By Kathleen Gallagher
This is not about a Twitter moment between Rep. Alexandria Ocasio-Cortez and Senator Ted Cruz. Or the winners and losers when GameStop, Koss, Tootsie Roll, and other stocks took their wild ride at the Wall Street Carnival.
This is about the majority of Americans who are losing while Wall Street gets on with our economy and our future. And it’s about Congress promoting financial inequality.
The Federal Reserve has flooded our economy with money, driving up profits on the stock market and Wall Street. That opened the door to a wild party where crazy things happen, like a dramatic surge in inventory at GameStop, a dying retailer that sells products in a dying format called video.
Heartland Funds’ Bill Nasgovitz put it in a recent comment: “… a champagne market that’s dizzying, expensive, blistered and destined to lead to a painful hangover.”
“The Fed’s instruments have a lot more impact on the financial sector,” said Willie Delwiche, investment strategist at All Star Charts, an investment research service. “But it is Congress that can influence the real economy.”
The ability of Congress to do this starts with taxes. A basic tax principle is that you get less of what you tax and more of what you subsidize. We tax cigarettes to promote less and subsidize agriculture to encourage food production.
It becomes more difficult when similar activities are taxed unevenly. The Catholic Church owned about a third of all land in Europe in the Middle Ages because it was the only entity that the government couldn’t tax. If part of the economy is disproportionately less taxed over a long period of time, it can own a large part of the economic wealth.
What our government does not fully tax is capital gains – like the capital gains on Wall Street. This tax break means that the rich are getting richer.
If you’re in the upper 37% tier, you’re only paying 20% of long-term investment returns – almost 50% less – to Uncle Sam. This difference adds up over time – just like the Catholic Church.
In the 1970s, Congress introduced tax laws and regulations – including lower tax rates on capital gains – that gave incentives to the stock market. Since then, it has tipped incentives more strongly by reducing the minimum holding period for long-term capital gains to one year.
The wealth gap has widened since then. And the Fed has fought, wave after wave, against the irrational exuberance and risk taking on Wall Street, involving a growing number of our best and brightest people who know an unfair advantage when they see it.
There are only two good reasons to allow lower taxes on capital gains: encouraging long-term investment and promoting technological innovation.
If Congress is to do this, it is silly to say that capital investment and innovation will happen in a year, the current holding period for long-term profit.
In the real economy, it takes more than a year to complete the work – such as securing financing, expanding the property, purchasing and installing equipment – around a factory extension.
The same applies to technological innovations. Regardless of whether it is genetic engineering, artificial intelligence or autonomous vehicles, the marketing of products and services usually takes at least five years, often much longer. It took Steve Jobs and all the people who made relevant advances much more than a year to develop the iPhone.
Current tax law encourages many bad behaviors, primarily associated with Wall Street.
Wall Street firms buy late-stage venture capital companies that typically go public and go public a year later to take advantage of preferential tax treatment on capital gains.
Private equity firms are buying established companies, cutting costs, laying off employees, and eliminating corporate investments so they can turn them around quickly and generate capital gains. If they weren’t given preferential tax treatment or if the holding period were longer, this strategy wouldn’t work as well. Financial engineering only works for two or three years, then the company’s value usually goes down.
Public company executives make stock options a bigger part of compensation because they know they can receive preferential treatment against capital gains. This encourages companies to borrow to buy back stocks, which increases profits and increases the value of executives’ options.
Wall Street’s real genius was convincing our elected officials that whatever is good for Wall Street is good for the country.
Time and again, we save the reckless behavior of Wall Street by socializing its losses – so far $ 7 trillion on the Fed’s balance sheet. Attempts to unwind what is euphemistically called rejuvenation cause outrage.
In theory, the financial services industry should be the ballast that stabilizes our economy through its normal ups and downs. Instead, it has become a focal point that could suddenly collapse and shake the economy.
Wall Street is too indebted to off-balance sheet transactions to capture the tax treatment of capital gains and provide a buffer for business cycles. Wall Street pros, receiving massive compensation payments, have weighed on the capital markets like a spring cannon that goes off when slight anomalies arise.
It is time for Congress to address this problem and fix it.
Kathleen Gallagher was a business reporter for the Milwaukee Journal Sentinel and the Milwaukee Sentinel for 23 years. She was one of two reporters on the team who won the 2011 Pulitzer Prize for the One in a Billion series. Gallagher is now the Executive Director of the 5 Lakes Institute, a not-for-profit dedicated to growing the high-tech entrepreneurial economy and culture of the Great Lakes area. She can be reached at [email protected].