Vanguard's Low Blow
bloombergview.com
bloombergview.com
Vanguard is mutualized. This means the Funds own the Investment Manager. Unsurprisingly, the Funds vote for lower fees. The result is Vanguard charging its funds staggeringly lower fees than average [2]. This also means Vanguard makes less profit than competing Investment Managers.
Enter this guy [3]. He observes Vanguard paying less tax (on account of making less profit) than its competition. He concludes that Vanguard is dodging its tax bill. Vanguard, he argues, should be taxed as if it charged the higher fees it doesn't. They should also pay the back taxes they would have owed if they had charged these fees and earned those profits, again, that they didn't. This last part is helpful because he likes the whistleblower bonus the IRS would pay him if the case succeeds [4]. (Or maybe not [5].)
If this sounds bonkers, it's because it likely is. We don't tax SpaceX as if it were bilking the U.S. government on par with its competition. In any case, the boosted post-fee gains from Vanguard's funds are still taxed at the individual level. But my pie is better than your pie and so the idiots get their air time.
[1] http://www.wineinvestmentfund.com/disclaimer.aspx?url=http:/...
[2] https://investor.vanguard.com/mutual-funds/low-cost
[3] https://www.linkedin.com/in/david-danon-a0a5017
[4] http://www.newsweek.com/2015/12/25/vanguard-whistleblower-ta...
[5] http://articles.philly.com/2015-11-19/business/68386489_1_da...
The basic idea of if you and I both owned a house and rented it to each other is crazy. It would never happen, and is a hypothetical invented to extract taxes.
Economists might agree with that but politicians certainly wouldn't. The whole USA tax code is set up to reward some activities and punish others.
As for intentional distortions, I think the idea goes that they're all harmful in some way (some more than others) but that the benefit of behavioural change can outweigh the cost. I don't think that would be a terribly controversial statement among economists.
The banks are now paying 1%-1.5% but you still have to pay the tax man 2% - so your capital actually goes down. It's an implicit negative interest rate.
So people like me who didn't get a 6x mortgage* and live frugally end up subsiding my Audi-driving, 6x mortgage, overspending & debt-heavy "friends". The same people who have cause this situation by their dangerous borrowing.
* houses are how you fix this: the value in the house isn't seen as capital so it's not taxed, plus you can deduct interest payments from income taxes; i.e. the entire system is designed to increase property values.
So I'm paying the tax man 1.15% APR on my savings.
It's almost enough to make me move back to the UK: tax there is much lower and the wages are 50% higher in my niche.
The "huurwaardeforfait" is just a handy political fiction to get more taxes from home owners, who are subsidized a lot because mortgage interest is deductable. It was probably politically easier to get a law for a new tax through parliament than to lower the mortgage deduction at th etime.
The OECD recommends that member nations tax imputed rent because it improves fairness between renters and owners.
A randomly Googled link that explains it more: http://economix.blogs.nytimes.com/2013/09/03/taxing-homeowne...
Every time I masturbate I should be taxed on my profit made as a prostitute.
Probably because he needlessly brought a controversial issue into the discussion (prostitution).
The taxi issue is, in fact, interesting. Especially when you extend it to Uber. If your capital comes in the form a vehicle, you apparently aren't required to pay imputed rent but if it's a house you do.
That being said, the labor issue muddles this. You could argue that when you get a taxi you're paying exclusively for the driver's time, not the vehicle.
It's disappointing to imagine HN voters being so censorious as to downvote perfectly topical mentions of prostitution.
Imagine an alternate scenario. You own a home, but rent it out. Also, you rent an equivalent home from another person. In this alternate scenario, you'd have to pay income taxes on the rent you receive. Similarly, if your employer gave you free rent in a house they owned, you'd need to pay tax on the value of that rent.
Economically there is no good reason to distinguish between these two cases. It sounds like NL is doing things right, or at least righter than the US.
"Property can be rented for profit" and "Your specific property can be rented profit" are different assertions.
Say A is a stay at home dad, B is his spouse, and C works at an office. B and C both make $10 per month and there is a 20% flat tax. So total tax revenue is $4. Now, say that A wants to live a life of leisure. So he hires C to do nannying on the side, and they pay her $3 per month. Now, total income is $23, and total tax revenue is $4.6. But the same amount of work is being done as before! All that's happened is an activity moved from the non-taxed domestic realm to a taxed market one.
It seems that we typically draw the line at the individual or household. If not there, then where should it go?
