To summarise, Investment Managers manage Funds. When you invest in a mutual (or hedge or venture or wine [1]) fund, you put money in to a Fund. The Fund then pays an Investment Manager a fee for managing it. (Of course, you, the investor, indirectly pay this fee.)
Vanguard is mutualized. This means the Funds own the Investment Manager. Unsurprisingly, the Funds vote for lower fees. The result is Vanguard charging its funds staggeringly lower fees than average [2]. This also means Vanguard makes less profit than competing Investment Managers.
Enter this guy [3]. He observes Vanguard paying less tax (on account of making less profit) than its competition. He concludes that Vanguard is dodging its tax bill. Vanguard, he argues, should be taxed as if it charged the higher fees it doesn't. They should also pay the back taxes they would have owed if they had charged these fees and earned those profits, again, that they didn't. This last part is helpful because he likes the whistleblower bonus the IRS would pay him if the case succeeds [4]. (Or maybe not [5].)
If this sounds bonkers, it's because it likely is. We don't tax SpaceX as if it were bilking the U.S. government on par with its competition. In any case, the boosted post-fee gains from Vanguard's funds are still taxed at the individual level. But my pie is better than your pie and so the idiots get their air time.
While I ultimately agree with your conclusion, you're eliding the issue, which is the transfer pricing. You have one affiliated entity providing a service at below market rates to another affiliated entity. Ordinarily that raises concerns about tax dodging. Here, it has the effect of shifting money from something that isn't tax exempt (the asset manager) to something that is.
Ok they are affiliated entities, but the it seems relevant to me how they are affiliated. Since the manager is owned by the fund, it seems there is an argument that the entirety of the manager's business is an expense to the fund, just like if a company buys its own airplane and hires its own pilots and ground crew, instead of flying commercial all the time. Or like how Apple bought a bunch of semiconductor companies to design chips in-house, instead of just buying off-the-shelf components.
Reducing costs is typically one of the main reasons one organization buys or incorporates a subsidiary, instead of just going into the marketplace for what they need. Will that now be illegal if it reduces the total tax payments of the formerly separate organizations, as a side effect? That seems like a pretty dramatic intrusion into business decision-making.
Except here, we've got an entity that engages in two activities, one of which is for policy reasons tax-exempt (holding stocks in a mutual fund) and one of which is not (investment management).
Say a non-profit hospital ordinarily purchases services from a for-profit testing lab. The testing lab receives market-rates for its services, and pays tax on that income. Now, say the hospital purchases the testing lab, but continues to operate it as a for-profit subsidiary. But the hospital makes the subsidiary sell its services at cost, eliminating the subsidiary's tax liability while boosting the hospital's non-taxable surplus. Maybe that's still okay. But now say instead of a testing lab, the subsidiary is an advertising agency. Same result?
What is the difference between the hospital running the lab as a for-profit subsidiary at cost and the hospital folding all lab operations into the non-profit entity? Ditto for the advertising agency? The road you are going down would make any acquisition of a for-profit entity by a non-profit entity illegal.
Non-profit exemptions rest on the government's policy of forgoing tax revenues on specific favored activities. Non-profit entities have to take great care to avoid engaging in activities besides those favored ones. So the non-profit hospital likely couldn't fold the advertising activities into itself without jeopardizing their tax-exempt status.
The problem is not the acquisition of the for-profit entity by the non-profit entity. The problem is when those entities don't interact at arm's-length.
I'm not sure if this is a valid comparison, but imagine that a group of doctors got together and founded a hospital, and decided that they would run the hospital as a co-op, where employees would buy into the co-op rather than receiving a normal salary. However, as they grow they realize that they actually need some corporate guidance, so they find a management company. The management company doesn't want an ownership stake in the co-op, and the co-op doesn't want to dilute it's members, so instead they mutually agree to pay the management company a fixed X million dollars for it's contracting services. In the meantime, the co-op grows 10-fold, but the contract with the management company doesn't change (somehow, let's just assume the co-op doesn't require active management, they just need guidance occasionally or something). Now, someone looks at this and says, hey, if you had the normal management structure you'd be paying 10 times what you pay for your current management since they would take home y% of the profit and that would be taxed, but instead your co-op gets better tax treatment.
This would clearly be absurd, the management company is happy with their fee, and the co-op members are happy. The fact that "normal" corporate structure would pay more in tax shouldn't really factor into the decision since the question should be, given your corporate structure, are you paying taxes.
> In the meantime, the co-op grows 10-fold, but the contract with the management company doesn't change (somehow, let's just assume the co-op doesn't require active management, they just need guidance occasionally or something)
The question isn't what a "normal management structure" would cost. It's what the affiliated entity would normally charge in the market for the same service. Vanguard's sells its investment management services to the mutual fund at cost because it's owned by the mutual fund. It wouldn't do that otherwise.
So to make your example comparable, the co-op buys the management company, and makes it operate at zero profit. So the question is: would the management company be happy making zero profit if it weren't owned by the co-op? The answer is: probably not.
So, I'll admit that I don't understand the details of how vanguard is paying employees or the external people that actually manage the money, but presumably, they pay a fixed fee to someone to manage the money, and that fee is significant (but not a significant fraction of the money under investment). The fact that "normal" in investment funds is percentage of money under investment plus percentage of the profit shouldn't matter since they've found a way to run a company that doesn't need to pay those fees to get the money invested.
edit: I should add, that I'm fairly certain that the employees at vanguard are in fact getting paid.
edit2: So the question is should we look at whether the employees/contractors at vanguard are getting paid market rate, or whether vanguard as a whole is charging market rate to the investors. My comparison to the hospital co-op was that it's unfair to compare apples-to-orangutans.
But isn't one of the points of Vanguard that their investment management is cheaper by its very nature? Namely: passive, index-tracking funds are simpler and cheaper to manage than active ones?
I can see that they could have run afoul of some tax rules due to their structure, but it seems disingenuous to argue that they should charge management fees just as high as their active management competitors. (But sure, maybe they should charge more than they do now.)
Then again, as an owner of Vanguard index funds, maybe it's hard for me to be rational in this case. >:D
I feel like I'm missing something here... Is it not legal to run an investment management company as a non-profit? Likewise, is it not legal for the non-profit arm of Vanguard to mange its own investment as an integrated part of its organization?
At what point do these legal distinctions begin to take effect? If a friend and I pool resources and purchase some stock, then later sell it at a profit and split the trading fees, did we somehow owe unpaid tax?
It seems like this is a tax against vertical integration in financial services, which I'm not sure I understand the need for...
Can you back up and explain what "transfer pricing" is? The article itself kind of skirts around the issue, and it sounds like it's at the heart of the issue.
The Wikipedia article is pretty good: https://en.wikipedia.org/wiki/Transfer_pricing#Profit_alloca.... Basically, it has to do with the prices charged for goods and services between related entities. Generally, laws require that these prices be the same as they would be if the companies were interacting in arm's-length market transactions.
Consider, for example, a tax dodge Samsung is alleged to have engaged in. Samsung Electronics makes products in South Korea, then sell them at cost to Samsung Distribution, which is an affiliated company in a low-tax jurisdiction. Samsung Distribution then exports the products at market price to Best Buy, etc. Samsung Electronics books little or no profits in South Korea--all the profits are booked by Samsung Distribution in the low-tax jurisdiction.
