By Paul Atkins
Few American values rank higher than self-determination and the freedom of citizens to make their own choices. Proud individualism has been part of our country’s DNA since its founding. The tax reform bills moving rapidly through Congress largely embrace this philosophy. They would leave more in the pockets of working Americans and reduce the role that taxes play in financial decision-making, allowing people to take their own paths without much help or hindrance from Washington.
But one provision in the Senate version of the bill would restrict Americans’ ability to make their own financial decisions. The measure would dictate how investors manage their portfolios of stocks, bonds and other securities.
Current law allows households to decide when and how to sell securities in which they invest. They can direct the sale of their investments to fit their financial needs. Families depend on this freedom to get the best returns.
But the proposed change in the Senate version of tax reform would take that choice away.
The Senate bill would mandate a first-in, first-out (FIFO) scheme. When investors who hold multiple positions in the same security decide that it is time to sell, the government would force them to sell their oldest shares first. Requiring stock sales to be made on this FIFO basis will usually mean higher taxes for investors who sell their holdings accumulated over time. The FIFO provision’s tax implications will limit the ability of American households to fully realize gains from successful investments.
More broadly, requiring sales to be made on a FiFO basis will harm economic growth. By causing investor decisions to be heavily influenced by tax considerations, mandating this scheme would distort how capital is allocated across investment opportunities and penalize long-term investments in American companies.
The newly retired would be particularly disadvantaged if this provision becomes law. Now, retirees can sell their stocks to pay for their post-work plans as they choose. But if they are forced to sell their oldest shares first, their tax bills will likely go up and they will have to sell more just to pay the taxes. This means they may run out of savings sooner — especially if there is a market correction.
Drafters of the Senate bill clearly have realized the costs to investors of implementing the FIFO provision.
Believe it or not, mutual funds, exchange-traded funds, and other regulated investment companies are exempted from the provision. Why should investors who invest directly in securities be penalized by FIFO’s implications while those who invest through funds are not? The FIFO provision will introduce pitfalls for unwary investors while countenancing gamesmanship by the sophisticated who will maneuver around its complexities.
The FIFO provision has been included in the Senate bill to help pay for cuts in tax rates; it is estimated to raise $2.4 billion over ten years. But this is a small amount in the context of the overall tax reform bill and far too high a price for individual investors to pay. If lawmakers go down this road, they will shackle the decision-making of millions of American investors, at needless cost to retirement security and the markets’ ability to allocate capital in support of economic growth.
Overall, the House and Senate tax bills would make the tax code simpler and fairer. But the mandatory FIFO provision would do the opposite, making it costlier and more complicated for households to invest while penalizing certain investment strategies. The Senate’s coercive FIFO provision should not become law.