Given traditional gender roles, this is one factor that has historically led to massive undercounting of women's total contribution to the economy, which could potentially lead to distortions in selecting good public policy. (It's certainly not just a women's issue, but that's one of its big impacts.)
> Economically there is no good reason to distinguish between these two cases
The good reason is property rights. The ability for people to own things and use them as they see fit is almost a requirement for a free society. Governments have established that by creating rules and an environment where commerce can take place, they can collect taxes on that commerce. But I agree with the post you're replying to...creating fictional commerce and then taxing it doesn't seem right. If you're looking for a difference between the two cases you present, it's that the government is willing to act as an arbiter in any dispute that would result between landlord and tenant. When the landlord and tenant are the same person, there's no need for the government to be involved.
Note that this shouldn't preclude governments from collecting property taxes, just from differentiating between landlords and people who occupy their own homes.
This implies that things like dividends should not be taxed, since no commerce occurs. All that happened is a piece of property split into two. Would you favor this outcome? If not, why not?
Now personally, I'm in favor of eliminating all taxes on capital income (and capital, e.g. property taxes). Economically, the best tax is a consumption tax; you live in a home, you pay taxes on the value of living in it. No property tax, no income tax, etc.
Potentially such taxes could also be levied at the time of purchase, as they would be with a pair of skis.
But that's a political non-starter; our western systems of taxation are built around the lie that the rich benefit disproportionately from our society. A consumption tax, which taxes people based on the benefits they receive rather than the value they create for others, would automagically reveal that lie.
I'm fine with that, so long as the corporate tax side of the equation balances...companies use dividends to reduce their income and the taxes they pay. If a dividend is just splitting an asset in two, it shouldn't be deductible.
Why do you consider that a lie? There's a reason why kidnappers try to target rich people's kids... because rich people are willing to pay much more to gave their kid back - they literally value the kid's life more (in money terms).
Another perspective is, a geting injured/killed will deprive a rich person of a lot of consumption, but a poor person of just a little consumption. Therefore, by protecting rich people, governments provide more value than by protecting poor people.
> Now personally, I'm in favor of eliminating all taxes on capital income (and capital, e.g. property taxes). Economically, the best tax is a consumption tax; you live in a home, you pay taxes on the value of living in it. No property tax, no income tax, etc.
What about income tax? What about corporate tax (personally, I think it makes sense, because it's a choice - you don't need to pay corporate tax, but they you don't get the privileges of the corporation being a separate entity)?
I'm opposed to income tax as well. A consumption tax is the best tax, since it's both a) hard to dodge, b) transparent and c) doesn't penalize investment.
In principle an income tax is equivalent to a consumption tax, but in practice taxing labor income but not capital income induces all sorts of tax avoidance schemes that treat labor income as if it were capital income.
How much poverty are you willing to create to reduce inequality? That's the fundamental question. For me the answer is zero.
I also don't assign much value to proportionate representation. I think I'd prefer the rich to have more political power, they seem to be the least insane. Unfortunately, in our system we do have proportionate representation. The only way a rich person can influence electoral outcomes is by persuading poor and middle class people to vote for his candidate. Sadly, as Trump demonstrates, this can be done just as easily with nonsensical emotional appeals as with intellectual ones.
Unfortunately, inequality is, empirically, one of the strongest sources of disutility. So, as much as you might think you can "make everyone better off, but increase inequality in the process" when you use poor proxies for utility, you probably can't.
> I also don't assign much value to proportionate representation.
Comparative studies (at least among nominal democracies), show that proportionality is fairly strongly correlated with experienced utility of government. So, this may be incompatible with your claimed preference for utility. (see, e.g., Lijphart's Patterns of Democracy.)
> I think I'd prefer the rich to have more political power, they seem to be the least insane.
Maybe they just have more power to shape perceptions through media, image management, etc.
Note that if you pull out one of the ever popular left wing scatterplots putting cross-country inequality on the x-axis, I'm going to pull out one with a higher r^2 putting something politically incorrect like single mothers or black people on the x-axis.
As for proportional repersentation, if it indeed is instrumentally useful in creating utility that's fine. But I only care about it insofar as it actually gets us other good outcomes - it's not something I intrinsically value.
Without proportionate representation, it's unlikely that you can achieve "everyone better off", because your measure will be biased - such a system practically ensures that the rich/powerful are better off at the expense of the poor, because their desires are weighted more heavily!
