An argument against the capital gains tax

Guest Column

Jarosław Dominiak is president of the Individual Investors' Association (SII). He can be reached at jdominiak@sii.org.pl.

Regardless of the country in question, the actions of finance ministers rarely ever receive the accolades of the general public. This is primarily because there is rarely ever enough money in state coffers to satisfy everyone in terms of how the money is allocated. Another no less important responsibility of the finance minister is the type and amount of taxes paid by citizens.

In the last few months we have been witness to preparations for a financial reform program, in which a revolution in taxation is to play a key role. But at this stage of the plan, the actions of the Finance Ministry no longer bring to mind the standards that such an organization is obligated to meet in European countries.

One good example of this is the current proposal to introduce a capital gains tax on individuals. Stock markets are extremely fragile and sensitive to even the smallest of disturbances, including uncertainty caused by increased tax burdens. The idea to end the tax-free status of profit made on the stock exchange has met with considerable resistance from all branches of the capital markets industry.

It would be worthwhile to note, additionally, that the current government presented its strategy for the development of Polish capital markets only a year ago, and the deputy prime minister at that time emphasized that, should there be a tax introduced on capital gains, investors would have a minimum of one-and-a-half year's advance notice. Additionally, in order for the tax to be optimal, its form was to be widely consulted about with society as a whole. Unfortunately, the Finance Ministry has not lived up to any of these promises.

Among the strongest arguments against this tax is the risk of a continuing decline in market investment among small investors. Research carried out by SII from February to May of this year indicates that more than 50 percent of investors would reduce their engagement in the stock market if this tax were to be introduced, while for 25 percent of those surveyed the tax-free status of money made on the markets was the greatest incentive to invest in the first place.

To make things worse, the number of investors on the market has been falling rapidly for the past three years, so a scenario whereby shortly there won't be anyone to collect capital gains taxes from doesn't seem too pessimistic.

Another argument against a capital gains tax is its doubtful economic sense. Adopting a variety of different models, we can expect the government's purse to increase by zł. 30 million-zł.150 million (gross), but this is not taking into account the various costs associated with setting up new procedures for counting and collecting the new income. The dynamic nature of financial markets and the wide variety of financial instruments available to investors will ensure that collecting the tax will not be a simple thing. For this reason, the costs associated with collecting the tax will significantly decrease the income generated through it.

Equally important are the apparent non-budgetary effects of the tax. A decline in market liquidity, an additional burden on already weak financial vehicles and decreased access to capital for small and medium sized enterprises are the most serious effects of introducing such a tax without first carrying out a proper market analysis.

Such determination in favor of the tax as we have seen on the part of the Finance Ministry cannot be explained by the need to adapt the taxation system to European Union standards. In the EU there are countries where the capital gains tax rate amounts to zero percent (for example Holland and Belgium), while in others the tax system includes significant incentives to make long-term investments (Denmark and Germany). This approach among countries with a much more developed financial culture proves that perceiving taxes solely as a way to maximize government budget income is a mistake.

By ignoring the calls of capital market participants, the Finance Ministry is taking upon itself total responsibility for the strategic mistake that this tax, in its present form, could prove to be. Let us hope that somehow reason will prevail, and we will have a discussion of the merits of this tax once Parliament begins to consider the proposal.