The bewildering inconsistency of Clinton’s capital gains tax plan
Worrying about short-termism, or the tendency of investors and managers to put short term profits ahead of sustainable, long-term growth, is almost as old as capitalism itself.
Way back in 1890, economist Alfred Marshall described humans as often acting like, “children who pick the plums out of their pudding to eat them at once.” And since the economic recovery began back in 2009, the behavior of managers and investors of large, publicly traded companies has looked more like impatient children than empire-building titans of industry.
The short-termism of today can be seen in the tendency for managers and investors to seek higher dividends and more stock buybacks at the expense of capital investment or research and development spending. The total volume of share buybacks has climbed every year since the recession, nearly reaching pre-crisis highs, while the current economic recovery has been marked by a lack of corporate investment, which has seriously crimped economic growth.
One theory as to why this is happening is explained by the rise of activist investors and a culture of short-term investing. In a policy proposal that presidential candidate Hillary Clinton will lay out in a speech later this week, the former Secretary of State will propose to change the capital gains tax code in order to combat short-termism. Here’s the Wall Street Journal explaining the forthcoming proposal:
Investments held for less than a year would continue to be taxed at regular income-tax rates, which can top out at 39.6% or more for the highest earners. For those held just a little longer—likely two or three years—the current capital-gains tax rate of 23.8% for top earners would rise. The Clinton rate, which hasn’t been finalized, would be higher than the 28% President Barack Obama proposed earlier this year for the highest earners. The Clinton campaign hasn’t ruled out taxing such investments at the regular income-tax rate.
The idea is that if investors are penalized for being short-term holders of shares in a company, they’ll be more inclined to invest for longer-term horizons. And if short-term investors are to become long-term investors, they’ll be more inclined to back managerial decisions that place long-term growth over short-term profitability.
Unfortunately for Clinton, her proposal wouldn’t just be ineffective. It’s logic will undermine the types of reforms she will likely push for if she does win the presidency next fall. As Tim Worstoll points out in Forbes, the problem of short termism is actually more acute in the United States, where tax laws do already encourage investors to hold shares for a longer period of time than they do in the United Kingdom. There is no holding minimum in U.K. tax law, but investors there, on average, hold their investments for 15 days longer than they do in the United States. As he writes, “If very different tax laws produce the same outcome then it’s probably not the tax law influencing the outcome, is it?”
But more important for Clinton is the precedent she sets by arguing that capital gains taxes are so influential in changing investor behavior. There is a healthy debate in the economics community over how important capital gains tax rates are for economic growth. The right has often argued that capital gains taxes should be eliminated in order to encourage the sort of investment that has been sorely lacking since the end of the recession.
The left has in turn argued that it is unfair for investors’ income to be taxed at a lower rate than your average worker. Billionaire investor Warren Buffett has been the most articulate defender of this idea, writing that when he was managing funds for investors between 1956 and 1969, when tax rates on investments changed many times, “Never did anyone mention taxes as a reason to forgo an investment opportunity that I offered.”
Clinton is, therefore, attaching herself to an issue, short termism, that likely can’t be changed by tax policy. At the same time, there’s plenty of evidence that short-termism isn’t really a problem at all. Take a look at Silicon Valley, for instance. At the same time that folks on the east coast are complaining of investors too focused on short-term profits, people on the west coast are worrying about a “unicorn bubble,” in which investors are supposedly gullibly handing over their money to unprofitable companies at unrealistic valuations that can only be met with heavy investment in the future.
This is not to say that the dearth of corporate investments the U.S. economy is experiencing isn’t a problem. The numbers don’t lie. But the assumption that fiddling with the tax code a bit will all of a sudden lead to a boom in investment and long-term thinking is, at best, a distraction. Moreover, as if Secretary Clinton hopes to win the the presidency, she’s going to have to do it by defending the notion that higher taxes on the rich aren’t going to affect the behavior of the so-called job creators in a material way.