I'm asking about values, not specific world conditions. Sometimes the world lets us get everything we want - e.g., globalization and capitalism so far have reduced poverty and inequality together.
But sometimes the world doesn't give us the easy case. That's when we actually need to understand our values, and answer questions like "how many people will I push into poverty to reduce GINI by 1%?" If your answer is zero, you agree with me completely and don't care about inequality. Are you agreeing with me that inequality is irrelevant now?
Of course, it would be even better if I/we could simply reduce poverty and improves lives directly (without the detour of fighting inequality), but currently I don't know how (and neither does anyone else).
One of the best, if unrealistic, solutions I see are robots; but between now and when we invent really useful robots, I think it's important to strive to prevent outcomes as displayed in the movie Elysium (or the alternative future in the story Manna).
Why would we want rich people to throw lavish parties rather than creating future productive capacity?
Secondly, I do somewhat agree that we shouldn't disincentivize investment or saving up. I am not familiar with the US tax system, but in some countries you can defer paying taxes on what you put into a pension plan until the time when you collect your pension. If the interest you earn on your savings is more than the inflation, this is a win/win situation: You will earn interest on a larger amount, and society will collect tax on a larger amount in the end too. I could probably be convinced that it would be a good idea to make all investment and savings tax free provided that all dividends as well as any amount liquidated was taxed as income. Buy a house? Fine that's tax deductible. Sell a house? Get taxed on the entire amount as if it were income.
This is wrong because it focuses solely on imaginary numbers floating around. It's absolutely true that we can play any game we want with numbers in a bank computer.
However, a worker can either be building a new factory or they can be making a purse. The former is investment while the latter is consumption. If we encourage investment we get more of the former, while if we encourage consumption we get more of the latter. The constraint here is real resources, not money.
I could probably be convinced that it would be a good idea to make all investment and savings tax free provided that all dividends as well as any amount liquidated was taxed as income.
This discourages investment and favors immediate consumption. Again, read Scott Sumner: http://www.themoneyillusion.com/?p=28842
This also discourages re-allocating investments to their most productive uses.
So not only would a tax system based on consumption be hugely unjust from a social perspective, it also makes no sense from an economic perspective.
Again, think of real resources because thinking of money is confusing you. A worker can either do biomedical research (investment) or they can provide massages (consumption). This fact doesn't change no matter what games you imagine are happening with money.
But regardless, the intention behind your proposal still makes it a horrible idea. I can see that you will not be swayed by the argument that it is socially very unjust and would result a unimaginable inequality. But as I keep trying to tell you, consumption is the motor of capitalism. It is the demand part of supply and demand. Without consumption, there is no production. And production is what creates all the wealth. Everybody would be poorer.
Furthermore, while it's true the funding new ventures also contribute to wealth creation, and that lack of risk seeking capital would be a problem, it is simply not a problem that exists in our present condition as evidenced by the historically low interest rates. In fact there is an overabundance of capital in today's world. What is lacking is sound new ventures to invest in. If we were to further incentivize investment, we would only accelerate the formation of a catastrophic bubble.
Your understanding of macroeconomics is simplistic if you believe as you seem to do that more investing is always positive or that consumption is always negative.
A net investment in houses would involve more housing being owned than before. This would require more houses to be built, and this in turn would require people a shift of workers/materials/etc from other uses into housing construction. Present day consumption goes down in return for an increase in future consumption.
The result is that in the future, productive capacity has increased and more housing is available to consume.
If you want to see the result of a lack of real investment, look at SF. All sorts of games being played with money, but nominally wealthy people can't even afford a flat without roommates.
But as I keep trying to tell you, consumption is the motor of capitalism. It is the demand part of supply and demand. Without consumption, there is no production. And production is what creates all the wealth. Everybody would be poorer.
Why don't you explain the mechanism by which this occurs in real terms? I'm pretty sure you've wildly misunderstood Keynesian economics and are conflating the Keynesian cure for prideful workers (which we don't have now - full employment) for some sort of general growth prescription.
You were the one suggesting that investment should be exempt from tax. That requires a definition on the micro level of what constitutes investment, otherwise how do you determine whether or not some expenditure is to be taxed or not? From a practical point of view, how do you differentiate consumption from investment?
If you want to see the result of a lack of real investment, look at SF
Oh, so now there's more than one kind of investment, and only one is "the real kind"? As far as I can see, it doesn't get much realler than in SF: You've got risk seeking capital funding actual new ventures. As in actually creating new wealth. Provided of course that those new ventures succeed. Those rich people you talk of who can't afford to live there have the firstest of first world problems.
