Retrospective Capital Gains Taxation

This paper presents a new approach to the taxation of capital gains that eliminates the deferral advantage present under current realization-based systems, along with the lock-in effect and tax arbitrage possibilities associated with this deferral advantage. The new approach also taxes capital gains only upon realization but, by effectively charging interest on past gains when realization finally occurs, eliminates the incentive to defer such realization. Unlike a similar scheme suggested previously by Vickrey, the present one does not require knowledge of the potentially unobservable pattern of gains over time. It thus is applicable to a very broad range of capital assets.