DRAFT January 26. 1984 The practice of playing the stock market for relatively short-term gains has now reached such a high level that it tends to give a bad name to capitalism, thus threatening the cornucopia of goods and freedoms which only capitalism can provide. The country would be improved by revision of its income tax law to reduce s_u ch activity, instead of treating it as a treasured national resource. Short-tenn stockholdings are the norm for take-over arbitrageurs and now-numerous "pro- fessional-bad-guy" investors (often called "raiders" by their detractors) who buy stock in quantities sufficient to create or enhance take-over th rea ts and compound their stakes and encourage imitation as they are, more often than not, bought out at a profit either by the threatened corporation or in some forced sell-out of the corporation's enti:·e busi- ness. But the largest share of short-term stockholding now occurs i n simple super-activi t y by securities' portfolio managers as each seeks to be better than the others in predicting short-run changes in security prices. As large fees, commissions and othe r paper-shuffling profits are earned in the course of increased short-term activity, the result is augmenta- tion of a prosperous class of "new capital ist s," not at all in the mold of Andrew Carneg i e , who tend to do for the reputation of capitalism what the court of Louis XVI did for the reputation of monarchy. Too much easy money is now being made by too many pie-divider types as dis t inguished from pie-producer types. This is bound to raise anticapitalistic sentiments as ir is increas- ingly recognized, for ins tance, (1) that the work of one good dentist does more for general felicity t han that of thousands of investment counse lors whose clients in aggregate are poorer for their efforts as they try to out-perform one another in hyperactive management of pension fund. COnYnOn stock portfolios, and (2) tha t most of these Investment counselors (and stockbrokers and others who service them) are honorable, ene rgetic , often bri I liant people who would be more useful in other employment I f not drawn by f i nancial incentives to their present pursuits. The problem occurs in part because the stock market provides much more than the minimun liquidity necessary to create reasonable cash-in capacity for supp li ers of long-term capital to corporations. The extra liquidity entices into play a huge s upplement al group - speculators (including pension funds and other institutions with staid names) seeking relatively short-term gains.
Opinion Piece Page 2 Our 1 iquid stock ma rke t, sheltered by gentle tax laws, has acquired a Jekyl I-and-Hyde character and serves not only as an orderly place for transaction of essential economic business but also as a near-idea l gambling casino. In recent years the casino part , with its great wealth and prominence, fascinating denizens and occasional bonanzas, has drawn in ever-increasing cascades of short-term speculation. Current 100-Hilllon- share days bring to mind the words of Keynes as he looked back at 1929: "Spec.u.la.toM may do 110 haJUn a6 bubblv.. an a 1:.:t.e.ady otJt.eam 06 ente.Jtpl!Me. But .the. po6ai.011 (,~ 6e/U ouo when en;teJt.p!U.6e becomu .the bu.bbte. 011 .the whUti.poot on <ipec.ul.atimr. When .the c.a.paat development 06 a. courWt.y becomu a by- pMdu.ct o 6 .t.he act.<.v-Ui.M o 6 a c.a.6.-i.no, .the job .-i.6 likely .to be -i..U-do11e." What, If anything, sho uld be done about these developments? How much legalized gambling shou ld our laws encourage, incident to the process of investing In stocks? These are very difficult questions. One way to address questions of such difficulty is by the "thoug ht experiment" so beloved by Albert Einstein. Suppose the la.1s were revised to discourage anything but long-term holding of common stock. Assume, as an example, that the income tax rat e on any sort of mar ketable-common-stock-related gain was 70% for al,l non-underwriting holders, includ ing pension funds and charities, with 110 offsets permitted for losses, unl ess the holding period was at least five years. Would the country be improved? Although tinkering would be desirable to prevent fr inge inequities, it turns out that such tax law revision would be a good thing. The revision supposed would drastically reduce stock option trading and make the market for conrnon stocks le.66 liquid, but liquidity would remain much better than that available for owners of farms or industrial real estate and would be good enough. Conrni sslons on common stock transactions would be higher, but not greatly higher, and would not impede serious long-term investment. Investment in common stocks would become a 1 ittl e more like real estate investment, or the Investment made when Henry Ford received hi s grubstake. Investment in newly-issued Opinion Piece Page 3 convnon stock and common-stock-related securities like convertible debentures would continue , although the first public issues of formerly private companies would create a less liquid after-market, tend i ng to force