It's funny that you should mention SF, because it is a great example of what happens when there is an overabundance of capital and everyone is seeking to invest. You get investors taking on more and more risk to get a return on their capital and ultimately you get a bursting bubble. You see capital by itself does not magically cause value to be created, even when it is used to fund new ventures. If I build a house or a widget, or if I've performed a service, I've only created value, if that house/widget/service was needed in the first place. A man who invests in hotels on the South Pole or a sand selling business in the Sahara is actually destroying wealth. Just like everyone who invested in pets.com before the dot com bubble.
Why don't you explain the mechanism by which this occurs in real terms?
I'm not entirely sure what you mean by real terms? I can say it simpler terms if you like. It's not complicated: Imagine a supermarket. As people buy stuff, the shelves are gradually emptied. The shelves that are emptied first are the ones holding stuff that is most important i.e. valuable to people. Luckily the empty shelf is a great signal to whomever makes the stuff that gets sold in the supermarket to produce more of that stuff. There is of course a pricing component of that mechanism also, but that's basically how that works. If the producer of stuff is unable to keep up with the demand, then that's an opportunity to invest in a new factory that makes the same stuff. Of course not everything sold in supermarket is essential, but I'm sure you would agree that that doesn't mean it is without value. But if we were to tax everything sold in the supermarket heavily (and we would need to if we abolished other forms of tax), we would disincentivize buying anything except the bare necessities. If I understand you correctly, this is more or less the point. This then means that it becomes much harder selling anything other than the bare necessities, and as a consequence lots of businesses must close. Sure, there may be a tiny market selling motorized lawnmowers, but since everything becomes so expensive, most people will get by with a manual lawnmower. But this again means that people will have to spend more time mowing their lawns, and will have less time to do something else that could be valuable. And so on.
Look, I'm not saying that more consumption is always better. Clearly there comes a point at which people buy shit they don't need, and there is also a very real sustainability issue. It's a good idea to tax things like fossil fuels and cigarettes. But most of everything that's valuable gets produced because someone is willing and able to consume it.
Consumption is differentiated from investment in that consumption is stuff you intrinsically want, while investment is things you don't want except because it gives you other things later.
Again, standard economic terms.
Imagine a supermarket. As people buy stuff, the shelves are gradually emptied. The shelves that are emptied first are the ones holding stuff that is most important i.e. valuable to people. Luckily the empty shelf is a great signal to whomever makes the stuff that gets sold in the supermarket to produce more of that stuff.
How can they produce more? They haven't devoted any physical resources to building that new factory or otherwise upgrading their productive capacity.
But if we were to tax everything sold in the supermarket heavily (and we would need to if we abolished other forms of tax), we would disincentivize buying anything except the bare necessities. If I understand you correctly, this is more or less the point.
This is completely NOT the point. Read the Scott Sumner link I provided above. Here it is again: http://www.themoneyillusion.com/?p=28842
The point is that a capital income tax penalizes consumption in the future relative to consumption today. A consumption tax treats them equally.
That’s fine, but as I've argued previously, almost any purchase can be argued to fit either description. People do actually buy e.g. fine wine as an investment. How will the IRS determine if a purchase is an investment or consumption?
How can they produce more? They haven't devoted any physical resources to building that new factory or otherwise upgrading their productive capacity.
Presumably they make a profit from selling the stuff. And maybe they produce less of the stuff that doesn't sell well. But how do you even get that from what I wrote? Consumption is not antithetical to investment. I am not arguing against investment. It's not clear to me if you understand that investing does not automatically create a market. All those Chinese ghost towns we hear about are the result of investing in something for which there is no market.
This is completely NOT the point.
In that case I apologize for misunderstanding you. Still, it's an empirical fact that taxes act as a disincentive. And you would need to tax consumption very heavily if it were to replace current forms of tax. A large part of the population would simply not be able to afford anything but the bare essentials (if that) let alone have any money left for investment.
Read the Scott Sumner link I provided above.
I enjoy our discussion, but I am not interested in reading someone else make your argument for you.
The point is that a capital income tax penalizes consumption in the future relative to consumption today. A consumption tax treats them equally.