There is also a corporate-entity angle to this. Operating as a separate corporation has benefits: if one goes bankrupt, its creditors cannot reach the assets of a related entity. But if transactions between related entities are not arm's-length, it's easy to shift money around between them and abuse the protections of separate corporate forms by, e.g., leaving riskier lines of business undercapitalized in case of a tort judgment.
Holding stocks in a mutual fund is not tax exempt. You pay taxes on dividends and I think also you pay as the turnover produces net profits. You also pay capital gains on shares you sell. Eventually it all gets taxed
The mutual fund itself is tax-exempt and passes profits and gains onto owners of the fund. Think about the alternative: you create a corporation to hold the assets of the fund. Dividends on those assets would be taxed when the corporation receives them before they are distributed to shareholders.
That's not how transfer pricing works. Mutuality that extends to fund management means the ultimate owners are the customers of the fund - the people who placed their money with Vanguard. So unless you extend the concept of transfer pricing to all mutuality (something investor-owners would love), co-ops and other ownership and business models that don't maximize profit in the same way that investor ownership does, that just not a "transfer pricing" issue. That idea that investor ownership has some special place in the economy is a pretty vile concept.
I can understand the concern about tax dodging, but how far does this go? You could make the argument that any non-profit arrangement that throws of monetarily-beneficial goods below price is dodging taxes.
If I call up an old mentor and he gives me useful, money saving tips that I employ to amplify my business's profits, should he be taxed "as if" he billed me as a consultant?
If employees of a for-profit startup ask questions on a mailing list they're members of, should the mailing list be taxed as if it were selling consultancy services?
And how (too tired to come up with an answer myself) would this case differ from Vanguard? I'm guessing it has to do with the fact that the Vanguard investment management company is charging other people market price for its advice, but what if my mentor did that? Are we now in a world where, if I sell a good for-profit to anyone, I must pay taxes on the income I would have gotten, any time I give that good to someone else for free?
What if my wife's a professional childcare provider? Do I have to pay taxes on the imputed income from when she's alone with our kids? (There are non-G-rated versions of that question, btw.)
(Honest questions, all. Don't know if I'm missing something here or misunderstanding the tax threat model.)
Barter transactions are supposed to be taxed. Literally, if I have a friend who comes over and rakes leaves out of my yard in exchange for and while I repair the brakes on his car, we're both support to report income (me for the free leaf-raking I got and him for the free brake repair labor).
The fund doesn't pay taxes on fees paid to their investment management business. From their perspective that's a cost. And he investment management business is running at break even, so they don't pay taxes either.
Wouldn't near break even be the long term equilibrium in perfect competition for investment management services? Doesn't this really just expose how much other managers over charge?
But the law is there for a reason, to prevent tax dodges. Like selling a patent to fully owned foreign subsidiary in a low tax jurisdiction for $1. Then having that subsidiary collect royalties of millions from the parent domestic company. The expenses (of the royalties) are deducted, and tax is only payed on the much lower profit. The foreign subsidiary pays local (lower) taxes and keeps the profits in a foreign account. This is clearly a tax dodge. If you allow the IRS to levy tax on market rates for patent transfers and royalties, they can can redo the accounting to figure out what a fair tax would have been without the accounting games.
I'd really like to see the law changed to allow Vanguards actions (presuming they are indeed in violation) but I'd also be worried about adverse consequences.
Good summary, but you left out the Plaintiff's argument. Their argument is ridiculous but it bears summarizing.
The law requires transactions between affiliated businesses to be "arms-length" [1]. That means that both parties come to an agreement freely and independently and that the agreement not be influenced by a special relationship between the entities. Without this rule, you can run into situations that allow companies to dodge taxes. Apple and many other companies do this all the time to take U.S. profits and funnel them to Ireland to avoid paying U.S. taxes [2].
Plaintiffs are arguing that Vanguard is violating the transfer pricing rules by having its holding company charge its mutual fund affiliates fees that are substantially lower than market rates. In fact, their argument is that Vanguard is charging 0.20% of assets managed when it should be charging 0.75% of assets managed which they claim is the market rate. Plaintiffs further claim that by charging lower than market rates due to their special relationship that Vanguard owes $34.6 billion in back taxes from 2007 to 2014. As such, Plaintiff would be entitled to $10 billion commission by bringing this to the government's attention.
And that brings us to why Plaintiff is doing this. They know the odds are so ridiculously stacked against them but it's a cheap lottery ticket for a chance to win $10 billion. And if they can put enough FUD into news articles about Vanguard [3] they just might be able to convince Vanguard to settle for a few tens of millions to make them go away.
> Without this rule, you can run into situations that allow companies to dodge taxes. Apple and many other companies do this all the time to take U.S. profits and funnel them to Ireland to avoid paying U.S. taxes
It doesn't really change your overall point, but that's not exactly true. Apple uses transfer prices to take non-US profits and funnel them to Ireland. They then use tricks such as the Double Irish and the Dutch Sandwich to minimise their Irish taxes. However they can't avoid US taxes; all they can do is delay them. If and when those profits are moved to the US, they'll still be taxed at the full US rate; all the fancy Irish tricks won't do anything. And those tricks don't work on US profits at all; since Apple's IP is owned by the US firm, they can't transfer US profits to the Irish subsidiary.
This is true, but that's also why they're willing to buy high value companies outside of the US.
They can essentially have two separate budgets: Money already in the US [to be spent in the US] and money outside of the US which will have more buying power if spent outside of the US.
In nl we have one particularly crazy tax called the 'huurwaarde forfait'. It's basically a total fiction, the idea is that if you own a house that you are financing you are not renting, and this then rent that you are not spending - tadaa - is income.
That sounds like imputed rent which is not a total fiction; it is a well understood concept and most economists seem to agree that it probably should be taxed but the political cost of a change from the status quo makes it unlikely to happen in countries that aren't already doing so.
The OECD recommends that member nations tax imputed rent because it improves fairness between renters and owners.
imputed rent makes no sense to me. So every time I drive my car, I'm denying a taxi driver some income and so I should be taxed on the profit I am making as my own taxi driver?
Every time I masturbate I should be taxed on my profit made as a prostitute.
It's sad that TwoBit's perfectly reasonable objection to this got downvoted to death rather than countered with some plausible argument. Why is real estate unlike every other useful property?
> It's sad that TwoBit's perfectly reasonable objection to this got downvoted to death rather than countered with some plausible argument.
Probably because he needlessly brought a controversial issue into the discussion (prostitution).
The taxi issue is, in fact, interesting. Especially when you extend it to Uber. If your capital comes in the form a vehicle, you apparently aren't required to pay imputed rent but if it's a house you do.
That being said, the labor issue muddles this. You could argue that when you get a taxi you're paying exclusively for the driver's time, not the vehicle.
Maintaining a residence also requires labor. In the robocar future (that is, before the handyrobot future that surely will follow) perhaps it will be thought to require more labor than driving?
It's disappointing to imagine HN voters being so censorious as to downvote perfectly topical mentions of prostitution.
