Is Capital Gains Double Taxation?

Analysis of Capital Gains

I. Introduction

The topic of Capital Gains can be contentious, with many calling for various schemes to tax the wealthy including unrealized capital gains. However, a long discussed debate in economic, legal, and political circles is whether or not Capital Gains amounts to DOUBLE taxation. The argument that it amounts to double taxation is that the income when it is earned is taxed, and then taxed again when the proceeds from that income appreciate through investment and are sold. Essentially taxing the same income twice – once when it was earned through labor, and again from the appreciation from the asset purchased with the labor. Others defend it as a legitimate method of taxing new income derived from capital, which should be treated similarly to income from labor.

In this debate there is no right or wrong way, just different approaches for collecting Government tax revenue. This article analyzes the question of if Capital Gains is Double taxation, examines the structure, arguments, and implications of capital gains taxation. It unpacks both sides of the double taxation debate, analyzing the effects of inflation and asset illiquidity, explores international comparisons, and capital gains’ composition in Federal revenue.

II. What Are Capital Gains?

Capital gains are the profits earned from the sale of an asset—such as stocks, bonds, real estate, or a business—when the sale price exceeds the original purchase price. Those gains are then categorized by the amount of time they are held before sale to determine their tax treatment as follows:

• Short-term (held <1 year): these are taxed at ordinary income rates (10%–37%).
• Long-term (held ≥1 year): these are taxed at preferential rates (0%, 15%, or 20%) depending on the taxpayer’s income level.

Additionally, a 3.8% net investment income tax (NIIT) may apply for high earners, pushing the top effective rate to 23.8% federally [1]. Unlike labor income, capital gains are taxed only when realized (i.e., the asset is sold).

III. The Case That Capital Gains Taxation Is Double Taxation

A. Taxed Once on Earned Income

The money used to invest typically originates from wages, salary, or business income—already subject to income tax. For example, a worker earns $100,000, pays $25,000 in taxes, and invests a portion of the remaining amount. If that investment later grows, the appreciation is taxed again.

Critics argue this represents sequential taxation on the same income stream: first on the principal earned from income, then on its growth when an asset is sold, all of which is derived from the same initial income.

B. Taxed Again on Gains and Inflation

Capital gains taxes apply to nominal gains, not real (inflation-adjusted) gains. Meaning, unlike with labor where you get paid in regular near term increments, like weekly or bi weekly, gains can happen over much longer periods in years and sometimes decades where you do not have the same access to the capital as you would with normal income and it is exposed to inflationary effects over that time period. So, if someone gave you $10 in 1950, and $10 in 2025, which would be worth more? Inflation adjusted the $10 bill in 1950 would be worth over $130 dollars adjusted for inflation today. So, critics argue that not only are you taxed on the original income again, you are also taxed on the inflation.

Example: A property purchased in 1990 for $200,000 and sold in 2025 for $600,000 shows a $400,000 gain. However, if cumulative inflation was 140% over that period, the real gain is much lower ($400,000 gross gain – inflation $280,000 = $120,000 post inflation gain). However, tax is still levied on the full $400,000.

This results in effective tax rates on real gains far above the statutory capital gains rate. Meaning that adjusted for inflation, the tax rate is much higher than the 15 or 20% normally associated with long term Capital gains. In the example we looked at the capital gains of $400,000 at 20% capital gains rate would result in a tax liability of $80,000. If you applied it to the post inflation gain of $120,000 and used the tax liability of $80,000 that would be an effective tax rate of over 66%, well above the 20% Capital Gains rate.

C. Accessibility and Deferral

While labor income is paid regularly and can be spent immediately, capital gains are often effectively “locked in” for certain holding periods allowing investments to appreciate. While labor is of course exposed to the same effects, the duration is much shorter and the long term effects are not as noticeable.

• Investors must keep their assets invested for appreciation.
• Investors must sell assets to realize gains.
• Selling may trigger tax and reduce the reinvestment base.
• Long holding periods increase exposure to inflation and market risk, further eroding value.

IV. The Case That Capital Gains Taxation Is Not Double Taxation

A. All Income is Taxed

Supporters argue that the Capital Gains tax is not levied on the same income twice. Rather, the tax is applied to a new income stream – the appreciation of the asset in value. Classically, most income comes from Land, Labor, or Capital and Capital gains, like wages or interest, is a form of income that should be taxed.

From this perspective, only unrealized gains (conceptual gains in asset value, but not sold so the value is not realized or accessible) would be untaxed income. Once realized, they should face taxation like any other source of income.

B. Preferential Rates Offset Burden

To account for potential double taxation concerns, the U.S. tax code provides preferential tax rates for long-term gains. While ordinary income may face a top marginal tax rate (currently up to 37%), long-term capital gains face a top rate of 20% (plus 3.8% NIIT for high earners).

This rate differential is meant to:

• Compensate for inflation and risk.
• Encourage long-term investment.
• Offset any perceived over-taxation due to prior taxation of investment income principal.

C. Deferred Taxation

Investors have the benefit of controlling the timing of their tax liability by when they choose to sell their assets. Unlike wages, which are taxed immediately and subject to other taxes, like Social Security and Disability insurance, capital gains taxation is deferred until the investor chooses to realize the gain. This allows:

• Compounding growth without taxation drag.
• Strategic tax planning.
• Lower present value of future tax liability.

Some call this deferral a built-in subsidy that benefits investors and offsets claims of double taxation.