I am sure that's true, but so what? It's such an arbitrary point to make. It doesn't point towards any real world problem that we are having. The economic challenges that faces us today are not caused by people consuming too much today and saving too little for the future. Quite the opposite in fact. There is also no indication at all that there's any lack of risk seeking capital. It's never been easier to get funding for a new venture. In fact there are sign that it's become almost too easy, and that investors are taking on too large risks in order to get a return.
Those who have more benefit more from a state of order. Be this material possession like money or natural qualities like beauty.
The ACA case that decided the legality of the individual mandate also had the effect of prohibiting the government from instigating commerce for the purpose of regulating it. Note that the tax-penalty (can it be both at the same time? Can light be a wave and a particle at the same time?) over not having health insurance is not a tax on commerce in health insurance; it is a penalty for violating the individual mandate. So the court has ruled that it can penalize people for violating the law under its taxing power, but also that the government cannot instigate commerce. The only way then to tax imputed rent would be to mandate that property owners rent their dwellings out. This in turn would be a violation of government instigation of commerce. A catch-22.
So not only does it not seem right, it doesn't seem legal.
Scott Sumner does careful calculations explaining this here: uhttp://www.themoneyillusion.com/?p=28842
In the long run investment - i.e. devoting resources to increasing future productivity - is what is needed. To clarify the distinction, investment is research in self driving cars while consumption is driving an existing car.
[1] Prideful workers (the villains in Keynesian economics) are the people who refuse to accept work at a lower nominal wage than what they previously earned. Instead, they sit on their asses enjoying funemployment.
Consumption must grow at the same rate as production, right? So either can be the limiting factor on economic growth, and investing at a rate that doesn't match consumption growth is wasteful (it would be better for the economy if that money were expended on consumption instead), no?
Consumption must grow at the same rate as production, right? So either can be the limiting factor on economic growth, and investing at a rate that doesn't match consumption growth is wasteful (it would be better for the economy if that money were expended on consumption instead), no?
Yes, it's more or less true that consumption + investment = production. Investment is taking resources from consumption today in order to increase production in the future.
Let me make a software engineering analogy. Consumption = building cool, user visible features that product can show to upper management.
Investment = cleaning up tech debt, refactoring the code, or building massive infrastructure that (once complete) will enable many new features.
Product always wants new features. Whatever engineering can create, product will insist on deploying. If product insists on ignoring tech debt and refuses to invest in any infrastructure project, then eventually the rate at which new features are built will slow to a crawl. This is what happens when you shift from investment to consumption.
The idea of consumption increasing future wealth only applies in cases where production is below potential - where people could work but refuse to do so. The closest thing to stimulus I can cook up in my analogy is tricking lazy developers who refuse to work into actually working because you allow them to use node.js.
The main reason is that investment is merely delayed consumption (as you note above), so the consumption tax hits everyone equally regardless of whether they consume or invest. However, a capital income tax is additional taxation that applies only to the person who invests.
So you are saying because anything that could be rented can also be owned, the government should get to tax it as if you rented it? This applies to all items that can possibly be sold and creates interesting areas for where something might be illegal but free to give and which still has a market value on the black market, of which income tax is still expect.
For example, if you two people have sex, they both need to pay the tax a prostitute would've earned.
It also makes every action taxable... even if all you do is clean your room, you aren't paying for someone else to clean your room and thus owe tax.
B) You can win major plaudits by lowering client fees. Guess what - when investment performance inevitably goes through a bad patch the client will stay with a manager they like for a lot longer than one they don't. That gives you time to recover performance and avoid a yo-yo effect.
If your manager is telling you that you need to pay high fees because they're popular you are being ripped off.
The law requires transactions between affiliated businesses to be "arms-length" [1]. That means that both parties come to an agreement freely and independently and that the agreement not be influenced by a special relationship between the entities. Without this rule, you can run into situations that allow companies to dodge taxes. Apple and many other companies do this all the time to take U.S. profits and funnel them to Ireland to avoid paying U.S. taxes [2].
Plaintiffs are arguing that Vanguard is violating the transfer pricing rules by having its holding company charge its mutual fund affiliates fees that are substantially lower than market rates. In fact, their argument is that Vanguard is charging 0.20% of assets managed when it should be charging 0.75% of assets managed which they claim is the market rate. Plaintiffs further claim that by charging lower than market rates due to their special relationship that Vanguard owes $34.6 billion in back taxes from 2007 to 2014. As such, Plaintiff would be entitled to $10 billion commission by bringing this to the government's attention.
