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113 IRET Byline 1 (1993)

handle is hein.taxfoundation/iretbyln0113 and id is 1 raw text is: April 12, 1993 No. 113 Short-Sighted Plans For Higher Taxes On Financial Trading Markets Several provisions in the Clinton budget package would target financial markets. The changes, which are similar to ones put forward by the Bush Administration, would raise the costs of various financial activities - the holding of security inventories by security dealers, the trading of contracts on commodity futures markets, and the use of new security issues to obtain investment funds - thereby creating or worsening tax biases against the affected activities. The proposals would make it more difficult to direct capital to the best uses and tend to reduce the volume of investment compared to what it would otherwise be. They are not justified in terms of sound tax principles. The harmful consequences are inconsistent with the Clinton Administration's claim that its budget plan would be laying the foundation for long-term economic growth. Moreover, because the Administration fails to recognize the damaging economic consequences of the proposals, it overestimates their revenue-raising ability. Perhaps more threatening than the currently requested tax increases, though, are the precedents they might set for future tax changes. Mark-to-market inventory valuation for security dealers One provision would require security dealers to value their security inventories (securities held for resale rather than investment purposes) at market prices, not actual costs. Under current tax law, security dealers can value their security inventories at cost, at market value, or at the lower of cost or market value. Forcing dealers to employ the mark-to-market Institute for Research on the Economics of Taxation IRETg, -1,I Byl ine procedure would increase their effective tax rates (at least in rising stock and bond markets) by accelerating their tax liabilities. (Collecting taxes sooner raises effective tax rates because, due to the combined effects of inflation and the value of time, $1 now is worth more than $1 in the future.) The Administration estimates that mark-to-market accounting would increase security dealers' taxes by $4.4 billion for fiscal years 1994-1998. The cost method is a long-standing technique, widely used in many industries, for valuing inventories for tax purposes. Prohibiting its use by security dealers would be a major departure from normal tax practices. The change would generally increase the tax cost of holding inventories. In addition, by making it harder for security dealers to compute their year-end tax liabilities in advance, it would increase their risk of owing penalties for inadvertently paying too little in estimated taxes. Security dealers would probably respond to the tax-induced higher cost and added risk by trimming their security inventories. Dealers would also tend to carry smaller inventories because effective taxation of unrealized gains would cause a liquidity problem for some, and the most direct means of raising needed cash would be to sell off some holdings. The additional tax burden would weaken security dealers, important players in financial markets. Perhaps the dealers could pass some of the tax to their customers, but that would only shift the damage to other key financial-market participants. Further, because foreign dealers operating abroad would not be subject to this tax increase, the mark-to-market proposal would hand them a competitive advantage at the expense of U.S. dealers, pushing some security- industry jobs offshore. All of these effects are completely contrary to the Administration's claim that its proposals would bolster the U.S. economy. The proposed change is discriminatory because it would single out security dealers for punitive changes in inventory tax treatment. The Administration begins IRET is a non-profit, tax exempt 501(c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote economic growth and efficient operation of the free market economy. 1331 Pennsylvania Ave., N.W., Suite 515, Washington, D.C. 20004 Phone: (202) 347-9570

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