It would be easy enough to require taxes be paid on unrealized capital gains as they accrue. What would you prefer?
I'm not sure how easy such a requirement would be. For starters, there's the problem of tracking those unrealized gains. That would be easiest for publicly traded stock, which has a readily-ascertainable value. For everything else, it would require obtaining an appraisal each year. This would be unreasonably burdensome on the taxpayers who comply with the requirement, and impossible to enforce against the taxpayers who don't comply. Second, one of the main policies underlying the income tax system is that taxes should be imposed at a time when the taxpayer has the wherewithal to pay. Taxing unrealized gains before they are reduced to cash is contrary to that policy.
On the other hand, the current capital gains tax system doesn't make much sense, either. If longer-term investments are preferable to shorter-term investments, why does the law only distinguish between holding periods that are one year or less and those that are longer than one year? And if the concern is that taxing the gains in a lump sum is unfair because the gain was actually spread over multiple tax years, why is there a one-year-and-a-day lower limit, and why is the tax the same even for capital assets held over many years? If I sell an asset after owning it for one year, then the gain on that sale is taxed at ordinary rates. But if I wait a day, and then sell it, suddenly it's unfair to tax it at ordinary rates?
So, a better system would be one that, like the current system, taxes the gain only once it's realized and the taxpayer has (or should have) the wherewithal to pay, but unlike the current system, would account for multi-year holding periods differently than year-and-a-day holding periods. One way to do this would be the system in place during the late 1930s (according to
Wikipedia): the longer the holding period of an asset, the more of the gain that is excluded from income. Another alternative would be to determine the average capital gains per year by dividing the total gains over the number of years held, and then taxing the gain attributed to each of those years at the taxpayer's marginal rate for the year. For instance, say that a taxpayer sold a capital asset after ten years, and realized $100,000.00 of gain. For the first five years of the holding period, he had paid a marginal rate of 20%; for the next five, he paid a marginal rate of 30%. $100,000.00/10 years = average (unrealized) gains of $10,000.00 per year during the holding period. His total tax on the gains would be (($10,000.00 * .2) * 5) + (($10,000.00 * .3) * 5) = $25,000.00. Either of these options would be preferable to the current system, or a system of taxing unrealized capital gains.
