Monday, August 29, 2005

Proposal Three: Patient Capital

Proposal three in Mark Satin’s radical middle agenda is what Satin calls “patient capital.” He writes:

The only other income that wouldn’t be taxed is income on investments held for five years or more. Capitalism can’t work if investors only care about getting rich quick -- biggest single lesson from the Enron, WorldCom, Arthur Andersen, etc., scandals. It’s in everyone’s interest for American businesses to do long-range planning and build wealth over time rather than worry overmuch about short-term shareholder value.

At first glance, this proposal seems less important than some of Satin’s other ideas. But think about the implications. By taxing all income on investments that have been held for less than five years, the patient capital program would punish short-term investing—a major form of modern investing. There would be less incentive for investors (individual and corporate) to “ride the wave” and more incentive to think long-term and add real value to investments.

In many ways, I like this proposal. It in no way prevents individuals or companies from selling investments quickly—it just assesses a tax penalty if they choose to do so. But I wonder how it would affect the common investor who owns mutual funds. Even if we try, most of us do not track exactly which stocks and bonds our mutual funds hold. If our fund manager is moving around investments and that movement nets us a profit, would we be penalized? I’d hope not. I’d hope it’d be enough just to own the mutual fund itself for five years and not each individual investment within the fund.

But that would create a giant loophole where mutual fund managers could continue to buy and sell investments at a quick clip without suffering the tax penalties for doing so. And when it comes to money, once a loophole is opened, creative accountants will exploit it for all it’s worth.

I think, while a solid starting point, Satin’s “patient capital” proposal needs some greater detail so as to protect the interests of the common investor. Perhaps the five-year tax rule only cuts in if the investment is worth above a set amount (say, $30,000). Or perhaps the threshold is graduated to tie the number of years an investment must be held to its total worth (i.e. one year for a small investment and up to five years for the largest investments). Or perhaps, in the case of mutual funds, any tax would have to be absorbed by the broker and not the customer.

There are certainly other solutions. And they should be considered because I think the proposal has a lot of merit.

UPDATE: It should be noted that the “patient capital” proposal only works in a flat-tax or even our current taxation system. A VAT system would not levy taxes on any kind of income. It would promote fiscal responsibility on the purchasing side rather than the income side.


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