Tax loophole encourages financial games over job growth

By Carl Levin

U.S. Senator

We have learned a lot in recent months and years about how special tax breaks and loopholes favor the privileged and powerful at the expense of Michigan’s and America’s middle class.

As one of my first actions in the Senate this year I introduced a bill to close one of the most troubling of those loopholes. The bill, the Closing the Derivatives Blended Rate Loophole Act, meets the twin tests of helping to reduce the deficit while promoting the interests of American families. It would put an end to a tax loophole that showers benefits on short-term traders of certain financial instruments, but does nothing to promote economic growth and raises the tax burden on American families.

Our tax code taxes what are known as “capital gains” – income from the sale of stocks, real estate or other assets – at a much lower rate than the tax on income such as your paycheck. But generally speaking, taxpayers are allowed to claim a lower long-term capital gains tax rate on earnings only if those earnings come from the sale of assets that they have held for more than a year.

The reason is simple: we tax long-term capital gains at a lower rate because we want to encourage the long-term investment that helps our economy grow. But under current tax law, traders in certain complex financial instruments called derivatives have managed to win themselves an exemption from the distinction between short-term and long-term capital gains.

They can claim 60 percent of their income as long-term capital gains no matter how briefly they hold the asset. This “blended” tax rate applies if the trader holds the asset for 11 months or 11 hours or 11 seconds. The details may be complex, but the bottom line is that this treatment bestows a big tax break on those who typically hold the covered derivatives for only a brief period.

It encourages and rewards short-term speculation in complicated financial products and does little, if anything, to help our economy grow and create jobs. In fact, the increasing focus of our financial markets on short-term profit through trades that last just minutes or seconds threatens real damage to our economy. So we’re subsidizing activity that doesn’t help the economy, and could do harm, at the expense of middle-class taxpayers.

We lose significant tax revenue by allowing this tax break – a revenue loss that means we must either ask for more from American families or add to the deficit. What’s more, this misguided policy contributes to the basic unfairness that characterizes too much of our tax code by providing an unusual and unnecessary tax break to a small group of financial speculators.

The tax experts at the American Bar Association’s Tax Section wrote in December to the tax-writing committees of the House and Senate: “We are aware of no policy reason to provide preferential treatment for these gains and losses.” Ending this loophole by passing the Closing the Derivatives Blended Rate Loophole Act would not solve all the problems in our tax code nor end our deficit dilemma. But it would be another important step toward a saner, fairer tax code. It would demonstrate that Congress shares the concerns of so many Americans that the tax system is too often stacked against the interests of working families and in favor of the privileged few.

It would end a policy that encourages short-term speculation over long-term investment in growth.

And it would provide a down payment on the revenue we need to restore if we’re to engage in serious deficit reduction and avoid slashing critical programs.