Box 3 changes will make things worse.

As a Financial adviser with a duty of care to my clients, I have a responsibility to understand how the changes in tax legislation will affect them. When the Box 3 bridging legislation was first introduced, the changes to taxation left me in a state of disbelief. It appeared they hadn’t given any thought whatsoever as to the consequences.

Box 3 is the Netherlands very unique system of taxing capital growth. Most countries tax realised growth; once an asset is sold a proportion of the profits are taxed. If buy €10,000 of stock and sell it for €20,000, I will have €10,000 profit.  Assuming a 25% capital growth tax, I will owe €2,500 in taxes. If I don't sell the stock then no tax is due until the stock is sold.

The Netherlands does it differently. Currently your assets are measured at the start of the year and then growth is assumed based upon whether your investments are classed as cash deposits or investments.

This introduced tax traps to most investors. Low risk investments such as money market instruments and bonds were taxed at a rate that meant investors could often lose money by investing. This meant investors either faced unfair tax bills or avoided purchasing safer investments which a poor outcome for both lower risk investors and the Government.

This, among many other damning consequences led me to conclude the Government hadn’t thought things through. But this tax system was only temporary and is expected to be altered in 2028.

Keeping unrealised growth tax system

Now that we have an indication of what those changes are going to look like, we can evaluate whether the Government has learned their lesson. Like many, I had hoped that the new system would be based on realised growth but it seems the Netherlands is committed to being different and is proposing a tax on unrealised growth. I

Unrealised growth taxation means that you will be taxed on the actual growth of your investments, regardless of whether you sell or not every year.

Whilst measuring actual growth means that bonds no longer are a tax trap, the tax on unrealised (un sold) gains means that often people will still be forced to investments to cover the tax burden on those investments.

Tax on Volatility

Many critics have argued it’s a tax on volatility and I’m inclined to agree. Volatility is essentially the unpredictability in your investments. While investments have an average return, this return will vary year to year and the larger the differences in return or the larger the swings in price,  the larger the volatility.

​Under the proposed 2028 rules, the taxman will look at the value of your portfolio on December 31^st and tax you on how much it grew over the year, even if you didn’t sell a single share. This creates a massive, structural penalty for anyone holding assets that swing in value, like individual stocks or tech funds.

​Suppose we have two investors over a two-year period who both end up making exactly the same amount of money. To keep things easy to understand I will be assuming tax rates of 36%, but it should be recognised that the plans include an €1,800 tax free allowance for growth each year.

​Investor A buys a boring, highly stable asset. In Year 1, it goes up in value by €5,000. In Year 2, it goes up by another €5,000. Over two years, they made €10,000 in profit. The government taxes them 36% on the €5,000 growth each year.

​Investor B buys a highly volatile stock. In Year 1, the stock skyrockets, generating a massive “paper profit” of €50,000. The government rubs its hands together and demands a 36% tax on that €50,000. So, Investor B gets a tax bill for €18,000. But in Year 2, reality sets in and the stock crashes, losing €40,000 in value.

​Over the two years, Investor B’s net profit is exactly the same as Investor A: €10,000. But look at what happens with their taxes.

When Investor B’s stock crashes in Year 2, can they go to the Dutch Tax Authority and say, “Hey, that €50,000 I made last year disappeared, can I get a refund on the taxes I paid?” Absolutely not. The proposed rules strictly forbid “carrying back” losses to previous years.

​Instead, the government essentially says, “Tough luck. You can carry that €40,000 loss forward to offset taxes in the future, assuming you ever make money again.”

​So Investor B has paid €18,000 in real, hard cash to the government based on “phantom” wealth that entirely evaporated a few months later. Meanwhile, they might not even have the cash on hand to pay that massive Year 1 tax bill. If the bill arrives after the stock has already crashed in Year 2, Investor B is forced to sell off a huge chunk of their portfolio at rock-bottom prices just to pay taxes on what the stock was worth at its absolute peak. You are forced into selling at the worst possible time just to feed the taxman.

​The government gets to skim a 36% slice off the top of every peak your portfolio reaches, but when your portfolio falls into a valley, they leave you to drown. They take the upside and make you eat the downside. ​It creates a massive drag on compounding interest, and it turns investing in anything with volatility into a game of chance with the tax authority, with the odds stacked against you.

Compound interest

Compound interest is a wonderful thing, it allows investments to grow exponentially as the interest that you generate in an investment also grows. By limiting the ability for investments to compound, unrealised taxes not only harm the investor but also the Government collecting those taxes in the long term.

By taxing unrealized gains, the government introduces a constant "tax bleed" into your portfolio. Instead of letting your money compound untouched, they drain the pool a little bit every single year.

To see how this actually results in less money for the investor and less tax revenue for the government, let’s run a completely straightforward, 20-year simulation.

Let’s s suppose you invest €100,000 in an index fund portfolio over 20 years and we assume an annual growth of 10% with a tax rate of 36%.

In most sane countries, you let the €100,000 ride for 20 years and only pay taxes when you finally sell the asset and realize the cash. Because the government keeps its hands off your portfolio, your money takes full advantage of uninterrupted compound interest.

 Your €100,000 compounds at 10% for 20 years giving you a final pre tax portfolio value of €672,750. Your total profit is €572,750. Now, you sell and the taxman steps in to take his 36% cut of your profit.

Tax received by the Government: €206,190.

Final portfolio value: €466,560.

Compare this the proposed Box 3 system. You don't sell your shares for 20 years, but the government demands its 36% cut of your 10% paper profit every single year.

Because you have to sell off shares (or pay out of pocket) to cover this annual tax bill, your effective growth rate is no longer 10%. The government is skimming 3.6% off the top annually, leaving you with a net compounding rate of just 6.4%.

€100,000 compounds at 6.4% for 20 years leaving you with a final portfolio value of €345,806. The total tax received by the government during these years is €138,266.

Let's put those side by side so the sheer incompetence of the unrealized system really sinks in:

 Realized System: You return €466,560 and the government collects €206,190.

 Unrealized System: You return €345,806 and the government collects €138,266.

Under the proposed Dutch system, you are €120,000 poorer, and the government collects €68,000 less in taxes.

By keeping an unrealized tax system, the Dutch government is ensuring that its citizens will be poorer in retirement, while also ensuring that the state treasury will collect less tax revenue over the long run.

My conclusion stands: they really don't know what they are doing.