D. Addressing Income Inequality

While this item does not refute that Capital Gains is Double taxation, it speak to the concept of Fairness and balance. Capital gains are heavily concentrated among the wealthy. In 2021, the Top 1% of taxpayers earned 74% of all long-term capital gains in the U.S. [2]. If gains were exempt from taxation, a significant share of income would go untaxed. While a very small percentage, some Ultra High Net worth individuals may have enough Capital that their Asset appreciation may produce more than their lifestyle income requirements. For this group of individuals they can derive a majority, if not all, of their income through Capital appreciation vs labor. By taxing Capital gains you can offset this.

V. The Structural Problems in Capital Gains Taxation

Even if not technically double taxation, the structure of capital gains taxation introduces distortions and inefficiencies. The value of money, due to inflation, lowers over time. This makes the incentive to save and invest lower, if the economic rewards are not there for the risks of the lowering value of assets due to inflation.

A. Inflation Distortion

As noted, Capital gains are taxed on nominal (non inflation adjusted), not real (inflation adjusted), appreciation in asset value.

Sample: Effect of 3% Annual Inflation over 30 Years (~140%)

Inflation increases the risk of investing by lowering the return in real value of a long-term holder’s gain. In essence lowering the purchasing power of their initial investment leading to disproportionately higher taxation on the real gains.

B. Lock-In Effect

Since tax is triggered by realization of the sale of appreciated assets, investors often delay selling assets to avoid tax, even if reallocation would be economically optimal. This “lock-in effect”:

• Reduces liquidity.
• Discourages portfolio rebalancing.
• Distorts capital markets.

C. Wealth Leverage Arbitrage

Wealthy individuals increasingly use asset-backed loans to access liquidity without triggering taxable events. High net worth individuals can essentially deploy a Buy, Borrow, Die strategy to:

• Borrowing against appreciated stocks or property.
• Using proceeds for consumption/living expenses or investment.
• Die without selling their assets and never realizing a taxable event.

This strategy—unavailable to many lower-wealth individuals—creates tax arbitrage. See our article on Buy Borrow Die for more details on this strategy and how it works.

VI. International Comparisons and Policy Alternatives

Several developed nations take different approaches to capital gains taxation, from none to the majority of it being taxed at ordinary income rates. It is important to note, that the the tax compositions of every country are different, and that a lower or higher capital gains rate does not necessarily equate to a higher overall effective tax rate.

Several proposals in the U.S. to update the Capital Gains Tax have included:

• Indexing capital gains for inflation: adjusting basis to reflect real purchasing power.
  • What it means: That the inflation adjusted amount would be removed and only the non inflation gain amount would be taxed, lowering the overall tax liability. This could encourage more people to invest.
• Step-up basis reform: eliminating the reset of asset value at death.
  • What it means: When a person dies the benefactor receives the assets at the current valuation price. So for example if an asset has appreciated from $100,000 to $200,000 there would be an unrealized gain of $100,000. However, if the benefactor receives the asset and the current valuation is $200,000, they would have no taxable appreciation ($200,000 stepped up basis – $200,000 current valuation). This tax treatment significantly benefits the benefactor, and the tax efficiency of the estate.
• Universal savings accounts: exempting small-scale investors entirely.
  • What it means: Providing special exemptions so that smaller and lower income populations can invest, participate and benefit from the power of market based appreciation. Presumably with the intent to increase the wealth potential of market appreciation to larger portions of the population.

VII. Comparison

VIII. Capital Gains and Federal Revenue

Despite being taxed at lower rates and only upon realization, capital gains constituted a relatively small percentage of Federal Revenue, but a significant amount overall of Federal revenue:

• In FY 2022, capital gains taxes generated approximately $250 billion in Federal revenue—around 8% of total federal individual income tax receipts [3].

The amount of revenue collected from Capital Gains is volatile. During economic booms, capital gains revenue can surge (e.g., $325B in FY2021); during recessions or economic turmoil it can plummet substantially (e.g., $89B in FY2009) [4]. Federal Tax revenues benefit substantially from Market appreciation.

IX. Conclusion: Double Taxation?

Whether capital gains taxation constitutes double taxation depends on how one defines the income base:

• If the focus is on origin of funds (already-taxed income used to invest), then taxing gains may appear sequential (double).
• If the focus is on new income stream created, then it is simply a form of taxing new income, no different than any other income.

The real issue may not be whether it’s “double taxed” but how fairly, efficiently, and equitably it is taxed—especially given the inflation effects, lock-in effects, and the concentration of gains among the wealthiest households. These are all decisions of Government, and Tax Payers (voters) how they wish to compose Government Revenue.

Capital gains taxation is not unique in its complexity or controversy. It is a structural component of US Federal Tax Revenue, and at times politically sensitive portion of U.S. tax code.

X. Capital Gains Tax Rates Over Time (U.S. Federal)

Historical Top Capital Gains Rates as shown in Figure 1. Short term Capital Gains have essentially followed Ordinary Income tax rates which have come down since the 1940’s, and Long Term Capital gains have been in the range of 15 to 28% since the 1980’s.

Citations

[1] IRS. “Topic No. 409 Capital Gains and Losses.” https://www.irs.gov/taxtopics/tc409

[2] Congressional Budget Office. “The Distribution of Household Income, 2019.” https://www.cbo.gov/publication/57404

[3] Joint Committee on Taxation. “Overview of the Federal Tax System as in Effect for 2023.” https://www.jct.gov/publications/2023/jcx-3-23/

[4] Tax Policy Center. “Capital Gains Taxes.” https://www.taxpolicycenter.org/briefing-book/how-does-tax-system-treat-capital-gains

[5] Internal Revenue Service. “Historical Table 23 – U.S. Individual Income Tax: Top Capital Gains Rates, 1913–present.”
https://www.irs.gov/statistics/soi-tax-stats-historic-table-23