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Policymaking By Focus Group

Hillary Clinton, smiling, in front of white boxes labeled 'Capital Brand' with a green logo
photo courtesy iprimages

Google stock closed at an all-time high of $672.93 on Friday.

Unsurprisingly, as shares shot up over 16 percent, the company’s stock trading volume was about seven times normal, according to CNBC. More than 11 million shares changed hands as Google set a new Wall Street record.

Of the millions of shares that changed hands, do you think Google’s management knew - or cared - how long shareholders had held each of those individual stocks before selling?

Of course not. It makes no difference to a public company if a seller held a share for one week, one year or three years.

But it makes a big difference to the seller. If I sell a share of Google after a week, I will pay tax on any gains at ordinary income tax rates. After holding it for at least a year, I will pay the lower but still significant long-term capital gains tax rate on the sale.

That lower tax rate is partial compensation for what is otherwise a pretty bad deal for the investor: At ordinary tax rates, federal and state governments could take around half your profit via income taxes, but you bear nearly all the risk, since only $3,000 of annual losses can be deducted from ordinary taxable income. The one-year holding period is a crude attempt to separate out hedge funds and day traders, who make their living (or at least try) by capitalizing on short-term market moves, from long-term investors who put their savings to work in our capital markets.

That $3,000 figure, by the way, is not indexed for inflation, and hasn’t changed for over three decades. When congressional Democrats and the party’s presidential hopefuls suggest indexing federal rules like the minimum wage for inflation, they somehow never include capital loss deductibility in the list. According to Forbes, if the amount had kept up with inflation since it was last updated in 1978, it would be $10,700 today.

There is a pretty good case to be made that capital gains should be taxed like ordinary income if - though it is a huge and politically improbable if - you allow capital losses to be deducted against ordinary income to a much greater extent than is now the case. There is also a good case to be made that otherwise, capital gains rates are already too high, since they discourage investors from making moves to diversify their portfolios after a big run-up in stocks of companies like, say, Google or Apple.

There is no sensible case for the proposition that investors should have to wait even longer to qualify for the reduced rate on long-term gains. Yet The Wall Street Journal reported on Monday that Hillary Clinton will lay out a proposal to do exactly that. While the precise details are forthcoming, Candidate Clinton’s plan would reportedly be built on a sliding scale with at least three new capital gains rates depending on the length of time an investor holds an asset. For assets held in the neighborhood of two or three years, the current capital gains rate (which tops out at 23.8 percent) would rise, or possibly even vanish outright, leaving such investments to be taxed at the same ordinary income tax rates as investments held for a week or two.

So let me correct my earlier statement that there is no sensible case for this plan. There is no sensible economic case for this harebrained idea. But in the world of Democratic primary politics, there is evidently a political case that makes sense, at least one that makes sense to Team Clinton.

The rhetorical goalpost is what Clinton calls “quarterly capitalism,” or a business strategy that focuses on the next earnings report at the expense of long-term strategy. The theory goes that companies cater to shareholders by focusing on share buybacks and dividends at the expense of long-term strategic investments in facilities or people. Shareholders quickly sell out, and the company is left with a harmful perpetual focus on the present. By forcing shareholders to take the long view in order to evade tax penalties, the government will allow publicly traded companies to maintain a long-term focus.

Google, in other words, achieved last week’s peak via short-term management strategy that made it an overnight success. An overnight success that took a couple of decades to achieve.

Why would Clinton, as a presidential candidate, espouse a change in tax laws citing patent economic nonsense as her motivation? Two reasons.

First, this change is a tax increase that targets mainly people who have capital to invest. Clinton and her party are almost always in favor of taxing such people more heavily, whatever the stated reason.

Second, despite the proposition’s being economic gibberish in practice, it almost certainly tested well in focus groups of Democratic primary voters, who Clinton is trying to draw away from candidates further to her left, such as Bernie Sanders and Martin O’Malley. All three candidates recently appeared in Cedar Rapids, Iowa, where Clinton’s strategy seemed to be to ignore her primary opponents and focus on the general election to follow. Clinton, however, learned from her sorry 2008 experience that it is a mistake to ignore her party’s base - the ones who vote in primaries - outright.

Clinton’s proposal will do nothing for the small business sector of the economy that consists of enterprises that aren’t publicly traded and have no prospect of ever going public. And it will prove actively harmful to high-growth startups that do hope to go public, by reducing the demand for shares when investors realize that they are not only taking a long-shot risk on the fledging company, but face punitive tax rates on any gains they do manage to accrue unless they hold their shares for at least a few years - during which any number of bad things can happen to a newly public company. The proposal would make such investments a “lose-lose-even-worse” proposition.

The things that would actually help businesses get started, grow and prosper do not tend to test well with Democratic primary focus groups, however. So we’re not likely to hear them as suggestions from Clinton, or her primary opponents, any time soon.

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