One puzzle about this presidential campaign is why more middle-class Americans haven’t embraced Mitt Romney’s most detailed tax proposal: his plan to eliminate all taxes on investment income for those earning less than $250,000 annually. After all, Americans support innovation and free markets, two Romney planks that should fit well with a tax break for investments. The reason no one seems to care points to why the Romney campaign has struggled.

Romney’s idea is economically sound. First, it would eliminate a huge distortion in the marketplace. Right now, middle-class Americans can reap tax-free investment gains from the sale of their homes. This Clinton-era policy helped encourage people to put too much of their wealth into the residential real-estate market, and we know how that turned out.

Second, it would encourage more Americans—particularly younger Americans, who have never experienced a stock-market boom—to become long-term stock investors, something the economy needs. As Edward Conard, a former Romney colleague at Bain Capital, points out in his new book, Unintended Consequences, too many American investors choose to put their money in debt, rather than in stocks. The rush to “safe” financial instruments such as bonds creates a herd mentality that makes such investments less safe.

Romney’s idea hasn’t caught on, though, because Americans seem uninterested in putting their hard-earned savings into stock investments. And who can blame them? Anyone who reads newspapers can see that the stock market is rigged. Exchanges and other stock-trading venues favor high-speed, high-volume traders over the little guy or gal, as whistleblowers and congressional investigations have made clear. Stock trading is murky rather than clear: the term “dark pool,” Wall Street shorthand for activity that traders don’t want the public to see, says it all. Events such as the May 2010 “flash crash,” which sent the stock market plummeting 1,000 points within minutes for no real reason, have further harmed confidence.

Consider in this light Facebook’s initial public offering this past May—the first big stock offering in a long while to capture major public attention. One investor told the Wall Street Journal that he bought some shares for his 11-year-old daughter’s college fund because his daughter, already familiar with Facebook, had asked him to do so.

The Facebook IPO could have encouraged people to get back into the market—but Wall Street blew it. Nasdaq, the exchange that handled the offering, had to halt trading when it couldn’t complete orders; many investors had to wait for days to find out whether they had even purchased the stock. Then, of course, the price fell, from $38 on the first trading day to $21 as of this writing (it was even lower over the summer). Allegations abound that underwriters withdrew key information about Facebook ad revenue from small investors, even as they let big buyers in on the gossip.

No wonder nobody wants to take Romney up on his offer of tax-free stock-market gains. To many, that sounds like a sure route to losing money. What to do if you’re the candidate? Romney should couple his tax proposal with a pledge to reform the stock market. He could give a speech saying that he understands that the stock market, the underpinning of American capitalism, is badly dysfunctional, and he should ask why President Obama doesn’t seem bothered by it. He should say that as president, he would make the stock market and other stock-trading venues play by a uniform set of rules—whether they’re dealing with a billion-dollar hedge fund or a worker with $1,000 to invest.

Americans may still be fuzzy on their understanding of credit-default swaps, but they get the stock market—and they used to like it. If Romney started talking about how to make it work again, they would listen.

Donate

City Journal is a publication of the Manhattan Institute for Policy Research (MI), a leading free-market think tank. Are you interested in supporting the magazine? As a 501(c)(3) nonprofit, donations in support of MI and City Journal are fully tax-deductible as provided by law (EIN #13-2912529).

Further Reading

Up Next