Why the proposed rise in capital gains tax is wrong
By
Tom Bulford Jun 02, 2010
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Today, I'd like to talk about investing for the long term. It's important, but only if you do it for the right reasons.
What led me to today's idea was a radio phone-in where I heard a caller say this:
"I have been a shareholder in British Airways for a decade and have sat and watched as the management has consistently destroyed the value of the company."
He's not wrong. In that time, BA's share price has halved. So why on earth, after ten years of watching this corporate disaster movie, was this guy still clinging onto his shares?
Perhaps he simply couldn't admit that he was wrong. Perhaps he thinks the airline business will suddenly undergo a Damascene conversion and make a proper return on its vast invested capital.
But perhaps he has been persuaded that this show of loyalty is somehow good for the economy.
Why the Government could be making a big mistake
Now our new Government is showing every sign of making this same mistake. There is talk of slapping capital gains tax on short-term gains, while reducing or eliminating it for gains that have accrued over a number of years.
Of course, this would essentially restore 'taper relief' which existed just a few years ago. And that's typical of the regular lurches of policy that so annoy investors.
There is all kind of woolly thinking and mixed-up prejudice in this. There are those who simply want to have a pop at short-term traders. They believe they're creaming off huge profits on a daily basis.
That's ridiculous. In fact, with the exception of a few very good and gifted players, trading is far more likely to result in losses than gains. Frankly, we should be happy to let those traders learn the hard way.
Next there is the notion that industry needs the long-term support of committed investors who will not pull their money out at short notice. But no-one can sell a share without somebody else buying it. That means the only thing that matters is how much money companies can raise through the issue of shares. Who holds them after that makes no difference.
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There is also the view that long-term shareholders will take more trouble to understand the strategy of a business and will be more sympathetic when things go wrong. There is some merit in this. But, rather than engendering long-term support through the tax system, this should be achieved by company bosses presenting a compelling story and being honest about progress.
As has been shown time after time – the tax-free status of one's principal residence being the prime example – tax breaks simply distort the efficient flow of capital.
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In the case of taper relief, the effect is to create a band of shareholders who rely upon the tax system and the passage of time to enhance their investment return. This is more important than the return achieved by the company to which they have trusted their money.
Taper relief only encourages shareholders to become lazy and complacent. In my experience, short-term traders are far more likely than long-term investors to identify the strengths and weaknesses of a business.
Short-term traders were 'accused' of bringing down Northern Rock. But the real problem was that Northern Rock had a hopelessly unsustainable business model. Had it been left to long-term shareholders, the problem would have been allowed to get bigger and the subsequent inevitable crash would have been all the more painful.
What the Government needs to understand is the difference between taking a long-term view and holding an investment for a long time. Let me give you an example.
When it's right to take a long-term view
Back in 2000, investors supported the share issues of dotcom start-ups that had promising, if speculative, long-term business plans. At a fair price investors were right to do so.
But when, just a few months later, the share price of these dotcoms had multiplied ten or twenty times, they were equally right to conclude that these prices were more than could be justified by a reasonable long-term assessment.
And so they sold out, driving down the share price and ensuring that dot-coms could not raise capital by issuing further shares at inflated prices. For sure, these shareholders had made a gain in a short space of time. But they had only done so by taking a sensible long-term view and applying it to their investments.
What the economy needs are shareholders who actively assess likely long-term returns and shift their money accordingly. Investors should not be encouraged to show loyalty to a low-return business like British Airways. They should be urged to move their money into businesses that make a better return, and thereby contribute to economic growth and job creation.
A docile, long-term retention of investments does nobody any favours. It is the intelligent, reasoned, long-term view that matters.
• This article was written by Tom Bulford for his free twice-weekly small-cap investment email The Penny Sleuth.
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