Congress’s Stealth Tax | Wall Street Journal | 06.24.02

Congress is racing to enact an accounting reform bill. But have the members stopped to consider the fine print? If they did, they would find in the Senate version of the legislation a provision with the potential to cause more havoc in our markets than a dozen Enrons.

The bill, written by Sen. Paul Sarbanes (D., Md.), would create an accounting oversight commission. Instead of Congress giving this entity a budget, the new agency will simply determine what it needs each year, then assess each publicly traded company in the nation, based on the company’s proportion of the total market capitalization of all publicly traded firms. In other words, for the first time in U.S. history, Congress is prepared to enact a tax, not on income, not on sales, but on capital, and one that is determined by an unelected bureaucracy, not by the legislative branch.

“Cost of capital” is a concept absolutely central to all financial thinking and all but lost on most Washington policy makers. In essence, if a company or industry’s return on investment exceeds its cost of capital, it tends to draw more investment, either through reinvested profits or successful stock offerings. If returns don’t make the mark, investment goes elsewhere.

It doesn’t take an MBA to see that a tax of a 10th or even a 100th of 1% on a company’s market capitalization is little different from increasing interest rates by the same amount. The latter boosts the cost of debt financing, the former of equity.

It doesn’t take a Ph.D. in economics to see that with the Federal Reserve Board having dropped interest rates farther, faster in the last year-and-a-half than at almost any time on record, desperately trying to boost a faltering economy, a tax on equity capital goes in exactly the wrong direction at the most delicate possible moment.

And it doesn’t take even an undergraduate degree in political science to know that new taxing mechanisms tend to start small and grow unimaginably, just as the income tax itself did.

Normally the pro-market Republicans in the House could be expected to block such a mad move. But the GOP House of 2002 seems to view the accounting reform legislation in the same way as the Republicans of the mid-1990s viewed the Independent Counsel Act. A broad cross-section of the GOP opposed that now-notorious law on Constitutional principle. And yet when it came up for renewal, the GOP-controlled Congress reaffirmed it by an overwhelming vote. It was a product of Watergate, a Republican scandal, and so long as the Democrats favored it, Republican congressional leaders didn’t feel they could take it on. Only when the Democrats experienced its destructive potential during their own presidential scandal did a consensus form, and a bad law was dropped from the books.

Similarly, now the House GOP leadership fears that President Bush’s “close identification” with corporate interests and the party’s pro-market tradition mean that any hesitation in embracing the Senate legislation — even insisting on the House’s Constitutional obligation to originate tax legislation — will attach the taint of the financial reporting scandals to the GOP. No matter how destructive the bill, House Republicans want no controversy in dealing with the Senate on this issue.

But why should they be so fearful? According to a recent poll, a slight majority of Americans place responsibility for the ethical lapses of a small number of corporate chieftains on the ethical lapses of the Clinton years, the period when these corporate excesses began. Indeed, the policies of the Clinton administration may have contributed directly to the scandal’s development, with the Securities and Exchange Commission starved for funds in one Clinton budget after another. And with their dramatically greater dependence on big dollar individuals and corporate donations, the Democrats are at least as vulnerable as the Republicans to the taint of this scandal.

Still, with the Democrats seeking an issue that will help sink the president’s buoyant approval ratings before November and the Republicans running scared, Washington is racing forward in what amounts to an anticorporate jihad — not only preparing to tax capital but threatening to tie up CEOs in criminal prosecutions and civil suits every time a zealous prosecutor or trial lawyer decides to challenge accounting choices that are inherently ambiguous.

With the market spiraling downward as the reform legislation approaches passage, official Washington might remember a previous market collapse. It took decades to recognize that Congress’s rush to pass the 1930 Smoot-Hawley bill, not the “malefactors of great wealth” or Keynes’s “animal spirits,” triggered the Great Crash of 1929. Market movements such as we’ve seen over the past week have almost always been a product of disastrous political decisions. It is hardly likely that this time is an exception. The first step toward a recovery would be to junk the Sarbanes bill, or at least radically revise it.