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You could make the same argument about buying into a mutual fund, yet mutual funds have to distribute capital gains every year. Similarly, if I tried to re-cre

You could make the same argument about buying into a mutual fund, yet mutual funds have to distribute capital gains every year. Similarly, if I tried to re-create an index in my own account with individual stocks, I would end up incurring cap gains as I had to add and remove stocks when the index changes. For whatever reason, we seem to feel like ETF’s deserve different treatment.

AnthonyMouse 8y ago
The real question is why we don't treat other things the way we treat ETFs, which is more efficient. If you own Stock A and it has appreciated significantly over the years, but now you think Stock B is a better choice, the fact that trading one for the other is a tax realization event may cause you to not do it. This doesn't get the government any revenue this year, and it costs the government revenue in the future if you were right that Stock B is now the better choice, because you'll have less taxable appreciation when you finally do cash out during your retirement. It also makes the economy less efficient in general by locking up capital in whatever people invested in years ago.
- cheerlessbog 8y ago
  If I sell my car and buy another for the same price, should I avoid sales tax? Making it possible to trade stocks without tax consequences may make it easier to better deploy capital, but it would also have a destabilizing effect, because it could make the markets more exposed to emotional reactions and poor information.
  - AnthonyMouse 8y ago
    > If I sell my car and buy another for the same price, should I avoid sales tax? Did the person you sold your old car to have to pay an equal amount of sales tax? Because in that case yes. > Making it possible to trade stocks without tax consequences may make it easier to better deploy capital, but it would also have a destabilizing effect, because it could make the markets more exposed to emotional reactions and poor information. This sounds like the argument a monopolist makes for why competition is bad.
    - cheerlessbog 8y ago
      > Did the person you sold your old car to have to pay an equal amount of sales tax? Because in that case yes If you like, but that is not how sales tax works. My point is that taxing economic activity that is not in cash form (such as trading shares) is not generally considered unreasonable. Arguably, by selling my car, I am better deploying economic resources, as the other guy evidently had more use for it than I do. If we taxed only translation into cash, the largest fortunes would grow the most rapidly of all, as wealthy people have less use for cash, proportionally. That's arguably against the public interest. Anyway - I am not taking a position - I am observing that it is not illogical to prefer the current system.
      - AnthonyMouse 8y ago
        > If you like, but that is not how sales tax works. It frequently is. In many cases it goes the other way, e.g. if you buy a PC for $1000 and pay sales tax on it, and then you sell it some years later for $200, the buyer often doesn't owe sales tax because you already paid it when the PC was new. And when a business buys a product as inventory they don't pay sales tax on it, because the customer will. It's generally not a good policy to charge the same tax twice on the same product. But that's not even what we're talking about here: > My point is that taxing economic activity that is not in cash form (such as trading shares) is not generally considered unreasonable. My point is that it isn't doing that. You can't avoid income tax by having your employer buy you a car. The value of the car just becomes taxable income. Deferring taxes when securities are exchanged isn't doing that, because your tax basis in the new securities would be the same as it was in the original ones. You still owe the tax whenever you want to sell the securities and spend the money. Doing it this way would also allow you to get rid of a lot of the rules that really do reset the tax basis, like the one that happens to inherited property. The concern there is that property inherited through generations would have a tax basis of nearly zero, so the entire value would be taxable income and that amount of tax would make it uneconomical to ever sell the property, even if continuing to own it was highly inefficient. But if you could exchange it for another investment vehicle of equal value and just transfer the tax basis then that wouldn't be necessary and the government could continue to defer the tax obligation rather than waiving it entirely as they do now.
  - sokoloff 8y ago
