January 9th, 2003


Taxation and Corporate Behavior, or, Why I Don't Like Taxing Dividends

A lot of us don't consider the distorting effect that taxes have on behavior -- mostly because we don't see ourselves taking a lot of actions to avoid taxes.

But taxes do have a considerable impact on the way even individuals do things. For example, over half of the money I have saved is with an asset management company, called "American Funds". Not because I like them; in fact, I don't. The funds that I have to choose from have higher costs than I'd like, they're actively managed and I'd rather buy an index fund, and many of their biggest holdings are with companies that I hate. Or they have investing strategies that I dislike. I'm not happy with them.

Oh, they’re not horrible, as far as I can tell, but they’re far from my ideal. I’d much rather have all my investments in Vanguard's funds; I particularly like their index funds.

So why do I have all this money with American Funds and not Vanguard? Because the company that administers my 401k only offers us American Funds (and only ten of their products, for that matter.)

And the tax advantages of investing through a 401K are huge. When money’s put into a 401k, it’s tax-deductible, and it grows tax-deferred. The employer-match I get from Toddler Bank is negligible compared to the advantages of having money grow tax-deferred. But I went over all that in this enty, so I won’t do that again.

Another common way that taxes distort behavior is the home mortgage interest deduction. This gives a tax incentive to have a long-term mortgage on your own home. It encourages people to stay heavily leveraged in their homes, because it’s more tax-efficient to use the money that might pay off that loan for another investment. (“Hmm, I can use this $100,000 to pay off my home mortgage, and lose my $5,000 a year tax deduction, or I can buy stock with my $100,000 and continue to make loan payments and get the tax deduction.”)
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