The Case Against Taxing Unrealized Gains: Ohanian's Critique and Its Implications for Tech and Venture Capital

The debate over wealth redistribution and tax policy has long occupied center stage in economic discourse. At its core lies a tension between the goals of equity and innovation: how to balance the need for social fairness with the imperative to sustain the dynamism of capitalist economies. Eric Ohanian, a prominent economist and advocate for market-driven growth, has sounded a cautionary note about policies that impose taxes on unrealized capital gains-particularly in the context of technology and venture capital. His critique, rooted in the broader framework of incentive alignment and entrepreneurial behavior, raises critical questions about the unintended consequences of wealth redistribution measures.

The Innovation Paradox

Ohanian's argument hinges on a fundamental insight: innovation is inherently risky and uncertain. Startups in the tech sector, for instance, often operate for years without profitability, relying on the promise of future value to attract investment. Taxing gains that have not yet materialized, Ohanian contends, disrupts the delicate calculus that underpins such ventures. As stated by David R. Henderson, such policies could "deter investment in high-risk, high-reward ventures typical of the tech industry." This is not merely a theoretical concern. The venture capital ecosystem thrives on the ability to reinvest unrealized gains into new ideas, a process that taxation could curtail by reducing the pool of available capital and dampening investor appetite for risk.

The Baumol Effect and Incentive Misalignment

William Baumol's seminal work on entrepreneurship provides a useful lens to understand Ohanian's critique. Baumol distinguished between "productive," "unproductive," and "destructive" forms of entrepreneurship. Productive entrepreneurship-such as technological innovation-drives long-term economic growth. However, when the incentive structure of a society shifts, resources may flow toward less socially beneficial activities. Ohanian's concern is that a poorly designed unrealized gains tax could skew incentives in precisely this way. By making high-risk innovation less attractive, such policies might redirect entrepreneurial energy toward safer, less transformative pursuits-what Baumol terms "unproductive" or even "destructive" endeavors.

The Wider Economic Risks

The implications extend beyond individual investors or startups. A 2021 study by the National Bureau of Economic Research found that tax policies reducing the cost of capital can stimulate investment and labor demand, though their impact on wages and productivity remains mixed. This suggests that while redistributionist policies may achieve short-term equity goals, they risk undermining the very mechanisms that generate sustained economic growth. Ohanian's critique, therefore, is not an abstract defense of capital but a pragmatic warning about the fragility of innovation ecosystems.

The Redistribution Dilemma

Critics of Ohanian's position often argue that income inequality justifies redistribution. Yet, as highlighted in a Hoover Institution report, such policies can have unintended consequences. If high earners anticipate higher tax burdens on future gains, they may scale back investments or seek alternative avenues to preserve wealth, such as tax avoidance or regulatory capture. This dynamic, Ohanian implies, could erode the social returns of innovation, particularly in sectors like technology where long-term payoffs are critical.