Tuesday, June 10, 2008

Capital Gains Shenanigans

While I attempt to be unbiased in my political and philosophical commentary, I find a glaring inconsistency that necessitates elucidation. Barack Obama notes that investors such as Warren Buffet are aligned with his proposals to raise the capital gains to at least 20%. In a recent Bloomberg News article, Obama is quoted as saying that Warren Buffet and other investors have indicated that capital gains tax rates of 20% “will probably not have any significant impact in terms of investment.”

In fact, this may very well be the case as Jesse Drucker (WSJ, page A1, “IRS Targets Billionaire's Lucrative Tax Strategy”, June 9, 2008) exposed a popular tax scheme used by wealthy individuals to effectively sell their shares but postpone capital gains taxes. This scheme involves “lending” the shares to a major investment bank in exchange for cash and an agreement turn over ownership of the shares at some point in the future, effectively postponing tax liabilities for often more than a decade. The middle class investor, obviously, does not have the same access to such tax avoidance schemes.

Perhaps it is time for politicians of all political stripes to realize that targeted tax cuts, special interest tax credits, and punitive tax rates on capital distort market behavior and lead to unintended consequences. By progressing towards a flatter and simpler tax system, inefficiencies will be reduced and markets will behave more efficiently. Then again, such an environment would leave politician impotent in the field of political favors and kickbacks that dominate Washington so don’t hold your breath.