November 19, 2009
Recent Securities Transaction Tax Proposal Would Impose Substantial Costs on Middle-Class Fund Investors
This proposal taxes Main Street, middle-class savers seeking diversification, rather than Wall Street.
The securities transaction tax proposed on November 18, in a Congressional “Dear Colleague”1 would impose substantial costs on nearly 90 million mutual fund, exchange-traded fund (ETF), and closed-end fund shareholders. Most of these shareholders are middle-class investors saving for long-term needs, such as retirement and college, and for readily-accessible reserves to meet emergencies.
The proposal would impose $9 billion2 of double taxation on equity and hybrid mutual fund shareholders, because the tax would apply at both the fund and shareholder levels. ETF and closed-end fund shareholders also would be subject to substantial double taxation.3 These fund shareholders would suffer a significant disadvantage compared to direct investors in stocks, in violation of a basic principle of fund taxation.
The proposal would impose $120 billion4 of tax on money market fund investors, even though the proposal purports to apply only to stocks, futures, forwards, and certain derivatives. This tax would be due because all shareholder transactions in money market funds are purchases and sales of stock. Bond fund investors also would be taxed on their shareholder transactions under this proposal.
The proposal would raise taxes on middle-class investors, inflict substantial damage on money market funds, businesses, and state and local governments that rely on those funds to purchase their debt,5 depress stock prices, and drive stock trading to foreign markets that do not impose this tax.
Equity Fund Investors Would Be Taxed Twice Under the Proposal
Investors in equity funds would be taxed twice if the tax applied both to the shareholders’ transactions and to the funds’ portfolio transactions. A double-layer tax runs counter to the basic principles of fund taxation, which seek to provide comparable tax treatment for fund shareholders and direct investors and would harm the fund’s middle-class investors.
The Proposal Would Tax Investors in Bond, Hybrid, and Money Market Funds on Debt Holdings
Investors in bond, hybrid, and money market funds would pay this tax on their fund share transactions—even though the proposal intends to exempt the bonds or other debt instruments in the funds’ portfolios. Taxing fund shareholders, but not direct investors, on investments in bonds and other debt instruments would be contrary to basic tax principles, would harm middle-class investors, and could lead to massive redemptions from money market funds. These redemptions would significantly reduce the supply of short-term credit to corporate America, states, and municipalities.
The Refund Mechanism for Providing Exemptions Will Be Highly Unworkable for Tax Paid by a Fund
The tax refund mechanism for providing exemptions from the tax, as contemplated by the proposal, is highly unworkable. The complexities arise because the exemption must be applied to the tax paid by both the fund shareholder (with respect to transactions involving fund shares) and the fund itself (with respect to transactions involving the fund’s portfolio); if the tax is applied at the fund level, exempt investors will suffer the transaction tax on the fund’s portfolio transactions—even though this tax would not be paid had they invested directly, outside the fund, in the same securities. Once again, the proposal would harm middle-class investors.
Applying the refund mechanism with respect to fund portfolio transactions would be problematic because the fund effectively could be required to determine and report each day the per-share tax paid and the value of the transactions on which the tax was paid. Since fund shares are held not only by the funds themselves, but also through various intermediaries in omnibus accounts, this information could not be disseminated without the creation, at substantial cost, of highly complex reporting mechanisms. Moreover, because fund shareholders typically hold shares in multiple funds,6 they could not apply the annual $100,000 exemption without aggregating their allocable share of the transactions for each fund and then determining the tax to be refunded. Considerable burden and complexity would arise in making these determinations.
1 Proposal described in November 18, 2009 Congressional Dear Colleague “Let Wall Street Pay for the Restoration of Main Street”.
2 A 25 basis point tax on $3.659 trillion of equity and hybrid mutual fund shareholder transactions, as occurred in 2008, would raise $9 billion a year. See, 2009 Investment Company Fact Book, pages 129 and 130.
3 The consolidated notional volume in exchange-traded products on NYSE Arca, for just four days (June 29 through July 2, 2009) amounted to $230 billion. One-third of this volume was in SPDR Trust Series, which tracks the S&P 500 index, and is bought and sold on a daily basis by fund managers for cash management and risk hedging purposes. Had a 25 basis point tax been imposed during this four-day week, shareholders of exchange-traded products would have paid tax of nearly $600 million.