Lots of bad potential legal proposals this week. Let’s think about thinking about this stuff.
1) Let’s tax buybacks! Here’s a proposal to tax stock buybacks. There has been a never ending chorus about the evils of stock buybacks over the years. I’ll let you read some of my past work (here and here) if you want to know why most of that is wrong.
This specific proposal would tax buybacks by 2% at the corporate level. The basic thinking here seems to be that buybacks are somehow a free lunch that returns capital to shareholders thereby allowing them to avoid taxes. But that’s simply not true. A buyback necessarily involves a seller of stock and that seller of stock will often have a capital gain. That’s one of the nice things about buybacks. Unlike dividends, which impose a tax on shareholders, the buyback puts the tax control into the hands of the shareholder. It doesn’t avoid taxes. It just allows the shareholder to decide whether they want to incur the capital gains tax in the first place by selling their shares back to the company. So this new proposal just adds a tax on top of a situation that already includes a capital gains tax. And let’s not forget that corporations don’t really pay taxes in the first place. Those taxes really get paid by shareholders, workers and consumers in the end. So this is just another bad corporate tax that will fall on consumers at the end of the day.
Anyhow, there’s a much longer and better explanation at the Tax Foundation so go have a read.
2) Let’s tax ETFs! Part of the same Democratic tax proposal includes the elimination of the in-kind tax treatment of ETFs. One of the reasons ETFs are more tax efficient than mutual funds is because they can (again) allow the shareholder to control taxes rather than having taxes imposed on them. For instance, one of the worst parts about mutual funds is that you could buy a mutual fund one year, incur no actual gains and still get a capital gain distribution at the end of the year because a bunch of other shareholders have gains that the fund has to distribute. That’s crazy inefficient and frankly wrong. And it’s a big part of why so many mutual funds are converting to the ETF structure. As I’ve said before, the mutual fund structure is a dinosaur product with antiquated operations based on inefficient technologies. Any proposal that puts them on par with ETFs is a step backwards, not forward.
More importantly, ETFs don’t evade taxes. They might allow you to defer some taxes, but you don’t evade taxes with an ETF. But one thing you are able to avoid with ETFs is the inefficient capital gains distributions that are often no fault of your own or not even yours to begin with, because of the antiquated way in which mutual funds are structured. This proposal doesn’t fix a problem. It validates the mutual fund structure which is an inherently inefficient tax structure and will result in tax increases for millions of Americans for no good reason other than what appears to be a misunderstanding by legislators.
Dave Nadig had a great piece on just how silly this idea is. Go have a read.
3) “Tax the rich” because taxes don’t fund spending! Joe Weisenthal wrote a piece for his very excellent newsletter talking about AOCs Met Gala dress which said “tax the rich”. He emphasized the MMT idea that taxes don’t fund spending so we should all remember that we don’t need rich people’s money to run the government. Now, I am a huge Joe Weisenthal fan. But I also think Joe gives MMT a little more leash than they deserve. I think they’re guilty of rhetorical overreach here. Let me explain.
One thing MMT people hate is how Conservatives like to say that we need to “pay for” all government spending with taxes. It implies that the government is somehow always being irresponsible if it doesn’t balance its budget or worse, pay back the debt. MMT people are right about this. These are mostly nonsense narratives. The government not only cannot and will not ever pay back the national debt. But it also makes sense to run big budget deficits often (especially during big downturns, in fact, those deficits will automatically develop due to automatic stabilizing polices and collapses in tax receipts). At a broader level the balance sheet of the entire economy needs to always expand to support the demand for new growth. We don’t actually pay back the assets and liabilities at the aggregate level. This is true for the entire household sector, corporate sector and government sector. Aggregate household debt will always grow. The assets grow, the liabilities grow and so too does the net wealth. This is a good thing so long as it doesn’t cause financial instability. It’s fair to say that the debt has grown too much or too fast, but that’s a different debate really about financial stability.
As I’ve explained before, MMT people take this one too far in the other direction. Instead of saying we need to “pay for” spending with taxes. MMT people like to say that taxes don’t actually pay for anything. Taxes “destroy” money in the MMT world.¹ And government spending creates money. This creates the illusion that the government does not fund itself from the private sector. Except this cannot be true either. For instance, when I built my house I created hundreds of thousands of dollars of net wealth when it was reassessed in value. If I took out a HELOC to fund some other spending it is specifically because my creation of net new capital gave me more funding. The same exact thing happens at the government level when the private sector creates net wealth. This new net wealth gives the government funding capacity that it would not have otherwise had. As MMT people like to say, “resources constrain government spending”. What they conveniently leave out is that creating more resources also expands the government’s potential funding capacity. And the way they fund that spending is, in part, by taxing some of that net wealth and moving it to public domain for redistribution.
Of course, the government doesn’t have to tax dollar for dollar to spend. It can just print money. But when it taxes it is drawing on the net wealth of the private sector thereby allowing it to spend without having to print money. In the counterfactual world without all that private net wealth, the government just prints money that is not resource supported and you get super high inflation because the government doesn’t actually have the underlying capital to fund their spending.
The bottom line is, taxes absolutely fund spending. And the government also doesn’t need to “pay for” every dollar spent with taxes. It’s not an either or thing so both sides have this one wrong and it’s misleading to promote erroneous narratives in the pursuit of getting political support.
¹ They construct this narrative by consolidating the Fed into the Treasury and then arguing that taxes result in the government obtaining its own liability. Which is a crazy misleading way to present the interbank system since it is, by definition, an intermediary system in the process of transferring reserves. It’s literally called the INTERBANK system because it’s just an intermediary. But in the MMT world they construct it to look like this is the origin point of all money and also the point where all money is destroyed. It’s wildly misleading when you understand that the flows of most funds in the economy starts in the non-government sector and simply flows through the interbank system when it’s redistributed.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.