Paper gains, very real taxes

There is a simple principle that has underpinned sensible investment taxation almost everywhere: you pay tax when you actually make money, meaning when you sell an asset and pocket the proceeds. The gain must be real, not merely a number on a screen, before the government arrives to take its share. The Netherlands is now proposing to abandon this principle.

Starting in 2028, the Dutch government plans to levy a 36 per cent tax on investment returns that includes unrealised gains – meaning the increase in the value of shares, bonds and other assets that you still hold and have not sold. If you buy shares for a hundred euros and they are worth a hundred and thirty euros at the year's end, you owe tax on thirty euros of gain that exists only on paper, and which could easily vanish the following year.

The Dutch have a particular reason for this peculiar step. Their Supreme Court struck down the old system, which taxed a notional return on investments regardless of what investors actually earned. Strangely, the new system is intended as a correction toward taxing "actual" returns. The good intentions behind the reform do not make the outcome less problematic. What the Netherlands has produced, under judicial compulsion and apparently with a straight face, is a mechanism that forces investors to sell assets to fund tax bills on non-existent gains.

The more worrying aspect, however, is not the Dutch situation itself but the broader trend it represents. Scroll through any corner of social media where economics is discussed, and you will encounter a thriving community of neo-socialists who have arrived at a remarkable conclusion: socialism did not fail – it was simply never done properly. The Soviet Union, Maoist China, Cuba – these were all, apparently, unfortunate misapplications of a fundamentally sound idea. 

The right people, equipped with the right intentions and sufficiently modern technology, will finally get it right. Within this worldview, taxing paper gains is not overreach but an obvious act of justice. The rich are simply too rich; their wealth – even the theoretical kind – is an insult, and the state is the right instrument to correct this. The idea that market value constitutes real money that the government is entitled to right now, not when you actually sell, fits neatly into this framework and is gaining quiet respectability in policy circles well beyond the Netherlands.

In the United States, proposals for a billionaire minimum tax on unrealised gains have periodically surfaced. Once these ideas move from late-night Twitter threads into enacted law in a well-governed European democracy, they can no longer be dismissed as the hobby horse of excitable social media inhabitants.

India does not need to speculate about where this road leads. We have been there. In the early 1970s, the tax burden on wealthy individuals was not merely high; it was mathematically absurd. The top marginal income tax rate hit 97.75 per cent in 1973. Simultaneously, the Wealth Tax Act levied an annual charge of up to 8 per cent on the total market value of assets: jewellery, real estate, and financial holdings as assessed on the 31st of March each year. 

This was not precisely a tax on unrealised gains, but it achieved the same effect. If your assets appreciated, your wealth tax bill rose regardless of whether you had sold a single share or received a single rupee of actual income from them.

The combined arithmetic was, in many cases, simply impossible to honour from regular income. Total tax liability routinely exceeded total income for high-net-worth individuals. The predictable outcome was not compliance – it was the birth of India's black-money economy, massive underreporting of assets, a dysfunctional stock market, and the general stagnation of industry and business that characterised those decades. 

Our experience is a useful corrective to the optimistic assumption that sufficiently clever design can make a tax on paper gains workable. The problems are not incidental but structural, with the inevitable human response of relocating or hiding wealth when the burden becomes severe enough.

What India spent thirty years learning the hard way, the Netherlands and some other parts of the world are apparently willing to discover afresh. And a cheerful brigade on social media will applaud every step of the journey.

Also read: Tax incentives: A debate on habit formation