The Market Institute President Charles Sauer has a new article out in RealClear Policy on a new proposal by Senator Ron Wyden on the tax treatment of ETF’s.

He writes:

“Senate Finance Committee Chairman Ron Wyden recently proposed a policy that would change the way that exchange-traded funds (ETFs) are taxed. Not only would it not bring in additional revenue but it is also proof that our government is too big. Senator Wyden’s proposal is a band-aid on a band-aid to a policy that was written to address something that shouldn’t have been needed in the first place.

ETFs are great. They are an investment vehicle that large and small investors use to diversify their holdings. They give small investors the ability to invest like big investors, but without the overhead. And, there are ETFs that fit just about anyone’s tastes, risks, political leanings, or moral philosophies. They are diverse, abundant, profitable, and interestingly have some tax advantages that make them even more attractive – or efficient which is the key in this case.

Under the current system of taxation ETFs make sense. They shield investors from paying capital gains taxes on every purchase or sale of holding in an ETF. This doesn’t exempt investors from paying capital gains, but they pay the taxes based on the sale of the ETF, not the buying and selling of the funds underlying the ETF. As Dave Nadig recently wrote:

The reason ETFs are allowed to do this goes back all the way to a 1935 Supreme Court ruling that gave birth to the “General Utilities Doctrine,” which allowed corporations to just hand out securities to any shareholder for any reason with no gains (which was probably over-broad). It was repealed in 1986, but Registered Investment Companies (ETFs, Mutual Funds, CEFs) get a pass from a combination of two other pieces of regulation: Section 311(b) basically says, “you gotta pay taxes when someone hands you appreciated property,” but a different piece of the code, Section 852(b)6, gives RICs a pass on those rules — essentially allowing ETFs to do what ETFs do…

So, the government created regulations, the Supreme Court decided that these were too broad and tried to fix the problems, later other band-aids were added, and finally ETFs were created to fill a demand. Now, Sen. Wyden wants to put yet another band-aid over this “loophole” that isn’t a loophole, in an attempt at best to raise money (it won’t) and at worst to hurt mom and pop investors (it will).

The proposed ETF tax is poised to punish middle-class families. The American people elected Joe Biden on his repeated promise not to increase taxes for anyone making $400,000 or less. However, the median household income of households owning ETFs is $125,000. The tax would break President Biden’s promise while increasing costs on the middle-class families who have come to rely on ETFs for their finances.”

Read more on why this proposal would harm small investors by heading over to RCP for the full article.