If you think that's bad, wait until you have savings. Instead of taxing interest earnings as income they assume you earn 4% on your capital and tax that at, say, 50%.
The banks are now paying 1%-1.5% but you still have to pay the tax man 2% - so your capital actually goes down. It's an implicit negative interest rate.
So people like me who didn't get a 6x mortgage* and live frugally end up subsiding my Audi-driving, 6x mortgage, overspending & debt-heavy "friends". The same people who have cause this situation by their dangerous borrowing.
* houses are how you fix this: the value in the house isn't seen as capital so it's not taxed, plus you can deduct interest payments from income taxes; i.e. the entire system is designed to increase property values.
It is taxed at 40%, so it's an inherent -1.2% interest rate. Otherwise you're spot on.
The "huurwaardeforfait" is just a handy political fiction to get more taxes from home owners, who are subsidized a lot because mortgage interest is deductable. It was probably politically easier to get a law for a new tax through parliament than to lower the mortgage deduction at th etime.
I'm not mobile: my wife owns a pharmacy here and our kids are settled. Otherwise I'd be either in the UK or US working for one of the tech giants right now ;)
Is it legal to keep the money as cash (literal cash, not in a bank at all) or do you still have to declare it as savings? Not sure what inflation is like for you but it's sub-1% in the US so if yours is comparable and you don't have to declare that type of savings you'd probably come out marginally ahead.
In theory, I could see how you could make an economic argument for taxing people at the theoretical rate of return (incentivizing deploying your capital in value-creating investments instead of sitting on it). In practice, that is insane.
Economically this is correct - you do have an imputed stream of rental income from a property. You are just choosing to consume it directly (by living in the house) rather than sell it to another party, receive money and turn the money into other consumer goods.
Imagine an alternate scenario. You own a home, but rent it out. Also, you rent an equivalent home from another person. In this alternate scenario, you'd have to pay income taxes on the rent you receive. Similarly, if your employer gave you free rent in a house they owned, you'd need to pay tax on the value of that rent.
Economically there is no good reason to distinguish between these two cases. It sounds like NL is doing things right, or at least righter than the US.
I'm going skiing this weekend. I own my car, skis and the rest of the equipment I'll need to get there and enjoy a couple days on the slopes, but if I were to rent those items, there would be taxes paid, both in sales tax and on the profits made by the rental companies. So, if I were in the NL should their government require me to pay taxes on the items I own due to it depriving the government of the taxes I'd be generating by renting everything? Would that tax vary depending on how many times I used my equipment? That seems nonsensical and creates an ad absurdum situation...would someone be taxed for cooking their own meals since restaurants pay taxes?
> Economically there is no good reason to distinguish between these two cases
The good reason is property rights. The ability for people to own things and use them as they see fit is almost a requirement for a free society. Governments have established that by creating rules and an environment where commerce can take place, they can collect taxes on that commerce. But I agree with the post you're replying to...creating fictional commerce and then taxing it doesn't seem right. If you're looking for a difference between the two cases you present, it's that the government is willing to act as an arbiter in any dispute that would result between landlord and tenant. When the landlord and tenant are the same person, there's no need for the government to be involved.
Note that this shouldn't preclude governments from collecting property taxes, just from differentiating between landlords and people who occupy their own homes.
"creating fictional commerce and then taxing it doesn't seem right"
The ACA case that decided the legality of the individual mandate also had the effect of prohibiting the government from instigating commerce for the purpose of regulating it. Note that the tax-penalty (can it be both at the same time? Can light be a wave and a particle at the same time?) over not having health insurance is not a tax on commerce in health insurance; it is a penalty for violating the individual mandate. So the court has ruled that it can penalize people for violating the law under its taxing power, but also that the government cannot instigate commerce. The only way then to tax imputed rent would be to mandate that property owners rent their dwellings out. This in turn would be a violation of government instigation of commerce. A catch-22.
So not only does it not seem right, it doesn't seem legal.
Governments have established that by creating rules and an environment where commerce can take place, they can collect taxes on that commerce.
This implies that things like dividends should not be taxed, since no commerce occurs. All that happened is a piece of property split into two. Would you favor this outcome? If not, why not?
Now personally, I'm in favor of eliminating all taxes on capital income (and capital, e.g. property taxes). Economically, the best tax is a consumption tax; you live in a home, you pay taxes on the value of living in it. No property tax, no income tax, etc.
Potentially such taxes could also be levied at the time of purchase, as they would be with a pair of skis.
But that's a political non-starter; our western systems of taxation are built around the lie that the rich benefit disproportionately from our society. A consumption tax, which taxes people based on the benefits they receive rather than the value they create for others, would automagically reveal that lie.
> the lie that the rich benefit disproportionately from our society
Why do you consider that a lie? There's a reason why kidnappers try to target rich people's kids... because rich people are willing to pay much more to gave their kid back - they literally value the kid's life more (in money terms).
Another perspective is, a geting injured/killed will deprive a rich person of a lot of consumption, but a poor person of just a little consumption. Therefore, by protecting rich people, governments provide more value than by protecting poor people.
> Now personally, I'm in favor of eliminating all taxes on capital income (and capital, e.g. property taxes). Economically, the best tax is a consumption tax; you live in a home, you pay taxes on the value of living in it. No property tax, no income tax, etc.
What about income tax? What about corporate tax (personally, I think it makes sense, because it's a choice - you don't need to pay corporate tax, but they you don't get the privileges of the corporation being a separate entity)?
For the most part, rich people produce far more than they consume. Poor people consume far more than they produce. Consumption inequality is vastly lower than income inequality.
I'm opposed to income tax as well. A consumption tax is the best tax, since it's both a) hard to dodge, b) transparent and c) doesn't penalize investment.
In principle an income tax is equivalent to a consumption tax, but in practice taxing labor income but not capital income induces all sorts of tax avoidance schemes that treat labor income as if it were capital income.
Do you value "equality" at all? E.g. do you find huge inheritance unfair (because it's something you didn't produce) or not? How about "proportionate representation" (one person, one vote, as opposed to the current situation where rich have vastly more political power)?
I don't particularly value equality - rather, I value utility. If I can make everyone better off, but increase inequality in the process, I will.
How much poverty are you willing to create to reduce inequality? That's the fundamental question. For me the answer is zero.
I also don't assign much value to proportionate representation. I think I'd prefer the rich to have more political power, they seem to be the least insane. Unfortunately, in our system we do have proportionate representation. The only way a rich person can influence electoral outcomes is by persuading poor and middle class people to vote for his candidate. Sadly, as Trump demonstrates, this can be done just as easily with nonsensical emotional appeals as with intellectual ones.
> I don't particularly value equality - rather, I value utility. If I can make everyone better off, but increase inequality in the process, I will.
Unfortunately, inequality is, empirically, one of the strongest sources of disutility. So, as much as you might think you can "make everyone better off, but increase inequality in the process" when you use poor proxies for utility, you probably can't.
> I also don't assign much value to proportionate representation.
Comparative studies (at least among nominal democracies), show that proportionality is fairly strongly correlated with experienced utility of government. So, this may be incompatible with your claimed preference for utility. (see, e.g., Lijphart's Patterns of Democracy.)
> I think I'd prefer the rich to have more political power, they seem to be the least insane.