And that brings us to why Plaintiff is doing this. They know the odds are so ridiculously stacked against them but it's a cheap lottery ticket for a chance to win $10 billion. And if they can put enough FUD into news articles about Vanguard [3] they just might be able to convince Vanguard to settle for a few tens of millions to make them go away.
[1] https://www.irs.gov/pub/int_practice_units/ISI9422_09_06.PDF
[2] https://en.wikipedia.org/wiki/Double_Irish_arrangement
[3] http://www.reuters.com/article/vanguard-lawsuit-taxes-idUSL1...
It doesn't really change your overall point, but that's not exactly true. Apple uses transfer prices to take non-US profits and funnel them to Ireland. They then use tricks such as the Double Irish and the Dutch Sandwich to minimise their Irish taxes. However they can't avoid US taxes; all they can do is delay them. If and when those profits are moved to the US, they'll still be taxed at the full US rate; all the fancy Irish tricks won't do anything. And those tricks don't work on US profits at all; since Apple's IP is owned by the US firm, they can't transfer US profits to the Irish subsidiary.
They can essentially have two separate budgets: Money already in the US [to be spent in the US] and money outside of the US which will have more buying power if spent outside of the US.
But the law is there for a reason, to prevent tax dodges. Like selling a patent to fully owned foreign subsidiary in a low tax jurisdiction for $1. Then having that subsidiary collect royalties of millions from the parent domestic company. The expenses (of the royalties) are deducted, and tax is only payed on the much lower profit. The foreign subsidiary pays local (lower) taxes and keeps the profits in a foreign account. This is clearly a tax dodge. If you allow the IRS to levy tax on market rates for patent transfers and royalties, they can can redo the accounting to figure out what a fair tax would have been without the accounting games.
I'd really like to see the law changed to allow Vanguards actions (presuming they are indeed in violation) but I'd also be worried about adverse consequences.
Reducing costs is typically one of the main reasons one organization buys or incorporates a subsidiary, instead of just going into the marketplace for what they need. Will that now be illegal if it reduces the total tax payments of the formerly separate organizations, as a side effect? That seems like a pretty dramatic intrusion into business decision-making.
Say a non-profit hospital ordinarily purchases services from a for-profit testing lab. The testing lab receives market-rates for its services, and pays tax on that income. Now, say the hospital purchases the testing lab, but continues to operate it as a for-profit subsidiary. But the hospital makes the subsidiary sell its services at cost, eliminating the subsidiary's tax liability while boosting the hospital's non-taxable surplus. Maybe that's still okay. But now say instead of a testing lab, the subsidiary is an advertising agency. Same result?
It's worth reading Matt Levine's take on this: http://www.bloombergview.com/articles/2015-11-25/calpers-fee... (scroll down to "Vanguard and taxes").
The problem is not the acquisition of the for-profit entity by the non-profit entity. The problem is when those entities don't interact at arm's-length.
This would clearly be absurd, the management company is happy with their fee, and the co-op members are happy. The fact that "normal" corporate structure would pay more in tax shouldn't really factor into the decision since the question should be, given your corporate structure, are you paying taxes.
> In the meantime, the co-op grows 10-fold, but the contract with the management company doesn't change (somehow, let's just assume the co-op doesn't require active management, they just need guidance occasionally or something)
The question isn't what a "normal management structure" would cost. It's what the affiliated entity would normally charge in the market for the same service. Vanguard's sells its investment management services to the mutual fund at cost because it's owned by the mutual fund. It wouldn't do that otherwise.
So to make your example comparable, the co-op buys the management company, and makes it operate at zero profit. So the question is: would the management company be happy making zero profit if it weren't owned by the co-op? The answer is: probably not.
edit: I should add, that I'm fairly certain that the employees at vanguard are in fact getting paid.
edit2: So the question is should we look at whether the employees/contractors at vanguard are getting paid market rate, or whether vanguard as a whole is charging market rate to the investors. My comparison to the hospital co-op was that it's unfair to compare apples-to-orangutans.
I can see that they could have run afoul of some tax rules due to their structure, but it seems disingenuous to argue that they should charge management fees just as high as their active management competitors. (But sure, maybe they should charge more than they do now.)
Then again, as an owner of Vanguard index funds, maybe it's hard for me to be rational in this case. >:D
At what point do these legal distinctions begin to take effect? If a friend and I pool resources and purchase some stock, then later sell it at a profit and split the trading fees, did we somehow owe unpaid tax?