    > If I sell my car and buy another for the same price, should I avoid sales tax? In most states, when you sell your car and buy another in a single transaction, you do avoid sales tax on that amount. (This is common in a dealer "trade-in" scenario.)
    - cheerlessbog 8y ago
      Interesting, I learned something. I did not realize this was the case in the US. Arguably a tax subsidy for dealers, since I presumably don't receive that treatment if I instead sell the car myself a week later.
      - niij 8y ago
        This applies to private sale as well within the same tax year.
      - sokoloff 8y ago
        I agree. I suspect it's also supported as an economic stimulus (which I find slightly morally repugnant, though it's undoubtedly utterly practical for government to do it).
- jedberg 8y ago
  For the same reason you pay income tax every year not just when you die. Taxes are designed to fund the government and also address inequality. You need to be taxed more frequently to address the inequality issue.
  - AnthonyMouse 8y ago
    > For the same reason you pay income tax every year not just when you die. You pay income tax every year because you consume about that amount of resources every year and the things you want to buy aren't tax deductible. If you didn't, and you have enough money to be worth doing it, there are already a zillion tax shelters that cause taxes to be deferred until you actually want to spend the money on something. It would reduce inequality to make that available to ordinary people rather than only the super rich, as well as encourage people to have more savings so they have more stability and aren't as impacted by a large sudden expense. > Taxes are designed to fund the government and also address inequality. You need to be taxed more frequently to address the inequality issue. Except that you aren't, you just keep the holdings you have already instead, and then everything is worse for everybody. The government ends up with less in the long run, so does the taxpayer, so does the new business looking for investment capital to challenge the incumbents. About the only beneficiaries are the incumbents who retain capital that wouldn't continue to be allocated to them in a more efficient market.
    - jedberg 8y ago
      Unless you keep your capital as cash under the mattress it’s already participating in the economy and being allocated.
      - AnthonyMouse 8y ago
        You are using the efficient market hypothesis in exactly the circumstance where it fails to be true. In theory it shouldn't have mattered if you invested in Blockbuster or Netflix because if Blockbuster was doomed then their share price should reflect that already. But in the early 2000s Blockbuster still had a higher market cap, in part because someone who invested in Blockbuster in 1989 but now thinks Netflix has more promise would have to be extra sure before making the exchange since it would cause a lot of taxes to immediately come due. So then they don't, and it becomes harder for the challenger to raise capital and easier for the zombie incumbent to waste resources in its death throes, which is inefficient.
travisp 8y ago
> You could make the same argument about buying into a mutual fund, yet mutual funds have to distribute capital gains every year. This is sort of true, but no longer completely true -- because of ETFs. For example, Vanguard uses ETFs that connect with their Mutual Funds in such a way that it has virtually eliminated capital gains distributions on the majority of its index mutual funds. They are now taxed more similarly to ETFs. > Similarly, if I tried to re-create an index in my own account with individual stocks, I would end up incurring cap gains as I had to add and remove stocks when the index changes. However, if you did this with your own stocks, you could also take capital losses, which mutual funds cannot do (they cannot distribute capital losses to you), and you could also just decide to hold onto the individual stocks indefinitely. At a small percentage of your portfolio, it would probably not significantly effect performance (some evidence even suggests that stock portfolios that never sold stocks when dropped from the indexes even outperformed the indexes!). Even worse, in a mutual fund, you can actually buy into already existing capital gains that you never even profited from. For instance, if a mutual fund had a lot of gains in 2017, you buy in at the end of 2017, and then the mutual fund realizes those gains, you would receive those distributions and pay taxes, which seems pretty unfair to pay capital gains taxes on. There's a lot of nuance and oddities in how all of these taxes work, but it certainly seems far from clear that the way ETFs "dodge" (defer) capital gains taxes until you sell the asset is unfair. To me, mutual funds seem to be the weird tax structure, not ETFs, which at least have a clear and predictable capital gains cost (your sale price minus your purchase price).

