US Congress Looks for New Ways to Tax Financial Services

May 4, 2010

During a congressional hearing, lawmakers searched for ways to use the tax code to dampen short-term speculation in the financial markets and close the budget deficit. To fix the problem, they suggested changes in tax structures, including discounted capital gains tax for long-term investors, transaction tax, bank tax, and financial speculation tax, Thomson Reuters WG&L Accounting & Compliance Alert reports.

Congress is nearing the final stages of its work on a bill to reregulate Wall Street, but that doesn’t mean it’s finished with the financial sector.
Sen. Sherrod Brown (D-OH) said he wants to find ways to use taxes to erase the short-term, speculative mindset so common to big traders, which he blamed for contributing to the financial crisis.
“We can see the effects of short-termism,” said Brown during an April 29, 2010, hearing of the Senate Banking Subcommittee on Economic Policy. “Just look at the oversupply of toxic assets that clogged our credit markets.”
Short-termism entails decision making to meet some benchmark today without regard for the needs of, or the costs imposed on, the future, Brown said.
“Most often, the metrics employed are the narrowest of financial measures, like short-term changes in return on equity and share price, which fail to capture the more complex impacts of business and investment as they play out over a longer term,” said Judith Samuelson, executive director of Aspen Institute business and society program.
One cause of short-termism is the “federal securities laws, which encourage Wall Street’s earnings fixation,” said J.W. Verret, assistant professor of law at George Mason University. “This is an example of the unintended consequences of regulation, as the quarterly reporting requirements of the securities laws actually make the problem worse. Analysts predict quarterly earnings, and companies feel pressure to meet those predictions.”
Indeed, according to a McKinsey study, the number of firms offering the market short-term or quarterly forecasts grew from a handful, 92 in 1994 to over 1,200 by the time of the Enron implosion in 2001.
From 2004 to 2007, a George Washington Law School study found that 270 of the 500 in the Standard & Poor’s large cap index spent more money on stock buybacks than on productive investments. The immediate effect was a boost in the share price, but many academics criticize buybacks for diverting funds from long-term capital investments.
Damon Silvers, director of policy and special counsel of the AFL-CIO, said that the 10-year rate of return on U.S. equity markets is negative in nominal terms as a result of short-termism.
“For our economy—we have seen a period of jobless growth during the real estate bubble be replaced by a period of disastrous job loss,” Silvers said. “In the last 10 years, we have lost over 5 million manufacturing jobs. Workers’ incomes were stagnant in real terms before the bubble burst, and now they have declined much further. Our capital markets have simply failed to invest in the key long term needs of our society—as evidenced by our $2 trillion infrastructure deficit.”
In the 1980s, manufacturing made up 25% of U.S. gross domestic product GDP and financial services made up 11-12%, according to some of the data presented during the hearing. By 2004, manufacturing accounted for only 12% of U.S. economy while financial services were 21%.
To fix the problem, the Aspen Institute recommended several structural changes to give incentives to long-term investors, including imposing an excise tax on trading; capital gains discounts for great holding periods of stock; removing deduction limitations on long-term capital losses; and enhancing shareholder rights for shareholders who meet certain minimum holding period requirements.
Silvers said that the AFL-CIO supports President Obama’s bank tax, which would lessen the effects of short-termism.
The organization also wants Congress to consider either changes in capital gains taxes or an excise tax to discourage short-term speculation—a financial speculation tax.
“A financial speculation tax is the very simple idea of assessing a very small tax on all financial market transactions—stocks, bonds, commodities, derivatives, futures, and options,” Silvers said.
Sen. Tom Harkin (D-IA) and Rep. Peter DeFazio (D-OR) have sponsored bills proposing a 0.25% tax on securities trading with an exemption for retirement plans.
The Congressional Budget Office estimates the Harkin-DeFazio proposal would generate more than $100 billion a year in revenue.

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