"It's not nice to fool the politicians," seems to be the message from Congress these days.
In the 1970s, Americans discovered hard assets as a refuge from inflation. While the politicians in Washington spent their way through the decade, ordinary citizens in increasing numbers fled from the depredations of a debauched currency, turning from the traditional stocks, bonds, and savings accounts to gold, silver, diamonds, stamps, antiques, fine art, and other exotica. But if people can make an end run around inflation, its political power as a tool of indirect taxation is accordingly reduced. So we shouldn't be too surprised to find Congress attempting to block this citizens' strategy of self-protection.
First came a ban on investing in gold or silver or other "collectibles" as part of tax-sheltered Individual Retirement Accounts (IRAs) or Keogh accounts. This prohibition was adopted by Congress as it was hammering out the final version of President Reagan's 1981 income tax rate cuts.
Then came a requirement that precious-metals dealers keep records of their purchases of gold and silver coins or bullion from customers and hand over to the IRS the name, address, Social Security number, and amount paid. This measure was tacked on to the 1982 tax increase.
By the summer of '83, a lobbying group had sprouted up in Washington—the Industry Council for Tangible Assets—to oppose legislative moves to undercut hard-asset investing. And it looks like the next congressional strategy will be to tackle hard assets as "unproductive" and boost the tax on proceeds from their sale.
Already in 1981, Rep. James Shannon (D–Mass.), a member of the tax-drafting Ways and Means Committee, introduced a bill to deny the lower capital-gains tax rates to all "unproductive" assets. In March 1983 the Democratic Study Group, a caucus group of anti-free-market Democrats in Congress, published a list of 41 "revenue options" for fiscal 1984, including: "Eliminate Capital Gains for Non-Productive Assets." Sen. Bill Bradley (D–N.J.), a member of the tax-writing Finance Committee, circulated a letter in June promoting a book entitled Inequity and Decline; the book, Bradley noted, proposed among other things that Congress eliminate "capital gains preferences for investing in gold, collectibles, and other nonproductive assets." And during hearings in July, Rep. Pete Stark (D–Calif.) voiced support for the idea.
This notion that some assets are unproductive and should be taxed more heavily fits in nicely with a political plum that Congress would like to pluck—reducing the capital gains tax on stocks and bonds. These are the productive assets that supposedly stand in contrast to unproductive collectibles. Up until now, both have been taxed the same, although differently from ordinary income.
Since the early 1920s, the tax code has recognized that the appreciation of assets is a source of income unlike wages, dividends, and interest. Some allowance must be made for the difference between periodic flows of income and changes in market values when property is bought and sold. The issue is significant because of the importance of capital to economic activity. A progressive income tax tends to confiscate capital if no allowance is made for long-term holdings, because any accumulated gain is realized only in the year of sale, making the seller's tax rate in that year disproportionately high. A lower tax rate for capital gains and a minimum "holding period" to qualify for it have been the solution to this problem for 60 years.
But now the securities industry wants the holding period for investments reduced from one year to six months. Stock and bond traders earn commissions only when investors buy or sell shares, not when they hold them for years and years. If Congress shortened the term for which an investment must be held in order to qualify for the lower capital gains tax, this would boost investors' incentive to trade shares recently bought.
The proposal is even being sold as a "revenue enhancement"; for it would have, say some, an "unlocking effect." The Treasury only collects capital gains taxes when investors sell their assets, not during the time they are holding them. If clients' accounts were churned more often, the government could get its cut—and investors would enjoy the faster action, of course.
In order to justify changing the tax laws to increase the incomes of stock and bond traders, however, Congress has to find some excuse for classifying investment in securities as particularly beneficial to the economy. The trick is to put a negative label on the kinds of investments that stock brokers don't handle—coins and bullion and other tangible assets. That label is "unproductive." By this distinction, if you lend someone $1,000 for use in his business or buy shares of stock, it's productive; but if, to raise the same $1,000, he sells you a coin collection he inherited from his grandfather, it is unproductive. If the label "unproductive" can be made to stick to tangible assets, the law can be changed and the securities industry will be very, very grateful to Congress.