AnthonyMouse 8y ago

The real question is why we don't treat other things the way we treat ETFs, which is more efficient. If you own Stock A and it has appreciated significantly over the years, but now you think Stock B is a better choice, the fact that trading one for the other is a tax realization event may cause you to not do it. This doesn't get the government any revenue this year, and it costs the government revenue in the future if you were right that Stock B is now the better choice, because you'll have less taxable appreciation when you finally do cash out during your retirement. It also makes the economy less efficient in general by locking up capital in whatever people invested in years ago.

cheerlessbog 8y ago
If I sell my car and buy another for the same price, should I avoid sales tax? Making it possible to trade stocks without tax consequences may make it easier to better deploy capital, but it would also have a destabilizing effect, because it could make the markets more exposed to emotional reactions and poor information.
- AnthonyMouse 8y ago
  > If I sell my car and buy another for the same price, should I avoid sales tax? Did the person you sold your old car to have to pay an equal amount of sales tax? Because in that case yes. > Making it possible to trade stocks without tax consequences may make it easier to better deploy capital, but it would also have a destabilizing effect, because it could make the markets more exposed to emotional reactions and poor information. This sounds like the argument a monopolist makes for why competition is bad.
  - cheerlessbog 8y ago
    > Did the person you sold your old car to have to pay an equal amount of sales tax? Because in that case yes If you like, but that is not how sales tax works. My point is that taxing economic activity that is not in cash form (such as trading shares) is not generally considered unreasonable. Arguably, by selling my car, I am better deploying economic resources, as the other guy evidently had more use for it than I do. If we taxed only translation into cash, the largest fortunes would grow the most rapidly of all, as wealthy people have less use for cash, proportionally. That's arguably against the public interest. Anyway - I am not taking a position - I am observing that it is not illogical to prefer the current system.
    - AnthonyMouse 8y ago
      > If you like, but that is not how sales tax works. It frequently is. In many cases it goes the other way, e.g. if you buy a PC for $1000 and pay sales tax on it, and then you sell it some years later for $200, the buyer often doesn't owe sales tax because you already paid it when the PC was new. And when a business buys a product as inventory they don't pay sales tax on it, because the customer will. It's generally not a good policy to charge the same tax twice on the same product. But that's not even what we're talking about here: > My point is that taxing economic activity that is not in cash form (such as trading shares) is not generally considered unreasonable. My point is that it isn't doing that. You can't avoid income tax by having your employer buy you a car. The value of the car just becomes taxable income. Deferring taxes when securities are exchanged isn't doing that, because your tax basis in the new securities would be the same as it was in the original ones. You still owe the tax whenever you want to sell the securities and spend the money. Doing it this way would also allow you to get rid of a lot of the rules that really do reset the tax basis, like the one that happens to inherited property. The concern there is that property inherited through generations would have a tax basis of nearly zero, so the entire value would be taxable income and that amount of tax would make it uneconomical to ever sell the property, even if continuing to own it was highly inefficient. But if you could exchange it for another investment vehicle of equal value and just transfer the tax basis then that wouldn't be necessary and the government could continue to defer the tax obligation rather than waiving it entirely as they do now.
- sokoloff 8y ago
  > If I sell my car and buy another for the same price, should I avoid sales tax? In most states, when you sell your car and buy another in a single transaction, you do avoid sales tax on that amount. (This is common in a dealer "trade-in" scenario.)
  - cheerlessbog 8y ago
    Interesting, I learned something. I did not realize this was the case in the US. Arguably a tax subsidy for dealers, since I presumably don't receive that treatment if I instead sell the car myself a week later.
    - niij 8y ago
      This applies to private sale as well within the same tax year.
    - sokoloff 8y ago
      I agree. I suspect it's also supported as an economic stimulus (which I find slightly morally repugnant, though it's undoubtedly utterly practical for government to do it).
jedberg 8y ago
For the same reason you pay income tax every year not just when you die. Taxes are designed to fund the government and also address inequality. You need to be taxed more frequently to address the inequality issue.
- AnthonyMouse 8y ago
  > For the same reason you pay income tax every year not just when you die. You pay income tax every year because you consume about that amount of resources every year and the things you want to buy aren't tax deductible. If you didn't, and you have enough money to be worth doing it, there are already a zillion tax shelters that cause taxes to be deferred until you actually want to spend the money on something. It would reduce inequality to make that available to ordinary people rather than only the super rich, as well as encourage people to have more savings so they have more stability and aren't as impacted by a large sudden expense. > Taxes are designed to fund the government and also address inequality. You need to be taxed more frequently to address the inequality issue. Except that you aren't, you just keep the holdings you have already instead, and then everything is worse for everybody. The government ends up with less in the long run, so does the taxpayer, so does the new business looking for investment capital to challenge the incumbents. About the only beneficiaries are the incumbents who retain capital that wouldn't continue to be allocated to them in a more efficient market.
  - jedberg 8y ago
    Unless you keep your capital as cash under the mattress it’s already participating in the economy and being allocated.
    - AnthonyMouse 8y ago
      You are using the efficient market hypothesis in exactly the circumstance where it fails to be true. In theory it shouldn't have mattered if you invested in Blockbuster or Netflix because if Blockbuster was doomed then their share price should reflect that already. But in the early 2000s Blockbuster still had a higher market cap, in part because someone who invested in Blockbuster in 1989 but now thinks Netflix has more promise would have to be extra sure before making the exchange since it would cause a lot of taxes to immediately come due. So then they don't, and it becomes harder for the challenger to raise capital and easier for the zombie incumbent to waste resources in its death throes, which is inefficient.

travisp 8y ago

> You could make the same argument about buying into a mutual fund, yet mutual funds have to distribute capital gains every year. This is sort of true, but no longer completely true -- because of ETFs. For example, Vanguard uses ETFs that connect with their Mutual Funds in such a way that it has virtually eliminated capital gains distributions on the majority of its index mutual funds. They are now taxed more similarly to ETFs. > Similarly, if I tried to re-create an index in my own account with individual stocks, I would end up incurring cap gains as I had to add and remove stocks when the index changes. However, if you did this with your own stocks, you could also take capital losses, which mutual funds cannot do (they cannot distribute capital losses to you), and you could also just decide to hold onto the individual stocks indefinitely. At a small percentage of your portfolio, it would probably not significantly effect performance (some evidence even suggests that stock portfolios that never sold stocks when dropped from the indexes even outperformed the indexes!). Even worse, in a mutual fund, you can actually buy into already existing capital gains that you never even profited from. For instance, if a mutual fund had a lot of gains in 2017, you buy in at the end of 2017, and then the mutual fund realizes those gains, you would receive those distributions and pay taxes, which seems pretty unfair to pay capital gains taxes on. There's a lot of nuance and oddities in how all of these taxes work, but it certainly seems far from clear that the way ETFs "dodge" (defer) capital gains taxes until you sell the asset is unfair. To me, mutual funds seem to be the weird tax structure, not ETFs, which at least have a clear and predictable capital gains cost (your sale price minus your purchase price).