As President Obama presents his "economic rejuvenation package" to the American people, he must use this great opportunity to send a message. He should signal that he wants to encourage private-sector capital formation, so jobs can be created, and set the course of our country toward long-term strength.
Earlier this year, I prepared and delivered to the Beltway, a position paper on the subject of encouraging economic growth via encouraging long-term behavior in our country. The following is an edited version of this paper.
The "Short-Termism" ProblemA creeping problem I call "short-termism" is a looming American weakness on the global stage. None of our most celebrated industries are exempt these days. From autos to computers to many other science-based enterprises - it is now common thinking to conclude that an Asian or even European competitor with a long-term attitude will have an edge over American competitors in the long run. What is driving this? The American competitor is usually a captive of "short-term" thinking and goals imposed by its institutional investors. These investors now constitute up to 60% - 90% ownership in most public companies.
As an example, just look at the spectacular success story in American biotechnology - Genentech. Genentech, as a young and vulnerable biotech, sold 60% of its shares to the Swiss company Roche in September 1990. This was also a particularly stressed time for the US economy, for individual companies and for Genentech.
The transaction provided cover to Genentech management to invest in R&D for the long term. Roche saw losses on its investments for the first eight years before its profit situation turned positive. But the prize for Roche's long-term thinking was historic. A strong and unprecedented flow of biotech innovations came out of Genentech. For example, drugs such as Herceptin and Avastin have revolutionized the treatment of breast cancer. And Roche's original investment of $2.1 billion has multiplied many fold in terms of long-term return.
Could such a long-term attitude have worked for US institutional investors? Unfortunately, this scenario probably would have proved too long of a wait for them - then and today - even if the rewards would be huge in the end.
Just look at how things have evolved for a typical large US public company. About two decades ago, I remember the average publicly held stock turned over about 50% in a year. Now, it's over 100%! Here's another way to look at this. For the 12 months ending March 2009, the Dow Jones Industrials' total trading volume was 35 times higher than the volume in the 12 months ending March 1989, or 70.9 billion shares compared with 2 billion shares respectively.
In this environment, the year end annual bonus for the fund manager managing the stock portfolio has often become the driver of shareholder pressure on public company management in the US. This can supersede the vital need to invest for the long term in important areas such as innovation, jobs, equipment, training and infrastructure. Board members, in order to get re-elected every year by the same investors, are forced to make compromises in favor of the short term; CEO's face similar pressures. It is no wonder then that some of the best ideas originating in America have seen their value being captured in Asia or Europe.
A Proposal
I think the tax system can be a powerful incentive to change this. One idea to encourage long-term thinking and vision - is to extend the 15% capital gains rate beyond 2010 (when Bush era tax cuts are set to expire). However, this rate would only apply on the condition that the asset be held for a minimum of five years, on a prospective basis starting January 1, 2011.
With this legislation, there may be more tax revenues in 2011 as some investor's cash out their existing holdings to invest in this opportunity. The amount of overall tax leakage over the next ten years should be relatively small with this scenario; one could hope the JCT score to be modest. However, an important statement would have been made. There will be encouragement for those who invest in the future of America for the long term - and cause a rethink among those who are caught in short-termism.
On a personal note, I focused intensely on the long term when, in 2003, I took over the difficult job of stabilizing, repairing and turning around Schering-Plough. I even led the way among our peer companies by dropping financial guidance, not only for the quarterly number, but also for annual financial guidance. This action, though not popular with many in the financial community at that time, helped us get the Company focused on doing what was right for the long term. The R&D pipeline and the strong global operations that Schering-Plough ultimately built from that made it the envy of many in the pharmaceutical industry.
I share this position paper with all as a concerned citizen who believes that there should be an attitude shift for the long term. This is how we can lead the way to jobs and growth. The President of the United States has a great opportunity to show the way.
There should be a sliding investment tax rate directly proportional to the term of the investment.
For a sound economy, we need to encourage long-term investing, and discourage short-term investing (gambling casino tactics). Longer term investments, such as retirement plans would be near zero tax, while the high-speed computer traders will be discouraged from distorting our markets in the future.
Reduced taxes for capital gains and dividends are little more than welfare for the wealthy.
"Much of the argument in favor of reducing taxation on the income from capital is spurious. It is a claim that by taxing returns from capital less heavily than returns from labor, those who receive those returns will invest them in new businesses, spurring entrepreneurship. The returns from capital that are favored, however, are not closely correlated with reinvestments in businesses. Most of the returns are those gained merely from secondary market trading and those increases in capital do not go to businesses but to other investors or financial institutions. There is a special provision that taxes initial issuance corporate stock gains more favorably, but that is only a small piece of the capital gains preference.
In terms of the economy, it is highly likely that tax cuts for lower income taxpayers will be spent domestically and thus provide important impetus to economic growth at this point in the recession. Tax cuts for the wealthy and owners of financial assets at the top of the distribution are much less likely to spur economic development--the wealthy are well known for utilizing tax shelters (legitimate and not so legitimate) and for moving assets offshore into tax haven jurisdictions (sometimes through illegitimate use of foreign banking secrecy laws to evade US taxation)."
http://ataxingmatter.blogs.com/tax/2010/08/dealing-with-the-sunset-of-the-bush-tax-cuts-part-iii-in-a-seriesconsidering-the-illadvisedness-of-f.html
The short termism isn't because of the capital gains rate, it's because CEOs are incentivized to manipulate their books and keep their share prices high. Their jobs, bonuses and stock options are dependent on meeting Wall Street's estimates of profits. The incentive is to cook the books through 'earnings management', which has been rampant for well over a decade.
"William J. Bruns, Jr., and Kenneth A. Merchant reported the results of their survey of the readership of the Harvard Business Review (HBR). That survey described 13 earnings-management situations that the authors had directly or indirectly observed, and asked HBR readers to rate the acceptability of those practices. Characterizing the results as “frightening,” they observed the following:
http://www.nysscpa.org/cpajournal/2007/807/essentials/p64.htm
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/smoothing.htm
We need to encourage the buy and hold investors and discourage short term day trading in the major markets. Maybe a secondary market for short term investments with higher risk and the primary market would be for the long term investor, fund managers etc.