Yet the attack on "unproductive" investments is likely to backfire, because it is intellectually flawed. It is an old fallacy. In his economic classic The Wealth of Nations, even Adam Smith described the labor of domestic servants as unproductive. Criticizing this analysis, the early giant of the British neoclassical school of economics, Alfred Marshall, wrote, "It is a slippery term, and should not be used where precision is needed." He explained:
There is doubtless in many large houses a superabundance of servants, some of whose energies might with advantage to the community be transferred to other uses: but the same is true of the greater part of those who earn their livelihood by distilling whisky; and yet no economist has proposed to call them unproductive.
A sense of fair play may prevent Congress from placing a higher tax rate on the hourly wages of distillery workers than on school teachers, but if any of them want to invest part of those earnings in gold coins rather than taking a flyer in the stock market, they had better watch out!
John Kenneth Galbraith once suggested that the tailfins popular on automobiles in the 1950s are unnecessary—"unproductive consumption," as it were. This example should demonstrate how dangerous the new discriminatory tax proposal really is. Just as the beauty of tailfins is a matter of opinion, so is the worth of investments.
Many investments prove to be duds, but should the tax laws classify them as "unproductive"? Bad investments are by definition not productive, and surely government revenues would be enhanced if capital losses were not deductible. Even the most aggressive tax increaser, however, recognizes that a bias of this nature would penalize any kind of risky investment disproportionately—even those that turned out to be the most beneficial and productive.
Even the notion of "productivity" that is put forward in favor of the shorter holding period for stocks and bonds, in contrast with tangible assets, is faulty. The superior social quality they are supposed to have is some connection with employment or economic growth, either through new-job creation or an increased productivity in existing jobs.
Except for new stock issues, however, shares of corporations traded among investors do not meet this criterion. Trading the shares of established businesses does not raise new capital. The stock market is essentially a resale market—its benefit to society comes from the liquidity it provides investors, partially reducing the risks of their portfolios. Investments in certain popular gold and silver coins provide exactly the same benefits.
The assumptions in an economic model often predetermine its conclusions. Consider this analysis of the error behind the "productive" versus "unproductive" model:
The imaginary construction of an autistic economy is at the bottom of the popular distinction.…Every phenomenon of the market economy is judged with regard to whether or not it could be justified from the viewpoint of a socialist system. Only to acting that would be purposeful in the plans of such a system's manager are positive value and the epithet "productive" attached. All other activities performed in the market economy are called "unproductive" in spite of the fact that they may be profitable to those who perform them.
The prominent Austrian economist Ludwig von Mises so identified the underlying idea of this "new" tax idea over 35 years ago.
A split in the investment community among securities dealers, financial institutions, fund managers, and tangible-asset traders is self-destructive. Confiscation of property through taxation is bad enough; arbitrary distinctions in that confiscation are likely to backfire. Investors have diverse goals, but all of them invest with the hope of being better off in the future. Investors in gold and silver and other tangible assets are aiming for future benefits the same as people who buy blue-chip shares, new issues in high-tech companies, or soybean futures. Perhaps the major difference in the investment expectations of tangible-asset investors is a stronger concern about the spending habits of Congress or a healthy skepticism about the Federal Reserve's manipulation of the money supply.
The trend toward widespread ownership of gold and silver coins is in the best interest of the entire investment community. As a symbolic resistance to the vicissitudes of monetary and fiscal policy, it might make passive acceptance of government economic controls less likely in the future—and awareness of that by legislators and presidents might foreclose the risk of such controls, which would destroy the free economy.
Members of Congress may find the distinction between productive and unproductive investments seductive. But they should not be allowed to use this old fallacy in their campaign against hard-asset investing.
Contributing Editor Joe Cobb is a staff member of the House Committee on Banking, Finance, and Urban Affairs.
This article originally appeared in print under the headline "Hard Times for Hard Assets".