Maybe they just have more power to shape perceptions through media, image management, etc.
What evidence do you have that inequality is a source of disutility?
Note that if you pull out one of the ever popular left wing scatterplots putting cross-country inequality on the x-axis, I'm going to pull out one with a higher r^2 putting something politically incorrect like single mothers or black people on the x-axis.
As for proportional repersentation, if it indeed is instrumentally useful in creating utility that's fine. But I only care about it insofar as it actually gets us other good outcomes - it's not something I intrinsically value.
But you don't necessarily increase poverty by decreasing utility and increasing inequality. Arguably, 8-hour workweek and restriction of child labor reduced utility of people (at least on the short-term), but markedly improved their quality of life and probably decreased inequality as well. IMO it's likely that we would be much more productive and "better off" in a society where we're all "equal" (to some degree - e.g. a very good model of society is described in the story Manna by Marshall Brain - every day, everybody get's the same amount of energy (which cannot be stored) and they can use it however they want - including donating it to worthy causes).
Without proportionate representation, it's unlikely that you can achieve "everyone better off", because your measure will be biased - such a system practically ensures that the rich/powerful are better off at the expense of the poor, because their desires are weighted more heavily!
But you don't necessarily increase poverty by decreasing utility and increasing inequality.
I'm asking about values, not specific world conditions. Sometimes the world lets us get everything we want - e.g., globalization and capitalism so far have reduced poverty and inequality together.
But sometimes the world doesn't give us the easy case. That's when we actually need to understand our values, and answer questions like "how many people will I push into poverty to reduce GINI by 1%?" If your answer is zero, you agree with me completely and don't care about inequality. Are you agreeing with me that inequality is irrelevant now?
I agree that equality is not important as a goal, but it's important as a means - I think (i.e. based on my observation of reality) that inequality results in bad outcomes (i.e. takes us further from the goal of "less poverty" or "better lives"), hence my drive to oppose and fight it.
Of course, it would be even better if I/we could simply reduce poverty and improves lives directly (without the detour of fighting inequality), but currently I don't know how (and neither does anyone else).
One of the best, if unrealistic, solutions I see are robots; but between now and when we invent really useful robots, I think it's important to strive to prevent outcomes as displayed in the movie Elysium (or the alternative future in the story Manna).
Taxation based on consumption is a horrible idea, because it impacts the people with low incomes much more than the people with high incomes. Everyone must spend a fraction of their income on consumption merely to exist. The poorer you are, the larger that fraction. Which means that a tax based on consumption is in effect a form of progressive taxation turned upside down where you pay less the more you earn.
Yes, it taxes people proportional to the benefit they receive rather than proportional to the value they create. Low/no income people tend to consume far more than they produce. Such a tax will stop penalizing investment which is a good thing.
Why would we want rich people to throw lavish parties rather than creating future productive capacity?
First of all, yes, consumption is almost always preferable to "letting your money work for you". Contrary to what you seem to think, most people who have more wealth than they need for consumption, don't use that wealth to fund new ventures. Instead they mostly just own assets that appreciate in value and/or pay a dividend. They do not create new wealth to any significant degree. While it is true to some extent that having money in the bank can help create new wealth, it makes no difference if it's one person putting a million dollars or a thousand people each putting one thousand dollars in the bank. The result in either case is that the bank can lend out a million dollars to someone starting a new venture. I mention this because when one person spends (consumes goods) a thousand dollars say, that money goes out if her bank account and into someone else's. The bank's ability to lend out money is unaffected. Meanwhile, thanks to the power of capitalism, money that is spent flows towards what society in aggregate deems most valuable, ensuring that more effort is spent on creating more of that valuable thing. This is in a nutshell why it's preferable for all, poor and rich, to prevent rampant inequality.
Secondly, I do somewhat agree that we shouldn't disincentivize investment or saving up. I am not familiar with the US tax system, but in some countries you can defer paying taxes on what you put into a pension plan until the time when you collect your pension. If the interest you earn on your savings is more than the inflation, this is a win/win situation: You will earn interest on a larger amount, and society will collect tax on a larger amount in the end too. I could probably be convinced that it would be a good idea to make all investment and savings tax free provided that all dividends as well as any amount liquidated was taxed as income. Buy a house? Fine that's tax deductible. Sell a house? Get taxed on the entire amount as if it were income.
it makes no difference if it's one person putting a million dollars or a thousand people each putting one thousand dollars in the bank. The result in either case is that the bank can lend out a million dollars to someone starting a new venture.
This is wrong because it focuses solely on imaginary numbers floating around. It's absolutely true that we can play any game we want with numbers in a bank computer.
However, a worker can either be building a new factory or they can be making a purse. The former is investment while the latter is consumption. If we encourage investment we get more of the former, while if we encourage consumption we get more of the latter. The constraint here is real resources, not money.
I could probably be convinced that it would be a good idea to make all investment and savings tax free provided that all dividends as well as any amount liquidated was taxed as income.
As I tried to get across before, most of what we think of as investment, doesn't actually create value. Buying land does not create value, buying stock does not usually create new value (unless it's from a new offering). Owning assets that appreciate in value does not create new value. So tell me again why any of these kinds of investment is something we should go out of our way to encourage? On the other hand, consumption in a capitalist society really does create value, because consumption is the all important signalling mechanism that tells us where to direct our resources, ensuring that more value is created. Consumption is not without problems, but it is unquestionably valuable.
So not only would a tax system based on consumption be hugely unjust from a social perspective, it also makes no sense from an economic perspective.
The issue isn't any individual act of saving (most of which are just reshufflings of investment assets), it's net investment. If the amount of money invested goes up, it buys more real investment resources. This means more workers and more physical resources are devoted to investment, and less to consumption.
Again, think of real resources because thinking of money is confusing you. A worker can either do biomedical research (investment) or they can provide massages (consumption). This fact doesn't change no matter what games you imagine are happening with money.
Yes, I probably am a little bit confused as to what exactly you mean when you talk about investment. Is buying a house an investment? How about a yacht? What about a vintage car? Stock? From a social point of view these are all more or less equivalent, as in they all result in money going out of your pocket into someone else's and some asset (which may or may not appreciate in value) being transferred to you. Depending on your point of view they can all be though of as both investment and consumption. This leads me to speculate if what you really mean is that it is spending that should be taxed and taking a profit that should be tax exempt? If not I would very much like to hear how you would define investment in such a way that it can unambiguously be separated from consumption.
But regardless, the intention behind your proposal still makes it a horrible idea. I can see that you will not be swayed by the argument that it is socially very unjust and would result a unimaginable inequality. But as I keep trying to tell you, consumption is the motor of capitalism. It is the demand part of supply and demand. Without consumption, there is no production. And production is what creates all the wealth. Everybody would be poorer.
Furthermore, while it's true the funding new ventures also contribute to wealth creation, and that lack of risk seeking capital would be a problem, it is simply not a problem that exists in our present condition as evidenced by the historically low interest rates. In fact there is an overabundance of capital in today's world. What is lacking is sound new ventures to invest in. If we were to further incentivize investment, we would only accelerate the formation of a catastrophic bubble.
