“We need an economy where companies plan for the long run and invest in their workers through increased wages and better training—leading to higher productivity, better service, and larger profits. Hillary will revamp the capital gains tax to reward farsighted investments that create jobs. She’ll address the rising influence of the kinds of so-called “activist” shareholders that focus on short-term profits at the expense of long-term growth, and she’ll reform executive compensation to better align the interests of executives with long-term value.” [Clinton]
I could happily live with this. She had me at “… where companies plan for the long run.” Let me start here, and then move forward into a familiar topic on this digital soap box. I, too, have had enough of “quarterly capitalism,” and it is high time someone offered a cogent proposal to deal with the specter.
First, no one should try to argue that all short term equity and bond purchases are necessarily bad – there are some valid reasons for such trading. However, as in most other things in life it is possible to have too much “of a good thing.” Let’s face it, high frequency traders aren’t investors – they’re traders, and shouldn’t be confused with those who are putting capital into the distribution system. Too much short term investing (trading) in the mix and we’re asking for problems, three of which from the investment side are summarized by PragCap:
- A short-term view tends to result in account churning, higher fees, higher taxes and lower real, real returns.
- A short-term view often results in reacting to events AFTER the fact rather than knowing that a well diversified portfolio is always going to experience some positions that perform poorly in the short-term.
- Short-term views are generally consistent with attempts to “beat the market” which is a goal that most people have no business trying to achieve when they allocate their savings.
If short term investing isn’t good on the investor’s side of the ledger, it’s not good on the corporate side either. Generation Investment Management (UK) issued a report in 2012 on “Sustainable Capitalism,” [pdf] that emphasizes this point:
“The dominance of short-termism in the market, often facilitated and exacerbated by algorithmic trading, is correlated with stock price volatility, fosters general market instability as opposed to useful liquidity and undermines the efforts of executives seeking long-term value creation. Companies can take a proactive stance against this growing trend of short-termism by attracting long-term investors with patient capital through the issuance of loyalty-driven securities. Loyalty-driven securities offer investors financial rewards for holding a company’s shares for a certain number of years. This practice encourages long-term investment horizons among investors and facilitates stability in financial markets, therefore playing an important role in mainstreaming Sustainable Capitalism.”
Or, put more succinctly, short-term vision creates market volatility (big peaks and drops) which makes our stock markets more unstable, and undermines executives who are trying to create companies with staying power. Instability and volatility improve the prospects for traders but not for investors, and not for the corporations and their management.
If we agree that “quarterly capitalism,” or “short-termism” isn’t a good foundational concept for our economy – from either the investors’ or the company’s perspective, then what tools are available to make long term investing more attractive, and to help corporations seeking “patient capital?”
One tool in the box is the Capital Gains Tax. If only about 14% of Americans have individual investments in “The Market” [cnbc] why should anyone give one small rodent’s rear end about the Capital Gains Tax structure?
Because: The present capital gains tax structure rewards investment transaction income more than on earned income. If we are going to allow this lop-sided approach, then there has to be some economic benefit in it for everyone? The current system:
“Capital gains and losses are classified as long term if the asset was held for more than one year, and short term if held for a year or less. Taxpayers in the 10 and 15 percent tax brackets pay no tax on long-term gains on most assets; taxpayers in the 25-, 28-, 33-, or 35- percent income tax brackets face a 15 percent rate on long-term capital gains. For those in the top 39.6 percent bracket for ordinary income, the rate is 20 percent.” [TPC]
Thus, if one’s income is “earned” by trading assets then the tax rate is 20% at the top of the income scale, but if the income is earned the old fashioned way – working for it – the rate could be 39.6%. This is supposed to incentivize investment. But note the definition of a “long term asset,” as one held for more than 12 months… that’s right: 12 months.
Contrast that definition of a long term investment with the Clinton proposal:
Notice that in Secretary Clinton’s structure the combined rate on capital gains moves from 47.4% for those “short term” investments, down to 27.8% if the investor holds the assets for more than six years. Five and six years fits my definition of “long term” much better than a “little over 12 months.”
Thus we have an incentive for longer term investments, which means less instability and less volatility. This seems a much better plan to practice “Sustainable Capitalism.”
But, what of the executive compensation packages that are tied to short term stock prices? Yes. That’s a problem. [NYT] And yes, President Bill Clinton’s attempt to rein in executive pay back-fired. However, Secretary Clinton has proposed legislation to provide shareholders a vote on executive compensation, especially on benefit packages for executives when companies merge or are bought out. Her proposal would have created a three year “claw back” period during which the SEC could require CEOs and CFOs to repay bonuses, profits, or other compensation if they were found to have overseen – or been intentionally involved in misconduct or illicit activity. Granted that doesn’t cover the entire landscape of corporate misadventure, but this could be combined with the following excellent suggestion for amending the tax code:
“Instead, Section 162(m) could be rewritten to allow a deduction for compensation paid to any employee in excess of $1 million only if the compensation is paid in cash, deferred for at least five years and unsecured (meaning that if the company goes bankrupt, the executive would not have a priority over other creditors). This approach would encourage corporate executives to act more like long-term bondholders and obsess less about short-term stock price movements.” [NYT]
Every bit of “encouragement” might help. I’d be very happy to see CEOs thinking like long term bond holders (if long term means more than 13 months) and less like the traders/gamblers in the Wall Street Casino.