What Clinton's Capital Gains Plan Won't Do
Hillary Clinton does not like short-term investments. This I gather from her recent pronouncements upon the subject, and also, her new plans to tax capital gains on a sliding scale depending on how long you hold the asset. I have one thought about this proposal, and it is this: "Why?"
There are two arguments you can make about the war on capital gains. The first is that tax rates on capital may not really matter much. But if that's the case, then what's the argument for the sliding scale? If it doesn't matter, then it's OK to jack up the tax rate, but your sliding scale is not going to noticeably affect "short-termism" in public corporations.
The other possibility is that it matters a lot. In that case the sliding scale will make a big difference. But the case for jacking up the top rate to 40 percent for stocks held less than two years looks considerably weaker. This is basic Econ 101.
Actually, I endorse a third view: On the margin, it's probably going to affect investment if you raise capital gains taxes by a lot -- and nonetheless, this is not going to do much to shift the incentives toward longer-term thinking at companies. That's because Clinton seems to fundamentally misunderstand the reason that public companies are so focused on short-term results that impact their stock price, rather than longer-term growth. To the extent that you think this phenomenon is real, and a problem, the issue is not that American investors, for reasons known only to themselves, have developed the attention spans of gnats. Instead, I'd argue that the problem is the massive shift toward institutional management of equity assets.
Here's SEC Commissioner Luis Aguilar on this phenomenon in 2013: "The proportion of U.S. public equities managed by institutions has risen steadily over the past six decades, from about 7 or 8 percent of market capitalization in 1950, to about 67 percent in 2010." Stocks used to be the province of affluent people who might hold them for decades -- and might well take it into their head to show up at your shareholder meeting and delicately inquire why the chief executive officer is getting paid so much when quarterly results look pretty dismal. Now they're the province of everyone -- and everyone is in the hands of professional managers who don't care how much the CEO is getting paid, would rather sell and buy something else than chivy the board into doing its job, and need to deliver price appreciation pretty regularly, lest their Morningstar profile become tarnished, or the regulators start asking the company to increase contributions.
Add to that the fact that you can now log in every day to see exactly how your 401(k) is doing, and you can see how short-termism might come to dominate executive offices.
But whether or not you think that institutional management is actually unleashing a great plague of short-termism upon the land, the important point is that the prevalence of institutional management will prevent you from fixing this problem by manipulating the capital gains rates. Pension funds do not pay taxes on the assets in their funds. Neither is your tax-deferred retirement fund subject to these taxes. And even taxable mutual funds are probably not going to be very responsive to this change, for a few reasons:
1. First, my mutual fund manager doesn't care about my tax bill as much as I do. My mutual fund manager is interested in keeping the returns up. Maybe they're interested in the expense ratio. When I go to Fidelity to look at the mutual funds on offer, that information is right up there at the top. The tax stuff is way down at the bottom, because they don't have to bill you for the tax. Maybe people will start shopping more aggressively on tax cost if we jack up the rates higher. But because taxes are a bill you get from your accountant, while statements are a piece of paper you get from them, I suspect not. The kind of investors who invest in mutual funds are often not the kinds of investors who crack out a calculator to compute their return net of taxes when they look at their statements. They are often, however, the kinds of people who sell their funds if their statements tell them that the returns have been less than spectacular for three years straight.
2. Mutual funds do have leeway on which stock they sell. If the fund has a big pile of Verizon stock, and some of it was purchased eight years ago, while some of it was purchased three months ago, they can say "I'm selling this vintage old stock, not that shiny new stock over here." And, according to a securities lawyer to whom I just popped this question, that is, in fact, what they typically do. This will tend to vitiate the effect of your new capital gains rule.
So this proposal will not much affect the incentives of two-thirds of the market. I doubt the tax incentives of the one-third that is left are going to substantially alter the behavior of CEOs and corporate boards.
But that does not mean that this tax will have no impact. It can still very much impact the incentives of people to invest money outside of tax-advantaged retirement funds and nonprofit endowments. So you have here a policy that might impede capital formation -- hurting growth, not helping it -- while doing nothing to fix the problem at which it is targeted. Again, I ask: "Why?"
Of course, I do know the answer to that question. Hillary Clinton is running for office. Voters are unlikely to parse the effects on capital markets, if the sound-bite version sounds good to them.
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