Your understanding of macroeconomics is simplistic if you believe as you seem to do that more investing is always positive or that consumption is always negative.
Your entire argument is focusing on the micro, not the macro. Buying a house is an investment for the person who did it. But if the person you buy from turns around and spends the money on consumption, there is no net investment. One person shifted to investment, another shifted to consumption, the macro effect is zero.
A net investment in houses would involve more housing being owned than before. This would require more houses to be built, and this in turn would require people a shift of workers/materials/etc from other uses into housing construction. Present day consumption goes down in return for an increase in future consumption.
The result is that in the future, productive capacity has increased and more housing is available to consume.
If you want to see the result of a lack of real investment, look at SF. All sorts of games being played with money, but nominally wealthy people can't even afford a flat without roommates.
But as I keep trying to tell you, consumption is the motor of capitalism. It is the demand part of supply and demand. Without consumption, there is no production. And production is what creates all the wealth. Everybody would be poorer.
Why don't you explain the mechanism by which this occurs in real terms? I'm pretty sure you've wildly misunderstood Keynesian economics and are conflating the Keynesian cure for prideful workers (which we don't have now - full employment) for some sort of general growth prescription.
Your entire argument is focusing on the micro, not the macro
You were the one suggesting that investment should be exempt from tax. That requires a definition on the micro level of what constitutes investment, otherwise how do you determine whether or not some expenditure is to be taxed or not? From a practical point of view, how do you differentiate consumption from investment?
If you want to see the result of a lack of real investment, look at SF
Oh, so now there's more than one kind of investment, and only one is "the real kind"? As far as I can see, it doesn't get much realler than in SF: You've got risk seeking capital funding actual new ventures. As in actually creating new wealth. Provided of course that those new ventures succeed. Those rich people you talk of who can't afford to live there have the firstest of first world problems.
It's funny that you should mention SF, because it is a great example of what happens when there is an overabundance of capital and everyone is seeking to invest. You get investors taking on more and more risk to get a return on their capital and ultimately you get a bursting bubble. You see capital by itself does not magically cause value to be created, even when it is used to fund new ventures. If I build a house or a widget, or if I've performed a service, I've only created value, if that house/widget/service was needed in the first place. A man who invests in hotels on the South Pole or a sand selling business in the Sahara is actually destroying wealth. Just like everyone who invested in pets.com before the dot com bubble.
Why don't you explain the mechanism by which this occurs in real terms?
I'm not entirely sure what you mean by real terms? I can say it simpler terms if you like. It's not complicated: Imagine a supermarket. As people buy stuff, the shelves are gradually emptied. The shelves that are emptied first are the ones holding stuff that is most important i.e. valuable to people. Luckily the empty shelf is a great signal to whomever makes the stuff that gets sold in the supermarket to produce more of that stuff. There is of course a pricing component of that mechanism also, but that's basically how that works. If the producer of stuff is unable to keep up with the demand, then that's an opportunity to invest in a new factory that makes the same stuff. Of course not everything sold in supermarket is essential, but I'm sure you would agree that that doesn't mean it is without value. But if we were to tax everything sold in the supermarket heavily (and we would need to if we abolished other forms of tax), we would disincentivize buying anything except the bare necessities. If I understand you correctly, this is more or less the point. This then means that it becomes much harder selling anything other than the bare necessities, and as a consequence lots of businesses must close. Sure, there may be a tiny market selling motorized lawnmowers, but since everything becomes so expensive, most people will get by with a manual lawnmower. But this again means that people will have to spend more time mowing their lawns, and will have less time to do something else that could be valuable. And so on.
Look, I'm not saying that more consumption is always better. Clearly there comes a point at which people buy shit they don't need, and there is also a very real sustainability issue. It's a good idea to tax things like fossil fuels and cigarettes. But most of everything that's valuable gets produced because someone is willing and able to consume it.
"Real" = physical resources. "Nominal" = money. Standard econ terms.
Consumption is differentiated from investment in that consumption is stuff you intrinsically want, while investment is things you don't want except because it gives you other things later.
Again, standard economic terms.
Imagine a supermarket. As people buy stuff, the shelves are gradually emptied. The shelves that are emptied first are the ones holding stuff that is most important i.e. valuable to people. Luckily the empty shelf is a great signal to whomever makes the stuff that gets sold in the supermarket to produce more of that stuff.
How can they produce more? They haven't devoted any physical resources to building that new factory or otherwise upgrading their productive capacity.
But if we were to tax everything sold in the supermarket heavily (and we would need to if we abolished other forms of tax), we would disincentivize buying anything except the bare necessities. If I understand you correctly, this is more or less the point.
Consumption is differentiated from investment in that consumption is stuff you intrinsically want, while investment is things you don't want except because it gives you other things later.
That’s fine, but as I've argued previously, almost any purchase can be argued to fit either description. People do actually buy e.g. fine wine as an investment. How will the IRS determine if a purchase is an investment or consumption?
How can they produce more? They haven't devoted any physical resources to building that new factory or otherwise upgrading their productive capacity.
Presumably they make a profit from selling the stuff. And maybe they produce less of the stuff that doesn't sell well. But how do you even get that from what I wrote? Consumption is not antithetical to investment. I am not arguing against investment. It's not clear to me if you understand that investing does not automatically create a market. All those Chinese ghost towns we hear about are the result of investing in something for which there is no market.
This is completely NOT the point.
In that case I apologize for misunderstanding you. Still, it's an empirical fact that taxes act as a disincentive. And you would need to tax consumption very heavily if it were to replace current forms of tax. A large part of the population would simply not be able to afford anything but the bare essentials (if that) let alone have any money left for investment.
Read the Scott Sumner link I provided above.
I enjoy our discussion, but I am not interested in reading someone else make your argument for you.
The point is that a capital income tax penalizes consumption in the future relative to consumption today. A consumption tax treats them equally.
I am sure that's true, but so what? It's such an arbitrary point to make. It doesn't point towards any real world problem that we are having. The economic challenges that faces us today are not caused by people consuming too much today and saving too little for the future. Quite the opposite in fact. There is also no indication at all that there's any lack of risk seeking capital. It's never been easier to get funding for a new venture. In fact there are sign that it's become almost too easy, and that investors are taking on too large risks in order to get a return.
What then would you tax? Yachts and jewelry? At what rate? Do you think you could run any society on what could be collected on taxes on non-essential consumption?
> This implies that things like dividends should not be taxed, since no commerce occurs. All that happened is a piece of property split into two. Would you favor this outcome? If not, why not?
I'm fine with that, so long as the corporate tax side of the equation balances...companies use dividends to reduce their income and the taxes they pay. If a dividend is just splitting an asset in two, it shouldn't be deductible.
Dividends are paid with after-tax income. You might be confusing them with distributions paid by pass-through entities (where corporate income is treated as personal income by the owners).
>But that's a political non-starter; our western systems of taxation are built around the lie that the rich benefit disproportionately from our society.
Those who have more benefit more from a state of order. Be this material possession like money or natural qualities like beauty.
Fundamentally income and capital are fungible. A lot of tax avoidance schemes work by turning income into "unrealized" gains. The general solution would be to tax held capital as well as just income. (The rent on a house must be equal to the cost of the capital it represents, as otherwise there would be an arbitrage opportunity).
