Sen. Wyden's ETF Tax Proposal Proves that the Government is Too Big

Sen. Wyden's ETF Tax Proposal Proves that the Government is Too Big
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Senate Finance Committee Chairman Ron Wyden recently proposed a policy that would change the way that exchange-traded funds (ETFs) are taxed. Not only would it not bring in additional revenue but it is also proof that our government is too big. Senator Wyden’s proposal is a band-aid on a band-aid to a policy that was written to address something that shouldn’t have been needed in the first place.

ETFs are great. They are an investment vehicle that large and small investors use to diversify their holdings. They give small investors the ability to invest like big investors, but without the overhead. And, there are ETFs that fit just about anyone’s tastes, risks, political leanings, or moral philosophies. They are diverse, abundant, profitable, and interestingly have some tax advantages that make them even more attractive – or efficient which is the key in this case.

Under the current system of taxation ETFs make sense. They shield investors from paying capital gains taxes on every purchase or sale of holding in an ETF. This doesn’t exempt investors from paying capital gains, but they pay the taxes based on the sale of the ETF, not the buying and selling of the funds underlying the ETF. As Dave Nadig recently wrote:

The reason ETFs are allowed to do this goes back all the way to a 1935 Supreme Court ruling that gave birth to the “General Utilities Doctrine,” which allowed corporations to just hand out securities to any shareholder for any reason with no gains (which was probably over-broad). It was repealed in 1986, but Registered Investment Companies (ETFs, Mutual Funds, CEFs) get a pass from a combination of two other pieces of regulation: Section 311(b) basically says, “you gotta pay taxes when someone hands you appreciated property,” but a different piece of the code, Section 852(b)6, gives RICs a pass on those rules — essentially allowing ETFs to do what ETFs do…

So, the government created regulations, the Supreme Court decided that these were too broad and tried to fix the problems, later other band-aids were added, and finally ETFs were created to fill a demand. Now, Sen. Wyden wants to put yet another band-aid over this “loophole” that isn’t a loophole, in an attempt at best to raise money (it won’t) and at worst to hurt mom and pop investors (it will).

The proposed ETF tax is poised to punish middle-class families. The American people elected Joe Biden on his repeated promise not to increase taxes for anyone making $400,000 or less. However, the median household income of households owning ETFs is $125,000. The tax would break President Biden’s promise while increasing costs on the middle-class families who have come to rely on ETFs for their finances.

If Wyden’s proposal is passed some amount of money will be collected in the tax year – around $20 billion. However, as a fundraiser this is robbing Peter to pay Paul – or a Bernie Madoff-style policy proposal. The way that capital gains taxes work is that at some point these taxes are paid by investors. An ETF, in its current form, delays this tax, but they don’t avoid capital gains.

Therefore, the Wyden proposal is merely another superfluous layer on an overgrown, overburdened, regulatory system. More band-aids aren’t the solution. The rationale that created the current system is that corporations needed to be taxed and that corporations owe us something. The problem in this thinking and this approach is that corporations are dynamic and profit-seeking. For instance, corporate taxes fall almost directly on labor. That means that a lower corporate tax rate would be better for labor.

We need a simpler system, something closer to what Norman Ture proposed in the inflow-outflow tax. We need a system where the government provides guideposts, but doesn’t get involved with the everyday actions. Taxes are okay – an efficient tax system is good. Harming a good investment product to grab future money today in the form of a band-aid is not a good solution, an efficient solution, or a helpful policy.

Senator Wyden has been a great senator. He has had a lot of proposals over the years that have been good. He has worked across the aisle when others haven’t. This proposal just isn’t one of his best, and hopefully he realizes that and works in a different direction. He should look toward solutions that create an incentive for investment. A policy that encourages wealth creation, saving, and building our economy – not quick gimmicks. 

Charles Sauer is an economist and president of the Market Institute.



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