Tax reform shouldn’t include an increase in capital gains tax

The goal of congressional tax reform should be threefold: First, to stimulate economic growth; to simplify the overly complex tax code; and to make the code fairer by eliminating the messy politically motivated loopholes and carve-out. Ultimately, if we accomplish these goals, the tax bill will be very good for our economy.

Buried deep in the Senate’s hastily passed bill is a measure that fails all three. It would change the way capital gains are taxed when investors sell off stocks. In the real world, investments aren’t static. People buy stocks throughout their lifetime and sell pieces of the stock in iterations. Under current law, when they sell a stock, they get to choose which purchase to sell — thus determining their gains and their tax bill.

For example, let’s say you purchase 100 shares of Coca-Cola stock in 2015 for $30 a share. In 2016, you purchase another 100 shares at $40 a share. In 2017, you scoop up another 100 shares at $50 a pop. The current price is now $60 a share. When you decide to sell 100 shares, which shares are you selling? If you sell your most recent shares under LIFO (last in first out), your gain would be $10 a share or $1,000. If you decide to sell your 2015 shares under FIFO (first in first out) your gain would be $30 a share or $3,000. If your goal is to minimize your tax bill, you would naturally use LIFO.{mosads}

 Under current law, the choice is up to the investor. Under the Senate tax bill, the government will force individual investors, but not mutual funds, to sell stocks under the FIFO (“first in first out”) principle under the assumption that stocks increase over time, and this will general more revenue for the federal government.

There are significant problems with this provision. First, it is fundamentally unfair. The Senate bill singles out individuals who purchase stocks, while exempting mutual funds, exchange-traded funds, and other regulated investments from the FIFO regulation. Second, by codifying a bias against institutional investing, the bill adds further complexity to the tax code when it should be simplifying it. Our tax code is already chock full of carve outs and favors for special interests that hired expensive lobbyists to plead their case. The tax bill — and the government — should not prefer one type of investing over another simply to score points with certain groups. Picking winners and losers in the marketplace is how we ended up with a 60,000-plus page behemoth in the first place.

Finally, the provision is anti-growth; it shifts the tax burden forward so that government can greedily get your money more quickly. It is naïve to think that the final tax bill will not affect behavior. When you penalize specific types of behavior you get less of that behavior. If government policy rewards investment and growth — America will see more of it.

The FIFO mandate creates an incentive against capital investment and ties the hands of investors. The result is less liquidity and an inefficient market. The FIFO mandate could also create perverse incentives, encouraging investors to invest in a new stock rather than purchasing more of a high performing stock.

There are very good economic growth provisions in the tax bills passed by the House and Senate, but lurking in the fine print are provisions like the FIFO mandate that nick away at the pro-growth benefits.

As a former member of Congress, I know a thing or two about the sausage making machine that spews out legislation. In the behind-the-door horse trading, skittish members need to be wooed and won. In the process, conference members should keep the above three goals in mind. Let’s not make economic growth the sacrificial lamb.

Former Rep. David M. McIntosh (R-Ind.) is president of the nonprofit Club for Growth.