prices tCMard level s which would attract serious buyers planning to hold for a long time. Host expansion of business plant would be financed , as it always has been, by retained corporate earnings and borrowings. The potentiality for crazy, greedy, speculative stock market orgies would probably be reduced. Such orgies are harmfu l to a country, have recently occurred in I s rael, Kuwait and Hong Kong, and can conceivably occur here, as in 1929 or worse. The "professional-bad-guy" gane, on balance not a good thing, would probably be dMlpened down to some extent from its present frenzy , and what was left would provide more tax revenue . Long-term think i ng would be more dominant, not only in the stock inv e stment process, but also in the cor porate management process, as the whirlpool of speculation, decried by Keynes, was reduced. It is contrary to the national i nterest to have corporate managers as pr e-occ upied as they now are with short - tenn records and tempora ry stock market effects. So pre- occupied , managers cause corpor a te action too similar to that of po l iticians vot ing to effect outcomes i n the next elect ion rather than the next generat ion. After antl-conmon-stock-speculation revision of the income tax law, some portion of the nation's best brain power would be diverted from stock speculation Into activities such as creation of more efficient retailing or diese l engines. Accunul ators of capital would tend to be a little more in the mold of Edwin Land, David Packard and Jack Nicklaus, whose con t ributions prevent resentment of their good fortune. Aristotle rightly concluded that power should go to people perceived as deserving power, and improvement in the reputation for quality of society's big winners would be desirable. There i s l i ttle to lose by shifting tax burdens to favor by a greater extent long-term Instead of short-term Investment. The present gross excess of short-term investment, if squeezed o ut , would not be missed by the overwhelmi ng majority of citi zens. Pension and end()f/lllent funds could eas i ly adapt to purchasing stocks with the same time horizons now used when pur- chasing rea l estate and, in aggregate , woul d be richer for the change. Stockbrok ers
Opinion Piece Page 4 can reasonably be required to join independent truck drivers, unionized air line stewardesses, etc., in adjusting to reduced incomes caused by changes made in the laws to Improve the economic system. Moreover, even If a little pro-social activity were eliminated along with more massive anti-social activity , that is no real objection. The problem is like that of the cancer surgeon who wisely uses his knife despite the inevitable destruction of a I ittle good tissue with the bad. With gambling proclivity entrenched in the culture, it would be unwise to try to eliminate all gambling. But it does not follow that gambling-type activity should be subject to subnormal Instead of above-normal income tax rates and be Intermixed influentially with the capital development of the country . While gains made in long-term common stock invest- ment should be tax-favored as an Inducement to saving and eventua l transfer of power, gains made in relatively short-tenn stock investment, in essence mere gambling-type activity, should either be taxed normally, or better yet, be taxed at above-normal rates. The rewards and penalties of the Internal Revenue Code channel the energies of the citizenry and have a high moral content as they encourage one kind of activity over another. Recently, Congress, at the request of commodity traders and other special interests, has legislated in a manner e~actly opposite from right by Imposing on a dollar earned in holding a stock index futures contract for ten minutes a tax rate l..fXilJeJL than Is paid on a dollar earned in fanning, teaching or night work as a janitor. To the extent the income tax law differs from norms of social value judgment, it becomes less respected, a serious thing when tax collection depends largely on voluntary comp~l- ance. The recent legislation impairs what we need , esteem for the tax law, to enhance what we would be better off without, more trading in stock index futures. The utility of 11 thought experiment ," for lesser mortals as well as Einstein, l ies in its capacity to force acceptance of truths which are counter-intuitive. Counter-intuitive as It may be for traditionalists and "free-enterprise" types, the country would work better if the income tax law were revised to deter the short-term speculation and 11£.duc.e liquidity in the stock market. The truly productive part of "free-enterprise" and the secur i ty of Its future would thereby be both (I) enhanced by increased emphasis on long- term effects of investment accanpanied by diversion of talent from speculation to more Opinion Piece Page 5 useful work and (2) less likely to be damaged by unsound future legislation attributable to public resentment of after-effects of stock market orgies and wasteful proliferation of "new capitalists" who produce too little for what they get. 1514 WOIWS