The GrayMan Writes About Taxes: Investment Vs. Speculation

With respect to capital gains from sales of stock and other assets, Form 1040 Schedule D instructs us to divide them into short-term and long-term gains, with long-term referring to investments held for one year or more. But is a year really “long term”? Thinking of a single year as long term is part of the problem we have with rewarding speculation over investment.

It was, after all, speculation in derivatives and risky mortgages that contributed to the housing bubble and its subsequent burst. (Call it “investment” if you like, but I disagree: investment connotes long-term, and the way these strange instruments were traded and manipulated and traded again never sounded like a long-term strategy.) The speculation filtered down to home buyers, many of whom did not buy a home in which they planned to live for years but instead bought one which they hoped to sell quickly as soon as rising home prices inflated their equity. Many people made a lot of money this way;* unfortunately, many more seem to have lost much more.

How do we encourage investment — real long-term investment — instead of speculation?

I propose that we structure the capital gains portion of the tax code to reward investment. Simply, the longer you hold a stock, shares of a mutual fund, or other investment vehicle, the less tax you would have to pay on any capital gains from the sale. The “investment tax” would be a “regressive” tax in which the actual tax rate would fall with the passage of time, down to whatever is considered a nominal rate.

The main benefit I see from this would be more stability in the stock market and more investment capital available for use as the basis of creating more wealth. The opportunity for speculation and making a quick killing on a stock deal would still exist, but the cost would be higher than if the stock were held longer. The different rates, the appropriate time scale, and the final nominal rate would all be determined based on what is expected to contribute most to economic stability and sound currency.

The same inversely-proportional tax rate could apply to dividends paid by the investment vehicle, with the exception that dividends automatically reinvested should not be taxed; only dividends paid when part of the investment is redeemed. (The key here is “automatically” — no cheating by taking the dividend and then investing it in something else.)

As an added bonus, we could allow for the ultimate “grandfather” clause by stipulating that investors over 70 years of age would not be taxed at all on dividends or capital gains received.

I suspect this idea would affect the venture capital business as well, but the tax level on short-term gains should still be reasonable enough to encourage investing in start-ups and expanding businesses. The idea is not to eliminate short-term investment or even speculation, but to encourage more long-term investment.

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While we’re on the subject of taxes, we’re a month away from the “Raleigh Tax Day Tea Party.” It’s part of the grassroots “Tea Parties” held in cities across the country against the stimulus package, which will stimulate less than its proponents think and saddle our citizens and our descendents with even more unreasonable amounts of debt.

Here’s a little about the national movement. The Raleigh event will be Wednesday, April 15th (of course), from 6:30 – 8:30 p.m. at the North Carolina State Capitol.

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*Sour grapes alert: We had the chance to do just that, and did not take it. Who knew we were going to be stationed in Northern Virginia for five years, when we expected to be there for two? Timing, as they say, is everything.

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