It seems like this is a tax against vertical integration in financial services, which I'm not sure I understand the need for...
Consider, for example, a tax dodge Samsung is alleged to have engaged in. Samsung Electronics makes products in South Korea, then sell them at cost to Samsung Distribution, which is an affiliated company in a low-tax jurisdiction. Samsung Distribution then exports the products at market price to Best Buy, etc. Samsung Electronics books little or no profits in South Korea--all the profits are booked by Samsung Distribution in the low-tax jurisdiction.
There is also a corporate-entity angle to this. Operating as a separate corporation has benefits: if one goes bankrupt, its creditors cannot reach the assets of a related entity. But if transactions between related entities are not arm's-length, it's easy to shift money around between them and abuse the protections of separate corporate forms by, e.g., leaving riskier lines of business undercapitalized in case of a tort judgment.
If I call up an old mentor and he gives me useful, money saving tips that I employ to amplify my business's profits, should he be taxed "as if" he billed me as a consultant?
If employees of a for-profit startup ask questions on a mailing list they're members of, should the mailing list be taxed as if it were selling consultancy services?
And how (too tired to come up with an answer myself) would this case differ from Vanguard? I'm guessing it has to do with the fact that the Vanguard investment management company is charging other people market price for its advice, but what if my mentor did that? Are we now in a world where, if I sell a good for-profit to anyone, I must pay taxes on the income I would have gotten, any time I give that good to someone else for free?
What if my wife's a professional childcare provider? Do I have to pay taxes on the imputed income from when she's alone with our kids? (There are non-G-rated versions of that question, btw.)
(Honest questions, all. Don't know if I'm missing something here or misunderstanding the tax threat model.)
"Vanguard is the only investor-owned mutual fund complex in America. We are known for many things—including our low fees, our commitment to high-quality client service, and our indexing expertise—but I would say the single most defining characteristic about Vanguard is our ownership structure. The Vanguard® funds own The Vanguard Group, which in effect means that the investors in our funds own Vanguard. Unlike other fund firms, we don't have stockholders or a parent company to please. Our mutual ownership structure enables us to focus clearly on the interests of our investors, without the potential conflicts of interest that can occur at other firms."
I wouldn't be too worried if someone decides to take a swing at Vanguard. I do consider Vanguard to be "good guys" but they're also so huge that its hard to imagine them getting hurt from a few feeble media attacks.
How is this even an issue, let alone the basis for a legal case?
Forgone fees go to the fund's investers, who are also its owners. And capital gains by investers are taxed, just as they are for other funds. Maybe they're taxed at lower rates than profits of other funds are taxed. But that's just because the fund manager is a not-for-profit.
Right?
That being said, I sort of see how a legalistic argument could be made.
Of course, that doesn't mean it can't rebate the profit back to the funds which could then apply it as a fee rebate. That should be totally legal, as long as it pays taxes on the profit before it issues the rebate.
This whole territory has been explored before, by the way. Mutual insurance companies used to have this same problem, and eventually Congress just added another carveout to 501(c) and made the problem go away. That's the other alternative here, and it's definitely cleaner and probably better for society as a whole.
It's asset-weighted fees are approximately 1/6 of its competition. That seems pretty competitive to me.
Less bombastically, who decides what a competitive fee is? If they charged 1/2 market rate would this suit have ever been filed?
If they were operating at a loss I think it'd be pretty easy to claim they were avoiding taxes and should be operating at break even. But they are operating at break even, so I think it's hard to make the argument that they should be charging more "just because other firms do" and not come off as just some opportunist trying to cash in on a whistle-blower payout.
How, and when you can engage in such activity I'll lead to tax attorneys, but it's not a no-brainer "You should always be able to charge lower fees and transfer profits away from one entity to another." There is some nuance.
It's a lot less crazy than it sounds, because they are wholly owned by Vanguard. So the customer is effectively setting the fees.
There are certainly scenarios where you could see how this is clearly abusive. As a contrived example, imagine if Apple moved its legal headquarters to Ireland and made California into a subsidiary. They would still have to pay the California subsidiary for the design services it provides, but they could set those fees at way below market price and thereby shift all tax liabilities to a lower tax jurisdiction. We have transfer pricing rules in place to prevent this.
The situation is more complicated than this because the fund (the client) is not a profit-seeking corporation, so it's not arbitrarily moving funds around. It's an odd scenario where the customers are also the owners.
That being said, in principle it's all mostly the same since investors own Vanguard.