The problem with taxing held capital is that you are penalizing investment relative to consumption. I.e., a person who consumes today enjoys a much higher NPV of consumption than a person who invests today and consumes in the future.
That's by design, no? Consumption stimulates the economy better than investment does (particularly under present conditions), and by discouraging investment we disincentivize the concentration of wealth and the political problems that leads to.
Consumption does in fact help create inflation thereby reducing real wages and fooling prideful workers [1] into returning to the workforce. In the US we are currently at full employment so this is not actually beneficial.
In the long run investment - i.e. devoting resources to increasing future productivity - is what is needed. To clarify the distinction, investment is research in self driving cars while consumption is driving an existing car.
[1] Prideful workers (the villains in Keynesian economics) are the people who refuse to accept work at a lower nominal wage than what they previously earned. Instead, they sit on their asses enjoying funemployment.
We're at full employment in the sense that workers seeking a job can find one, but wouldn't that figure not count those "prideful workers"?
Consumption must grow at the same rate as production, right? So either can be the limiting factor on economic growth, and investing at a rate that doesn't match consumption growth is wasteful (it would be better for the economy if that money were expended on consumption instead), no?
No, Keynes' prideful workers certainly count as unemployed. They are actively seeking work, they just refuse to take work at wages that offend them.
Consumption must grow at the same rate as production, right? So either can be the limiting factor on economic growth, and investing at a rate that doesn't match consumption growth is wasteful (it would be better for the economy if that money were expended on consumption instead), no?
Yes, it's more or less true that consumption + investment = production. Investment is taking resources from consumption today in order to increase production in the future.
Let me make a software engineering analogy. Consumption = building cool, user visible features that product can show to upper management.
Investment = cleaning up tech debt, refactoring the code, or building massive infrastructure that (once complete) will enable many new features.
Product always wants new features. Whatever engineering can create, product will insist on deploying. If product insists on ignoring tech debt and refuses to invest in any infrastructure project, then eventually the rate at which new features are built will slow to a crawl. This is what happens when you shift from investment to consumption.
The idea of consumption increasing future wealth only applies in cases where production is below potential - where people could work but refuse to do so. The closest thing to stimulus I can cook up in my analogy is tricking lazy developers who refuse to work into actually working because you allow them to use node.js.
But if you spend all your time working on infrastructure and don't make any new features then you end up with something worthless too. So it doesn't make sense to "tax" employees more for doing one than doing the other (or rather, if you want to tax them at different rates you'd do so based on measurements of how much of each was getting done, not some a priori number).
If you read the Scott Sumner link I provided above, you'll realize why a consumption tax is actually the tax which doesn't favor one over the other.
The main reason is that investment is merely delayed consumption (as you note above), so the consumption tax hits everyone equally regardless of whether they consume or invest. However, a capital income tax is additional taxation that applies only to the person who invests.
I've had a second read and I think I see the contradiction. The article says it would be fine to tax GDP (and ultimately taxing all production should be equivalent to taxing all consumption). If I have x dollars of income, I can buy x dollars of beer, or I can buy a factory that will produce x NPV dollars of beer in the future. But the GDP in those cases would be different, wouldn't it? So in a tax-all-GDP regime I should be taxed on the x dollars of income now and, in the investment case, also on my investment income (or equivalently on my owned asset).
Economically there is no good reason to distinguish between these two cases.
So you are saying because anything that could be rented can also be owned, the government should get to tax it as if you rented it? This applies to all items that can possibly be sold and creates interesting areas for where something might be illegal but free to give and which still has a market value on the black market, of which income tax is still expect.
For example, if you two people have sex, they both need to pay the tax a prostitute would've earned.
It also makes every action taxable... even if all you do is clean your room, you aren't paying for someone else to clean your room and thus owe tax.
It's a special case of the more general case of taxation of non-market services.
Say A is a stay at home dad, B is his spouse, and C works at an office. B and C both make $10 per month and there is a 20% flat tax. So total tax revenue is $4. Now, say that A wants to live a life of leisure. So he hires C to do nannying on the side, and they pay her $3 per month. Now, total income is $23, and total tax revenue is $4.6. But the same amount of work is being done as before! All that's happened is an activity moved from the non-taxed domestic realm to a taxed market one.
It makes sense economically, but at some point you have to draw a line. Should I be taxed when I cook a meal for myself, because it's a valuable service that would cost $X if I had somebody do it for me? Should I be taxed based on the price of transportation if I walk somewhere? Breathing?
It seems that we typically draw the line at the individual or household. If not there, then where should it go?
I don't know the answer to this question, but it's clearly related to the fact that work done to maintain one's own household gets left out of pretty much every measure of costs or productivity. (I suppose it's probably some form of externality. I ought to study more economics.)
Given traditional gender roles, this is one factor that has historically led to massive undercounting of women's total contribution to the economy, which could potentially lead to distortions in selecting good public policy. (It's certainly not just a women's issue, but that's one of its big impacts.)
This isn't even taxation of non-market services, this is just taxation of in-kind benefits. In much the same way, if YHOO were to give BABA shares to it's shareholders (non-market goods?), that would be subject to taxation.
This contains the massive assumption, which is repeated throughout every economic textbook I've ever seen, that staying at home taking care of kids doesn't count as labor or economic activity. The free labor donated to the economy by stay at home moms and dads would throw off everyone's equations if they ever bothered to count it.
We're talking about the case of a house someone is choosing to live in: You! Obviously its rentable; the question is the price (and it's one of the practical issues with taxing imputed rents; just like with Vanguard it's a difficult question to figure out what rent you would negotiate with yourself in an armslength transaction).
It is an imputed rent tax[1], which is in addition to property taxes. A property owner renting out a property would pay both property tax and then income tax on rent collected. This tax reflects that for owner-occupants.
Which makes sense for owners of multiple dwellings , but I've read plenty on the subject and still find the explanation a far reach.
The basic idea of if you and I both owned a house and rented it to each other is crazy. It would never happen, and is a hypothetical invented to extract taxes.
One of the key concerns with income taxes is minimizing economic distortion. That happens when you tax some activities more than others. If you get rid of imputed rent taxes, you have to raise taxes on everyone else to make the same revenue. If you do that, are you artificially subsidizing home ownership and causing more than the economically efficient balance between owning and renting?
I think the key difference is whether the distortion is intentional or just incidental. All things being equal, we'd prefer fewer incidental distortions of smaller impact.
As for intentional distortions, I think the idea goes that they're all harmful in some way (some more than others) but that the benefit of behavioural change can outweigh the cost. I don't think that would be a terribly controversial statement among economists.
Vanguard is a mutual company though, where all of the investors are owners. They're competing against for-profit investment agencies.
"Vanguard is the only investor-owned mutual fund complex in America. We are known for many things—including our low fees, our commitment to high-quality client service, and our indexing expertise—but I would say the single most defining characteristic about Vanguard is our ownership structure. The Vanguard® funds own The Vanguard Group, which in effect means that the investors in our funds own Vanguard. Unlike other fund firms, we don't have stockholders or a parent company to please. Our mutual ownership structure enables us to focus clearly on the interests of our investors, without the potential conflicts of interest that can occur at other firms."
