From personal experience I have come to understand the disincentive effect the current tax regime has on saving and investment.
My wife and I decided a few weeks ago we would try to set aside a little money each year to invest in the stock market - probably between $1,000 and $2,000 (most of our extra cash goes toward our children's college education).
We thought investing in the stock market would be fun, educational for us and the children, and might give us a better return than the money would earn in a passbook account, or even in a bond mutual fund.
But then I began to think about it in more detail. Mostly likely, the best we could do as "hobby investors" would be to equal the long-term market return over several years. That would give us a return, before taxes and expenses, of better than 10% per year.
After expenses - in the form of trading costs - the return would be considerably lower because we would be buying small amounts of any stock. Even with a discount broker, the transaction costs would hurt.
And then there were the taxes.
After transactions costs and taxes, our market-equaling return probably would drop to between 5% and 6%, perhaps even lower.
That would certainly be better than the after-tax returns on a passbook account, or even bonds, but would it be a better "after-aggravation" return?
Our tax return is relatively simple, yet it still takes several hours to pull together all the documentation the accountant needs to prepare the return, not including the filing that goes on during the year.
Keeping track of buying prices, selling prices, dividend payments, etc., for tax purposes would, I imagine, be a pain in the neck and would complicate our tax situation.
Is the likely after-tax "after-aggravation" return high enough to be attractive, to offset the lure of the instant gratification we might experience by spending that money on Broadway shows?
We haven't decided. If we decide to save the money, we probably will invest it through no-load mutual funds with a major mutual fund company, the administration services of which will do most of the record keeping for us. But the fun quotient won't be as high. Broadway might yet win out.
The equation would be very different with a flat tax. The tax situation would be infinitely simpler if dividends and interest were not taxed at the personal level, and if capital gains were taxed at the same 17% to 20% rate that would be levied on ordinary income.
A flat tax probably would simplify things so much that the "after aggravation" return would be high enough to offset that lure of instant gratification.
One shouldn't extrapolate from a sample of two (my wife and me), but I suspect there may be hundreds of thousands of other potential small investors who have decided the "after aggravation" return is not high enough. A flat tax might indeed increase saving and investment, as its proponents claim.
