business Property relief (BPR) applies to livestock, machinery … and assets developed to diversify income
Starting in 2026, the relief would be restructured so that
Estates will receive relief of £1m, with up to £500,000 of additional relief, as with non-farming estates. If a farm is jointly-owned by a couple in a marriage or civil partnership, the relief doubles from £1.5m to £3m.
Above the relief—tax deduction in American parlance—a tax rate of 20% applies. This rate is relevant, since Paul Kelso cites official government figures showing that “49% of farms in England” are worth £1.5 million or more.
Half of Britain’s farming community is only a heartbeat away from having to cope with this tax.
From a tax-efficiency viewpoint, this farm inheritance tax reform makes sense. It seeks to eliminate tax incentives unintendedly created through differences in tax treatment of different types of property. By moving closer to tax neutrality, the British government reduces allocative distortions in the economy.
The problem with this tax is that it is applied to property—or, strictly speaking, to the acquisition of proprietorship of said property. This means that the tax must apply to the value of the property, which is normally—but far from always—determined by the free market.
It is not determined by the taxpayer’s ability to pay the tax.
Tax theory prescribes that if a tax is to be an effective revenue instrument, the liability that it imposes on the taxpayer should be proportional to the ability of the taxpayer to pay the tax. This is how the income tax works, and it also applies to consumption-based taxes such as sales taxes, excise taxes, and value-added taxes. These taxes are constructed to be proportionate to the amount of money the taxpayer spends on taxed items.
The theory of the ability-liability taxation balance does not always apply perfectly, even when taxes are constructed along the lines of this theory. However, there is always at least a proximate relationship between, on the one hand, taxes on incomes and consumer spending and, on the other hand, the tax liability itself. When our income-tax liability increases, the reason is normally that we make more money; the abnormal case would be when government raises the income tax.
Taxes based on property values do not work this way. As demonstrated by the tax on unrealized capital gains that Kamala Harris proposed, there is no relationship here whatsoever between ability and liability. If we make the realistic assumption that her tax on unrealized capital gains would apply to much smaller amounts of wealth than she proposed, the following example would become entirely realistic.
A family buys a house in 2024, paying $300,000 for it. With a down payment of $50,000, they borrow $250,000, which is paid off on a 30-year plan.
Ten years later, they sell the house for $450,000. They have paid off one-quarter of the mortgage (due to interest payments dominating the early installments) which leaves $187,500. This is deducted from the $450,000 for a net value of $262,500.
When they bought the house, the net value was $50,000, which we deduct from the new net value. This leaves us with $212,500, which is the net capital gain on the home over the ten-year period. Since this is money that the home sellers get in their hands, it is a realized capital gain; the Kamala Harris tax of 25% would take $53,125 out of that amount, leaving the couple with $159,375.
However, suppose now that the family does not sell the house. Instead, suppose the county where they live assesses the value of their house to $450,000 after ten years. Applying all the numbers from the example above, we end up with an unrealized capital gain of $212,500.
In the first example, the family got the net worth of the house in their bank account; in the second example, they get no cash at all. The unrealized capital gain is purely a numerical exercise carried out by the tax assessor. Nevertheless, the tax on unrealized capital gains forces the family to cough up $53,125 in tax on that ‘gain.’
Let us keep in mind that this is an example where the tax on unrealized capital gains is applied to a ten-year period. If the tax were to become a reality, it would apply annually, which in this case means that we can—simply put—split the tax bill into ten installments. This makes it look much less ominous, but it nevertheless amounts to $5,312.50 per year, on average; for a family who would normally be approved for a $250,000 mortgage, this is a sizable annual tax increase.
The imbalance between the tax liability and the ability to pay that liability becomes far more pronounced in the case of the British farm inheritance tax. The inheritance situation is comparable to the ‘sell your house’ example above, but only up to the point where the tax is assessed. Since the farm is inherited, not sold, the new proprietor does not liquidate the assets. Therefore, he carries on running the farm on an ‘as is’ basis.
One of the key points with this is that, at least in the short run, he has to make do with the income that the farm has. In his aforementioned article for Sky News, Paul Kelso notes that £50,000 is a typical farm income; if an heir to a farm with that level of earnings is faced with as little as a taxable value of £100,000 (after the £1.5 million deduction), the 20% tax on that amount equals 40% of his farm’s income.
The two examples we have here, one tax on unrealized capital gains and one inheritance tax, have in common that they separate tax liability from taxpayer ability. In Kamala Harris’s defense, it could be argued that she purposely added a threshold to her tax precisely to avoid severing the ability-liability tie. However, the overwhelming experience with taxes, both in Europe and in America, is that once they are established, they always expand to burden more people.
As these examples show, it is economically dumb, fiscally irresponsible, and morally wrong to separate the taxpayer’s ability to pay from the tax liability that government is imposing on him.