Its a very good, trustworthy company. But its also one of the 800lb gorillas of investing.
I wouldn't be too worried if someone decides to take a swing at Vanguard. I do consider Vanguard to be "good guys" but they're also so huge that its hard to imagine them getting hurt from a few feeble media attacks.
It's also worth observing that fund and asset management is one of those areas where the more successful a manager you a the lower the fees you charge. People are used from other areas with higher fees = better. However a good manager can charge lower fees on a much larger pot of money and make an awful lot more than a worse manager charging higher fees on a much smaller fund.
This is untrue. Good investments are often capacity constrained. In this scenario it makes sense for managers to charge high fees to investors to allow them access the best products.
A) You need to build up to capacity, so you've got a multi-billion dollar fund already by that point that is charging low fees and presumably doing very well. You just close it to new business until outflows make space.
B) You can win major plaudits by lowering client fees. Guess what - when investment performance inevitably goes through a bad patch the client will stay with a manager they like for a lot longer than one they don't. That gives you time to recover performance and avoid a yo-yo effect.
If your manager is telling you that you need to pay high fees because they're popular you are being ripped off.
The argument falls flat on its face, because if Vanguard did charge higher fees, they would lose what makes them unique in this space, and money would run away from them. It's an open question of whether or not the Vanguard would make more revenue or not.
It's a lot less crazy than it sounds, because they are wholly owned by Vanguard. So the customer is effectively setting the fees.
There are certainly scenarios where you could see how this is clearly abusive. As a contrived example, imagine if Apple moved its legal headquarters to Ireland and made California into a subsidiary. They would still have to pay the California subsidiary for the design services it provides, but they could set those fees at way below market price and thereby shift all tax liabilities to a lower tax jurisdiction. We have transfer pricing rules in place to prevent this.
The situation is more complicated than this because the fund (the client) is not a profit-seeking corporation, so it's not arbitrarily moving funds around. It's an odd scenario where the customers are also the owners.
In the context of B2B it's not at all odd, you're right. (In fact, that's the whole reason transfer pricing rules exist.)
In the current era, it is however uncommon for consumers to simultaneously own and (exclusively) be the customers of a company. (Historically, that is of course the entire principle of mutual funds.)
Depending on structure, co-ops often do face special tax reporting requirements.
Moreover, in this case the fact that Vanguard is a co-op is a redeeming factor. If it were a typical corporation charging itself below-market transfer prices, that would likely be illegal.
Honest question: if the California subsidiary is able to provide those services at the set fees (i.e. pay salaries, etc.), how can it be considered "below market price"? Is it required by law to make a profit?
It's fairly nuanced and there are different standards used, but one key one is arm's length pricing. You need to charge what you would charge an arm's length customer (ie. market price).
Another standard does, in fact, set a minimum level of transactional profit based on comparable businesses. [0]
No, because it isn't the investors who avoided paying taxes. If they had been expensed at market rate, their return (and therefore tax burden) would have been lower, not higher.
That being said, in principle it's all mostly the same since investors own Vanguard.
What? I fully read the article and also Matt Levine's take. [0]
I'm well aware what a mutual fund is and, for the record, think this case is pretty stupid and unlikely to be won. But it's important to understand that there actually are tax principles in play here.
Have you heard of transfer pricing? I suggest reading anything.
An auditor friend told me a story about a company that opened a subsidiary to do all their vehicle leasing for the company cars. By charging the main company only their costs, this subsidiary was able to show 0 profit, and so they avoided paying some higher tax rate on the cars they were leasing. (I've probably simplified the story to the point of nonsense, but that was the basic idea).
You can see why that sort of thing would be illegal and that kind of subsidiary would be legally required to charge the market rate for the services they were providing.
Forgone fees go to the fund's investers, who are also its owners. And capital gains by investers are taxed, just as they are for other funds. Maybe they're taxed at lower rates than profits of other funds are taxed. But that's just because the fund manager is a not-for-profit.
That's the crux of the issue. Vanguard Group presents itself as offering it's services at cost, when in fact it's a for-profit company. As a for-profit company, according the laws that stand today and if you believe the claims of the plaintiff, it has to offer it's services at a competitive market rate.
Of course, that doesn't mean it can't rebate the profit back to the funds which could then apply it as a fee rebate. That should be totally legal, as long as it pays taxes on the profit before it issues the rebate.
This whole territory has been explored before, by the way. Mutual insurance companies used to have this same problem, and eventually Congress just added another carveout to 501(c) and made the problem go away. That's the other alternative here, and it's definitely cleaner and probably better for society as a whole.
> it has to offer it's services at a competitive market rate.
It's asset-weighted fees are approximately 1/6 of its competition. That seems pretty competitive to me.
Less bombastically, who decides what a competitive fee is? If they charged 1/2 market rate would this suit have ever been filed?
If they were operating at a loss I think it'd be pretty easy to claim they were avoiding taxes and should be operating at break even. But they are operating at break even, so I think it's hard to make the argument that they should be charging more "just because other firms do" and not come off as just some opportunist trying to cash in on a whistle-blower payout.
It's complicated by the fact that a non-negligible portion of the funds are held in retirement accounts where potentially no taxes are paid on the returns.
The issue is they are charging themselves a lower fee, instead on an "arms-length" (higher) fee that they would to a third-party. Somewhere in there, I suspect, is an argument that the lower fees are designed to avoid taxes, rather than reduce costs.
That only applies if it is, in fact, legal. We have specific laws in place to prevent corporate tax evasion through unrealistic transfer pricing, and it's unclear if Vanguard falls afoul of those rules.
Yes, in general that's the goal of transfer pricing. However, the way the rules are written it's not clear if they also apply to this case, particularly because the IRS does not recognize intent as a factor in transfer pricing rules.
To be clear, I do think this should be legal and kosher. But I sort of see how the argument could be made.
Right, the "as long as it's legal" is the interesting part. For instance, what if you have two entities, one of which is a "for profit" which pays full taxes, and then another that is somehow placed in a different preferential tax bracket. By shifting/transferring all of the costs to the higher tax bracket entity, and having it further reduce profits by charging low fees, and moving all of the resulting "profit" that then accrues to the lower-taxed entity.
How, and when you can engage in such activity I'll lead to tax attorneys, but it's not a no-brainer "You should always be able to charge lower fees and transfer profits away from one entity to another." There is some nuance.
Call it a trial balloon, before someone in Congress brings up similar against Vanguard and others. Would not be the first time a proxy was used to float a silly idea that just picks up steam.
Not at all. Vanguard, thanks to Jack Bogle, is virtually the sole outlier in the entire financial industry, which largely views its customers as an annuity to be tapped. They have many, many competitors which would be overjoyed if Vanguard were essentially forced by the courts to charge the "market" rate, thus eliminating their competitive advantage.
Yes, long term Vanguard client here. Because I opted to go with someone with lower costs the other funds are unhappy and want Vanguard to pay more in taxes?
So does the shoe then fit if Vanguard triples their fees making them the most expensive, do the other management companies then need to pay taxes on the difference between their now lower fees and Vanguards?
I think this is a ploy by the management firms that are being undercut and in a tight market (or a down market) the management fees become important.
