The second in a series of posts to answer questions I’m tired of explaining over and over again. See Flattened Taxpayers for the first.
Let’s start by clearing up a misimpression that people seem to have.
Buying and selling stocks is not investment income
Buying stock is not “investing in a company”, it is gambling on reselling some collectable you bought based on your assumption that the stock or Limited Edition Star Trek V Collector’s Plate is going to fetch more in the collectors market than it did when you bought it.
Actually investing in a company would require that the money you paid went to the company. Aside from when you buy into a public offering of new stock, your money did not go to the company, it went to another collector. It does nothing to help the company fund their start-up costs to produce a new product for the actual marketplace. And even in the case of a public offering you don’t help the company when you cash out that investment. You bought, say, 0.1% of that company and that was the only time you helped them bring something new to the market. If you purely sold that 0.1% of the company for 1/1000th of the actual value of the company at the time you sold it, then your income would be “investment” and your profits would be actual investment income tied to the increase in the actual value of the company you risked money on.
No purchase and sale of stock is investment. By the time the company is ready to float an Initial Public Offering they’re cashing out on the investment by selling off the company’s assets. Any purchase and sale of stock after the IPO is just gambling income and does not contribute to the free marketplace that Capitalism revolves around.
Neither is most venture capital
That said, now lets talk about actual investment income. If you are an “angel investor” or “venture capitalist” (which is really another name for unregulated banking with no guarantee on either your return nor their costs) then your income from that risk is the increase in valuation of the company’s actual assets over the time you were a partial owner. Any income you get beyond that isn’t investment and in no case does your selling your share benefit the company’s ability to bring products to market – they get no benefit from your profit so stop thinking that you’re risking your money to help get a startup going when you cash out.
Adam Smith, Capitalism and “Investment Income”
One of Adam Smith’s premises in The Wealth of Nations – the book that defined Capitalism back in 1776 – is that the greatest harm to a Capitalist market based economy was the creation of instruments that brought in income without producing valuable items that could be traded in the marketplace. He called these instruments “rents”.
These practices produced income sources for an essentially parasitic class that could use their wealth to create ongoing revenue for themselves with no risk and no contribution to society nor the marketplace. It’s important to remember that despite what the GOP or some Randian tells you, Adam Smith was an Enlightenment radical who created Capitalism to flatten society to a level competitive playing field. He was doing so at a time and place where most wealth was held by the landed houses of England who did nothing but being born into the right family to achieve wealth far beyond even the worst robber barons the US ever produced – families with trillion dollar plus family assets in current dollars.
Smith’s central premise was that society did best when ideas and products competed equally and the wealth created through the market was by production and sale of competitively better goods at a better value as determined by consumers.
What we call “investment income” does none of this. It is a Smith “rent” scheme. It is wealth distributed not by the competitive value of new inventions and improved products but by passing valueless paper around from one wealthy family to another. This is neither Capitalism nor good for a Capitalist economy. Smith himself said that as this is something that damages the efficiency and fairness of the market it is the job of the government to regulate it into harmlessness and to re-level the playing field so actual competition can continue.
As an aside and a reward for reading this far, the next time some “get the government out of the free market” idiot blathers on, you can now safely assume he doesn’t know what Capitalism actually is.
Now, let’s look at some “investor” assertions I’ve actually gotten in my discussions…
I earned the money I spend on stock from a job.
That’s really irrelevant. If I say “I used the money I made by selling food to starving orphans at minimal costs to buy equipment to torture kittens” do we really care how you got the money to torture kittens? No. No matter how you got the money it’s the issue of whether we as a society should subsidize what you choose to do with it.
I take risks
Should taxpayers subsidize your losses in your hobby of buying and selling collectables? We currently do. Investment loss is deductible and when we do that we’re precisely taking tax dollars from other people to cut your risks. I’d argue that we should not do this at all but that isn’t the question at hand.
I should be able to cash in on my gains
And I think so, too. In the case of long-term investment I suggest taxing your “cashing in” collectable sales profits at the same rate as income you gained by actually producing something of value to the market. That’s probably too generous but I’m trying to be reasonable during the transition period of moving toward actual Capitalism.
I also suggest that we tax short term gains at a 50% rate. Yes, it really should be higher as its meant to discourage if not eliminate a dangerous hobby. There are several damaging aspects of short-term investment that need to be addressed but lets focus on the worst of those. Short term profit taking discourages businesses from actually producing goods and services for the market and ends up replacing the productive free market with optimization for short-term shareholder return.
As a compromise, how about we say “if you want to claim short-term stock gain as regular income you are prohibited from voting your shares directly or via proxy, are prohibited from participating in any shareholder litigation and are barred from any interaction with the company you partly own during your period of ownership for a period of two years prior to your intended or actual sale. Any of these activities triggers marking the “investment” as stock manipulation and requires your shares to be sold at the price you paid for them or the current market value, whichever is lower and any income you received above that amount to be added to your tax bill.
The increase in stock price funds innovation
Some people will say that the increase in stock price in the speculation market continues to fund the company since that company gains as the shares they own increase in value. That anyone thinks that way shows that we have let the tail wag the dog. The purpose of the company in actual Capitalism is to produce a product for sale in the competitive marketplace. When their income is now tied to the immediate stock price rather than the value of their products in that marketplace they no longer are participating in the market and are now just speculators themselves and no longer focused on producing goods and services to stimulate the market based economy.
Summarizing, I fully support actual investment as measured by the purchase of a share of a company and the gain in wealth of the value of that share of the company itself. That is investment income. It is unsubsidized risk being rewarded by the marketplace. Speculating on buying and reselling collectables that do not directly fund the value of the company is both harmful to the company and to the economy and should be discouraged by any Capitalist government as part of their role to keep Adam Smith’s playing field level.