- - Tuesday, November 28, 2017

ANALYSIS/OPINION:

Lawmakers are rushing to finalize the details of the first major overhaul of the federal income tax in more than three decades. An obscure provision buried deep in the tax reform bill passed by the Senate Finance Committee is sure to rile retirees and other individual investors by mandating what stocks they have to sell first.

Under the guise of simplification, the provision would eliminate choice for investors both large and small. The measure would instead complicate the financial lives of millions of individual investors, rob retirees of part of their hard-won savings and inhibit economic growth by distorting investor decisions.

Under current law, investors who hold multiple positions in a security purchased at different times can decide for themselves how to manage sales to best suit their financial needs. The Senate proposal would change that, requiring investors always to sell their oldest securities first. That’s called first-in, first-out, or FIFO.

Consider an investor who holds 100 shares of Apple stock, half purchased in 2015 at $130 a share and the balance acquired 10 years ago at $15 per share, split-adjusted. Under current law, the investor can elect to sell the newer shares first. Under mandatory FIFO, that choice goes away. The amount of tax due after selling 10 shares at the current price of $175 a share would more than triple as a result.

Requiring FIFO doesn’t just raise taxes for investors, it also changes how they behave. Holders of successful investments accumulated over time will be less inclined to sell and discouraged from buying more. They’ll spend more time thinking about and planning for the tax effects of their investments. They will make investment decisions that, absent tax considerations, are less rational. As a result, markets will become less effective in allocating capital to highest and best uses, at an inevitable cost to economic growth.

The FIFO mandate runs counter to the stated goals of tax reform to create a simpler and fairer tax system. Professional managers of mutual funds, exchange-traded funds (better known as ETFs) and other regulated investment companies could continue to choose what they sell and when they sell it. Individual investors, on the other hand, would lose that privilege. The reason for this disparity has not been explained by members of the Finance Committee.

Mandatory FIFO would hit middle-income investors the hardest, because investments covered by the FIFO mandate often make up the bulk of their financial assets. Those wealthy enough to diversify into more rarified investments such as real estate and private equity would be less impacted.

Mandating FIFO would be a disaster for retirees who have diligently saved and invested over their lifetimes. When it’s finally time for them to dip into their investments to pay for retirement, FIFO would require them to recognize their oldest — and typically largest — gains first. That means paying more in taxes and having less income for living expenses. Comfortable retirements would be sacrificed to satisfy some anonymous policymaker’s idea of “tax simplification.”

For all the havoc the pending FIFO provision would cause, its contribution to paying for tax reform is meager — $2.4 billion over 10 years, in a bill that moves around trillions of dollars. If lawmakers continue down this path, they risk incurring the wrath of millions of retirees who have worked entire careers to finally enjoy personal and financial freedom. This little-noticed change would deny them the retirement they deserve and expect.

Brian D. Langstraat is chief executive officer of Parametric Portfolio Associates.


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