In the current era, it is however uncommon for consumers to simultaneously own and (exclusively) be the customers of a company. (Historically, that is of course the entire principle of mutual funds.)
Moreover, in this case the fact that Vanguard is a co-op is a redeeming factor. If it were a typical corporation charging itself below-market transfer prices, that would likely be illegal.
Another standard does, in fact, set a minimum level of transactional profit based on comparable businesses. [0]
[0] https://en.wikipedia.org/wiki/Transfer_pricing#Comparable_pr...
You can see why that sort of thing would be illegal and that kind of subsidiary would be legally required to charge the market rate for the services they were providing.
Strange lawsuit. Horrible if the case goes against Vanguard. We live in a strange world.
So does the shoe then fit if Vanguard triples their fees making them the most expensive, do the other management companies then need to pay taxes on the difference between their now lower fees and Vanguards?
I think this is a ploy by the management firms that are being undercut and in a tight market (or a down market) the management fees become important.
I'm pretty sure it is almost exclusively a ploy by David Danon (who brought this complaint) to extract a massive whistleblower fee.
It's not surprising that it irritates you.
Did I get that right?
The whistleblower is making the case that if Vanguard had kept all the profits then there would have been a $34B tax bill. But that's an assumption. It's far more likely that Vanguard would have paid out the extra money as a dividend so that there was no profit. Or they figure out some way to pay it out as extra shares in the investments, perhaps there is some way to make it be like unrealized gains so that there is no tax event until you take it out.
Can anyone who has some background shoot holes in the thoughts above?
To me this case looks shaky but I'm not a lawyer, tax guy, or even much of an investor (I do have money at Vanguard for whatever that is worth).
So the whole "if, else, else if" thing in "whistle-blower's" argument is ridiculous.
Edit: As it turns out most or all of Vanguard's ETFs are physical.
> Employs a passively managed, full-replication strategy.
[1]: https://advisors.vanguard.com/VGApp/iip/site/advisor/investm...
From the course, they highlighted synthetic replications risks as consisting of credit risk of the counterparty when swaps are used by the issuer to exchange, performance of the assets held by the ETF for the performance of the underlying index. Blackrocks' IVV [1] has a cost structure of 0.07%, which is pretty good - and does an extremely good job of tracking the S&P500. It uses, "Representative Sampling" - from their prospectus [2] BFA uses a representative sampling indexing strategy to manage the Fund. “Representative sampling” is an indexing strategy that involves investing in a representative sample of securities that collectively has an investment profile similar to that of the Underlying Index. The securities selected are expected to have, in the aggregate, investment characteristics (based on factors such as market capitalization and industry weightings), fundamental characteristics (such as return variability and yield) and liquidity measures similar to those of the Underlying Index. The Fund may or may not hold all of the securities in the Underlying Index.
[1] https://www.ishares.com/us/products/239726/ishares-core-sp-5...
[2] https://www.ishares.com/us/library/stream-document?stream=re...
A potentially major relative risk I can think of for synthetic ETFs vs real ETFs would be that it could diverge due to updates in the composition of the fund - particularly if a stock is removed or added. If the fund previously held a large position in a stock and decided to replace it, then that action will likely have a negative impact on the price of the stock, and you will only get knowledge of the fund adjustment the morning after or possibly later. This means when you readjust your synthetic position, you'll do so at inferior prices, which could hurt returns. Likewise, you'll probably buy new inclusions at a higher price. I saw this happen a couple of times - and usually within particularly volatile sectors with small cap companies where an ETF might come to hold a large chunk of a company.
That being said, I'd wager this effect doesn't outweigh the management fees charged for even the most frugal ETF, so creating it synthetically might be a good deal if you've got the manpower and cost structure to adjust your position regularly - or if you don't mind a bit of divergence. I'd be interested to hear other opinions on this as well.
"Vanguard is cheating state and federal tax authorities by charging its customers much less than other fund companies do."
This simply isn't true. A list of the 100 lowest ETFs [1] shows several form the Schwab near the top of the list.
You seem to be conflating management style with how something is traded. ETF just means it is traded on an exchange. An ETF can be actively managed. And a mutual fund can be passively managed.
Product is cheaper than the competition. Boo hoo.
I see no difference between what Vanguard is doing here, and what WhatsApp did for instant messaging - disrupting an incumbent industry with a new and cheap option.
I don't see how anything about it is wonky. Care to explain?
It's the ownership structure that makes things different.