To hear Hillary Clinton speak, you’d think she is a crusader for American’s middle class. She has made promise after promise to close Wall Street loopholes that allow the rich to get richer.
She’s promised to add a surcharge on high-income taxpayers and implement the Buffet Rule, which would establish a minimum 30 percent tax on some taxpayers.
Clinton also wants to radically alter the capital gains tax. Her proposal, designed to encourage longer-term investments to reduce what she calls “quarterly capitalism,” is flawed in both diagnosis and prescription.
Her plan is premised on the belief that activist investors are pulling capital out of companies that would otherwise use it to create jobs and economic growth.
Even if this were true, according to Leonard E. Burman, the Director of the Urban-Brookings Tax Policy Center and a professor at Syracuse University, it is still “not a compelling rationale for policy intervention.” Even the New York Times said it missed the mark, calling it “more show horse than workhorse.”
Clinton is reportedly taking her cues from the liberal Center for American Progress. They have found that, in the half decade that follows an “engagement” with an activist investor, spending on buybacks and dividends jumps from 22 percent of operating cash flow to 37 percent. At the same time, capital investments drop from 42 percent to just 29 percent.
The Democratic frontrunner, who accepts campaign donations from these same institutions she demonizes and still refuses to release the transcripts of her speeches to Wall Street, believes the solution is to complicate the tax code even further.
Forbes has declared that “If there was a prize for the most complex capital gains tax platform, it would assuredly be awarded to Hillary Clinton.” When taken in conjunction with her other tax proposals, they predict dozens of capital gains rates.
Clinton proposes creating six tax brackets for capital gains based on the length of time an asset is held. For top earners, the current 20 percent rate would more than double to 43.4 percent for assets held between one and two years, including a 3.8 percent investment income surtax.
This would be the highest rate in history, and would then stay high. For each year after two, it would only decrease by about 4 percent until it reaches the current long-term capital gains tax rate of 20 percent.
By creating multiple tax brackets, the Center for American Progress and Clinton seem to believe that it will encourage and incentivize investors to take a longer view, discouraging them from seeking short-term gains.
This strategy is mistaken in several respects. To begin with, less than half of the dollar volume of assets sold each year have been held for a year or longer. Additionally, when investors decide to sell an asset, capital gains taxes rank fairly far down on their sizable list of considerations.
The number of affected transactions is reduced further by the fact that, at most, only 40 percent of corporate stock is held by investors subject to capital gains taxes.
The vast majority is held in the portfolios of 401(k) and Individual Retirement Accounts, non-profit endowment funds, foreign investors, and the like, none of which would be impacted by Clinton’s proposal.
Further, a sensible investor would only cash out their stock, subjecting themselves to the resulting capital gains tax, if their investment was dramatically underperforming. If the investment was underperforming, then the cash they freed up could be better utilized in more productive companies.
This withdrawal and reinvestment no doubt further harms the underperforming business. However, keeping a low capital gains tax rate allows shareholders to bring greater gains to the economy through a more efficient distribution of resources.
With her sliding scale, intermediate-term investments of between one and five years become less attractive under Clinton’s plan. Some of this money will be moved into short- and especially long-term investments, but the increased cost could mean less capital in the marketplace as a whole.
Investors would also find it more difficult to rebalance their portfolios for risk as the market fluctuates, or to invest in exciting new ventures that come their way.
Clinton’s demonization of corporate executives and their push to improve quarterly earnings reports may please the liberal wing of the party she hopes to lead.
But “the bottom line,” according to Burman, “is that activist investors are less of a threat than passive ones and even if activist investors were a problem, this proposal is a poorly designed instrument to address it.”
Regards,
Ethan Warrick
Editor
Wealth Authority
