The proposal for a graduated capital gains tax may lead investors to hold stock for somewhat longer periods of time, but it is difficult to envision major changes in corporate behavior as a result.
The long period of income stagnation facing middle class and working class families has created a substantial demand for progressive economic policies. In response, former Secretary of State Hillary Clinton has repeatedly indicated that middle class living standards would play a central role in her campaign for the Democratic presidential nomination.
Last week, in a major speech she laid out an argument for more long-term investment and urging companies to focus on developing the skills of their workers. The major item that Secretary Clinton put forward in a previous talk was tax incentives for workplace training and profit sharing. While these are admirable goals, it is not clear whether the specific proposals she put forward are likely to push the economy in this direction.
In her most recent talk she proposed graduating the capital gains tax rate. Under this proposal people would have to hold stock and other assets for a longer period of time to get the full benefit of the capital gains tax rate. Currently taxpayers only need to hold stock for a year to pay the 20 percent top capital gains tax rate, rather than the 40 percent income tax rate for high earners. Clinton is proposing that they would have to hold stock for four years before getting the 20 percent rate.
Taking these in turn, we have a long history of creating tax breaks to promote various types of corporate or individual behavior. Few work as planned. In fact, one of the few areas in which there tends to be bipartisan agreement in Washington is that there are far too many tax breaks in the tax code already. Nearly all proposals for both corporate and individual tax reform start from the premise that it would be desirable to have a simpler tax code with lower tax rates. So Clinton’s proposal would be a clear step in the opposite direction.
Since there is no specific proposal at this point it is difficult to know what potential problems it poses. However, it is worth noting the abuses associated with a similar proposal from when President Carter was in office in the 1970s. Carter pushed through legislation to promote employee stock ownership plans (ESOP) as a way to give workers a stake in the companies for which they work. The proposal provided a tax break for companies that established ESOPs.
This tax break continues to the present, but if the goal was to give workers any sort of real voice in their companies, it has failed badly. ESOPs are largely seen by management as one more way to maximize profit.
In one recent case, Sam Zell, a real estate billionaire, put the money from workers’ pensions in an ESOP to help him finance the takeover of the Tribune Company, one of the country’s largest media companies. The deal eventually collapsed in a bankruptcy, with the pension taking serious losses. It’s unlikely that many Tribune workers felt much ownership in this deal. Perhaps Clinton’s plan will prevent the sort of abuses that surround ESOPs, but skepticism is certainly warranted.
The proposal for a graduated capital gains tax may lead investors to hold stock for somewhat longer periods of time, but it is difficult to envision major changes in corporate behavior as a result. The most frequent traders would not be affected at all, since they already hold stock for much less than a year. Furthermore, it is not clear that the duration of stock ownership will have much effect on corporate behavior.
There are far more direct routes to achieving Secretary Clinton’s stated goals. If the point is to make companies more interested in keeping their workers and improving their skills, the obvious mechanism to achieve the goal is to require some sort of severance payment for long-term workers. The United States is the only wealthy country that allows companies to lay off employees without cause and without any sort of compensation. While some countries have arguably gone too far in making it difficult to lay off workers, certainly it is possible to have modest severance payment when long-term employees lose their jobs without bringing the economy to a halt.
Similarly, if the goal is to eliminate the rapid churning of stock, then the proposal for a financial transaction tax put forward by Clinton’s leading rival for the Democratic nomination, Senator Bernie Sanders, would seem the best way to go. This would directly raise the cost of short-term holdings in a way that is virtually guaranteed to substantially increase the average length of stock ownership. It would also reduce the amount of economic waste in the financial sector by eliminating tens of billions of dollars of short-term stock trades.
It is still early in the campaign and we need many more specifics, but Secretary Clinton’s proposals to date do not appear to be an effective way to advance her stated agenda. Most of the candidates from both parties are pledging to help the middle class. Presumably the winner will be the person who does the best sales job in this area. Hopefully, the sales pitch will be grounded in economic reality.
(Center for Economic and Policy Research - CEPR - August, 2015)