In the “olden days”, buying stock was not a simple matter for the average American, who had no connection to the financial community. You found a broker, paid him what now seems like an exorbitant fee, and he set in motion the process to purchase the stock for you. It was a pain and it wasn’t cheap so you invested for the long-term; otherwise, your profits were so thoroughly decimated by fees that you’d never earn decent returns.
As we entered into an age where low fees were the norm and trades could be consummated with a mere click, “daytraders,” began to pop up. This was really only the tip of the iceberg, really, as even those “Wall Street hotshots” began to think about trading in a radically different way in the new age. Stocks slowly morphed from a form of ownership of real companies and into a form of abstract profit-making. Of course, there was always some sense of the abstract in the market, but it got to the point where a majority of the market participants arguably were ignoring the fundamentals behind the companies they were investing in. Investing became about psychology and little more.
Is it possible to have a fruitful and productive business environment when those who contribute the capital have no incentive to care about the long-term viability of the enterprises they invest in? Shouldn’t the goal be to encourage strong businesses that create real value for all of American society rather than temporary wealth for a few? I don’t think most Americans would disagree with that assessment. However, our tax code doesn’t clearly reflect these priorities any more.
Income and capital gains tax rates have shifted numerous times over the past century. Sometimes it seems like these shifts have come on nothing more than whims, while at other times, specific policy goals were being targeted. Yet, it still feels like the government has not necessarily adjusted to the new reality.
I often hear of proposals for lowering the capital gains taxes. I’m not opposed to this on one level, but on another level, I ask myself what purpose does it serve and what American societal interests does it advance? But I agree --- capital gains taxes should be lowered --- and raised.
Of course, lowering and raising capital gains taxes should serve a function. America should be promoting ownership. You can’t create real societal wealth by promoting abstract derivative investments that have only a tangential relationship to reality. Nor can you promote building real wealth by allowing people to profit off of doing nothing. You can create societal wealth, however, by building strong businesses that provide vital services to Americans and the rest of the world. Those types of businesses would be more likely to thrive in an environment where long-term ownership is promoted.
While I feel that a lot of dramatic changes need to be made to the American taxation system to promote real wealth rather than the illusions of wealth we have been promoting over the past few decades, amending the capital gains tax system would be a great start. I am quite flexible on the details of these proposals --- I merely suggest them as starting points for discussions, but here are a few ideas on how to promote long-term ownership in companies
To create incentives for long-term ownership, Congress should think about lowering the capital gains tax for investors with a long-term horizon. It should also eliminate the capital gains tax completely for investors with a very long-term orientation. While in one sense, it may seem counterproductive to eliminate CG taxes altogether on certain investments, I see no reason not to given the fact that investors are already taxed once at the “corporate tax” level. My proposals on this front:
(1) Create a 3-year Capital Gains (NASDAQ:CG) tax bracket that is taxed at the 15%.
(2) Create a 7-year Capital Gains (CG) tax bracket that is taxed at 5%.
The next step should be to create huge disincentives to short-term speculation. Additionally, while I believe a 1- to 3- year investment time frame does not qualify as “speculation” by any measure, it also does not necessarily serve the end goal of creating high-value enterprises. My proposals are as follows:
(2) Tax all CGs on investments held for less than three months, but greater than two weeks, at 70%.
(3) Tax all CGs on investments held for less than one year, but greater than three months, at 50%.
(4) Tax all CGs on investments held for less than three years, but greater than one year, at 25%.
As far as offsetting goes, I’d define the 1- to 3- year CGs as “Medium-Term Capital Gains” (MTCGs) and all the rest as Short-Term Capital Gains (STCGs) that would have to be offset only at the lowest (hence, least advantageous) tax rate.
My proposal for dividend treatment is that they should be taxed at the same rate as the medium-term capital gains rate, but that investors who qualify for one of the long-term CG brackets to claim a lower rate based on their time horizon.
I’ve heard arguments both ways on short-selling. On one hand, short-selling does not really promote strong businesses that create enduring value. On the other hand, short-selling does serve the vital function of incentivizing investors who look for cracks in companies’ earnings and reported financials.
This moves into a little bit of a different direction, but with the effects of excessive leverage wrecking our entire economic system, it’s time to finally consider altering the tax treatment of debt financing. One reason why debt financing is often preferred by businesses over equity financing is the tax savings created from the interest deductions. While these deductions make sense on one level (since companies with debt accrue fixed interest charges that offset their income), they also encourage companies to take on debt rather than use equity to finance their operations.
A leverage test
Any proposal I give on this is going to be flawed in many regards, but just to get the discussion going, I would suggest trying to come up with some sort of leverage test to decide whether or not a business can claim the interest deduction. The question is, what do you base it on? Long-term debt (LTD) over equity? Liabilities over equity? The former seems problematic in that businesses might try to find clever ways to classify LTD as a current liability. The latter seems problematic in that businesses might be punished for no other reason than the payment standards in their industry.
Should we eliminate deductions for interest payments altogether? That seems like an overly harsh way to achieve the goal of promoting more equity financing. Perhaps we could just limit the deduction --- for example, companies could only claim half of their interest payments as a deduction. While I’d consider my other ideas “rough drafts”, I am unfortunately not even able to get the ball rolling very much on this issue. However, it does seem like we should do something to stop actively promoting debt financing.
None of my proposals are meant to be rigid, inflexible policy ideas. In fact, I imagine there are many downsides to these proposals. This article was merely meant to ‘get the ball rolling’ and the bigger point is that we need to start thinking about ways to stop promoting speculative investment vehicles that create no real economic value to the American economy and start promoting healthy, viable businesses that will create true wealth for America.
One thing I dislike about American politics right now is that there is so little productive discussion on public policy; it’s all very simplistic pro- and anti- garbage. We need to move away from that and begin discussing issues on a pragmatic level again. On that note, I’m interested to hear others’ thoughts on how to achieve the objectives discussed in this article via tax policy or even via other policies.