Monday, August 03, 2015

Six Dangers of Tax Free Savings Accounts

Tax Free Savings Accounts should be scrapped, indefinitely. Here's why.

1) A Tax break for the wealthy

A Tax Free Savings Account is a tax break for the wealthy. It encourages a smart wealthy person to spread their wealth, slowly, among their family members. If increased to $10,000 per year, a wealthy family of four would stow away $40,000 per year. (More if you include Registered Educational Savings Plans)

As someone who has to budget to make their monthly mortgage and car payments, saving $40,000 per year is a pipe dream. Even if I paid off my mortgage, stowing away $40,000 per year on my salary is $20,000 away from what I can ever afford - post-debt.

2) Pump and dump.

The ability to create tax bubbles, essentially blowing up someone's tax free accounts while draining their regular investment accounts encourage people to manipulate the stock market.

Someone experienced in stock market manipulation could effectively do this on a large scale for a group of clients. While there should be checks and balances in place to prevent such manipulations, it's hard to prosecute when there is a massive claw back in law enforcement to investigate or prosecute such transgressions.

What we have is a perfect recipe for mass tax evasion.

Here's how.

An investor gathers millions, even billions of dollars in clients accounts. They get their clients to invest in particular stocks in their TFSA. The investor then manipulates the people's non-TFSA accounts to buy the stocks at an inflated price from their TFSA accounts.

What starts out as a $10,000 in stock X in their TFSA and $10,000 cash in their taxable trading account becomes $10,000 + (manipulated sell price increase) in their TFSA and ($10,000 - planned loss) in their non-TFSA account.

To put it simply, it's like taking air out of one balloon to put it into another balloon. In this case, a tax free balloon.

But it doesn't end there. The perpetrator can now claim a "Tax loss," in their regular investment account, decreasing their real income taxes.

In the above way, a savvy, wealthy investor could gradually transfer their earnings into a TFSA to the point where they never have to pay a dime in taxes again.

3) Laissez-Faire turns to manipulation

The traditional theory of market forces is to leave it be. It's illegal to manipulate markets in any way. But that is exactly what Tax Free Savings Accounts do. They artificially encourage people to invest in the stock market. The result artificially boosts the stock market beyond what it's intrinsic value should be.

This is a dangerous precedent and goes against the principles investment economics.

4) Good bye tax revenues.

The wealthy and the upper middle class are the people who can afford to be taxed at a higher rate. In a country that runs deficit after deficit, creating tax havens for the people who can afford to pay a little more tax is bad.
Taxes on investment income are historically pretty low. You divide the capital gains by two and add it to your annual income. With the generous amount people can stow away in their TFSA's, what's being created is a future where such taxable investment income will shrivel more and more.

5) It's the people struggling to get ahead who need a break, not the people who are already ahead. Who will pay the difference? The poor and the people struggling to get ahead are the one's who will pay a bigger share in the end to make up the difference, while the wealthy enjoy their tax-free earnings.

6) It will be tricky to undo this mess.

When the government realizes that allowing people to have tax free havens isn't sustainable and they actually need to tax it, what happens to the TFSA's? People invested in good faith, thinking their money would be safe from the government's touch.



What Should We do?

Do we simply cap it? Whatever is in your account can be kept tax free, but nothing else. No more annual additions.

Do we scrap it? Tax Free Savings accounts are no longer tax free. They are regular accounts.

Those are really the only viable options. Any hybrid of partial taxation becomes too confusing.

I say scrap it.

I can't afford it anyway.


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