> I think this is a ploy by the management firms that are being undercut and in a tight market (or a down market) the management fees become important.
I'm pretty sure it is almost exclusively a ploy by David Danon (who brought this complaint) to extract a massive whistleblower fee.
Good point. I'm pretty sure that Vanguard has thought this through. The article says "Danon collected a $117,000 whistle-blower bounty in Texas in November, meaning that Vanguard paid the state at least $2.3 million. It’s possible that Vanguard’s payment had nothing to do with the fee issue." So I'm going to guess it's some other arcane thing they missed.
If this lawsuit succeeds, then we'll live a surreal world where financial companies are routinely hammered for charging high fees...and for charging low fees. Perhaps we should have a state-mandated price list for all financial services.
Actually, Sanders proposed postal banking. That's not the same as Vanguard extending mutual ownership to the fund managers, but it's roughly the same effect: Retail banking and investing is a rip off in many cases, and having an alternative structure is going to save the small investors and retail banking customers many tens of billions of dollars.
I'm going to report David Danon to the IRS. He could have made more income as Wall Street corporate lawyer instead of working for Vanguard as a tax lawyer. The extra income he could have made would have resulted in more income taxes to the government. Obviously, he is a tax dodger.
This is a very good read and it lead me to think about this somewhat differently.
The whistleblower is making the case that if Vanguard had kept all the profits then there would have been a $34B tax bill. But that's an assumption. It's far more likely that Vanguard would have paid out the extra money as a dividend so that there was no profit. Or they figure out some way to pay it out as extra shares in the investments, perhaps there is some way to make it be like unrealized gains so that there is no tax event until you take it out.
Can anyone who has some background shoot holes in the thoughts above?
To me this case looks shaky but I'm not a lawyer, tax guy, or even much of an investor (I do have money at Vanguard for whatever that is worth).
Dividends are paid from after-tax earnings, so they can't get out of corporate income taxes that way. As the article said, they could give most of the profits back to the fund owners as dividends, but the government would still get getting more tax revenue from Vanguard than before.
This article seems to lean heavily on the argument "if the law said this, it would have bad consequences; therefore, the law doesn't say this", complementary to the popular argument "this thing is bad, therefore this thing is illegal / unconstitutional".
Slightly off-topic: a lot of Vanguard's ETFs are synthetic. Is there anyone who can say something about the risk involved in this in contrast to non-synthetic ETFs?
Edit: As it turns out most or all of Vanguard's ETFs are physical.
ETFs, in general, involve greater risk (in addition to) than the underlying equity. In Singapore, average consumers (those without a background, or higher degree in Finance) are not allowed to purchase (even through their broker) an ETF without first having taken a series of course material, and exams. (pretty good idea if you ask me).
From the course, they highlighted synthetic replications risks as consisting of credit risk of the counterparty when swaps are used by the issuer to exchange, performance of the assets held by the ETF for the performance of the underlying index. Blackrocks' IVV [1] has a cost structure of 0.07%, which is pretty good - and does an extremely good job of tracking the S&P500. It uses, "Representative Sampling" - from their prospectus [2] BFA uses a representative sampling
indexing strategy to manage the Fund.
“Representative sampling” is an
indexing strategy that involves investing
in a representative sample of securities
that collectively has an investment
profile similar to that of the Underlying
Index. The securities selected are
expected to have, in the aggregate,
investment characteristics (based on
factors such as market capitalization
and industry weightings), fundamental
characteristics (such as return
variability and yield) and liquidity
measures similar to those of the
Underlying Index. The Fund may or may
not hold all of the securities in the
Underlying Index.
I traded ETFs and their synthetic equivalents professionally for about 6 months. Take this as an incomplete answer. As Zr40 said, they do have a large number of non-synthetic ETFs, so I'm not sure if they actually do use synthetic ETFs, but I'll address your question independent of whether or not they do.
A potentially major relative risk I can think of for synthetic ETFs vs real ETFs would be that it could diverge due to updates in the composition of the fund - particularly if a stock is removed or added. If the fund previously held a large position in a stock and decided to replace it, then that action will likely have a negative impact on the price of the stock, and you will only get knowledge of the fund adjustment the morning after or possibly later. This means when you readjust your synthetic position, you'll do so at inferior prices, which could hurt returns. Likewise, you'll probably buy new inclusions at a higher price. I saw this happen a couple of times - and usually within particularly volatile sectors with small cap companies where an ETF might come to hold a large chunk of a company.
That being said, I'd wager this effect doesn't outweigh the management fees charged for even the most frugal ETF, so creating it synthetically might be a good deal if you've got the manpower and cost structure to adjust your position regularly - or if you don't mind a bit of divergence. I'd be interested to hear other opinions on this as well.
This list is incomplete. I own some VSTAX (Vanguard, .04%) and FUSEX (Fidelity, .04%) etfs, neither are on this list. I've seen even lower mentioned at Vanguard (The "institution" version of VSTAX, .02%)
I assume by VSTAX you mean VTSAX? That is on there as the ETF version is VTI. And institutional versions of the fund are not ETFs... they are only available to institutions, and for the .02% rate, you need to invest 100MM, which is the opposite of being exchange traded.
> You can't really compare costs of managed funds and ETFs.
You seem to be conflating management style with how something is traded. ETF just means it is traded on an exchange. An ETF can be actively managed. And a mutual fund can be passively managed.
Tax should be on profit, not revenue or turnover. By offering lower fees, Vanguard transfers wealth from the investment fund industry to the consumers of its products.
I see no difference between what Vanguard is doing here, and what WhatsApp did for instant messaging - disrupting an incumbent industry with a new and cheap option.
I don't see how anything about it is wonky. Care to explain?
The difference is that Vanguard is owned by it's customers so the low fees are transferring wealth from the consumers back to the consumers while (allegedly illegally) lowering their tax bill.
It's the ownership structure that makes things different.
Vanguard is mutualized. This means the Funds own the Investment Manager. Unsurprisingly, the Funds vote for lower fees. The result is Vanguard charging its funds staggeringly lower fees than average [2]. This also means Vanguard makes less profit than competing Investment Managers.
Enter this guy [3]. He observes Vanguard paying less tax (on account of making less profit) than its competition. He concludes that Vanguard is dodging its tax bill. Vanguard, he argues, should be taxed as if it charged the higher fees it doesn't. They should also pay the back taxes they would have owed if they had charged these fees and earned those profits, again, that they didn't. This last part is helpful because he likes the whistleblower bonus the IRS would pay him if the case succeeds [4]. (Or maybe not [5].)
If this sounds bonkers, it's because it likely is. We don't tax SpaceX as if it were bilking the U.S. government on par with its competition. In any case, the boosted post-fee gains from Vanguard's funds are still taxed at the individual level. But my pie is better than your pie and so the idiots get their air time.
[1] http://www.wineinvestmentfund.com/disclaimer.aspx?url=http:/...
[2] https://investor.vanguard.com/mutual-funds/low-cost
[3] https://www.linkedin.com/in/david-danon-a0a5017
[4] http://www.newsweek.com/2015/12/25/vanguard-whistleblower-ta...
[5] http://articles.philly.com/2015-11-19/business/68386489_1_da...