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18 Luglio Lug 2011 0817 18 luglio 2011

The damage a bad tax can do

The Italian fund management industry might have been a source of export growth for Italy as local fund managers used the experience they gained here to expand abroad. Instead the industry has been shrinking as Italian fund managers moved their funds abroad and foreign mangers gained market share. The critical reason seems to be the way that Italian funds were taxed until July of this year. So I want to try to put a number on the losses to Italy to show how necessary it is to get the taxation system right and avoid unintended negative consequences.
The law in question regards the taxation of mutual funds. Until the change in July, funds in Italy were taxed on the capital gains they made every day and the Net Asset Value (NAV) published was net of any taxes. When the investor sold, if the NAV said 100, the investor received 100. The new model sees the funds pay no taxes and it is only when the investor sells that tax is paid. So, if the investor bought the fund at 100 and it is now worth 125, tax must be paid after the sale on the capital gains of 25.
Why is this detrimental? First, when the fund is going up, the taxes paid out every year mean that there is a lower base for the next year. If the fund increases from 100 to 120 and pays out 2.5 in taxes, it starts the following with assets to invest of 117.5 instead of 120. If you assume a 10% return and taxes of 12.5%, the Italian investor earns 8 points less over 10 years (the investment is worth 231 under the old Italian system instead of 239) and 86 over 20 years (535 against 631). Long term, this is not favourable to the investor. Second, the fund pays the taxes and any losses registered by the fund could only be used against future gains made by the fund. So if an investor bought a fund at 100 which dropped to 90 and shares in ENI for 100 which went to 110, taxes were still due on the gains made from ENI and could not be offset by the losses in the fund. Third, because the funds were taxed in Italy, there were unattractive to non-Italian investors who had to pay Italian taxes, pay taxes in their own countries, then sort out the difference. It was easier to buy a fund which left the investor to pay the taxes.
In total, mutual funds based in Italy (diritto italiano) dropped from € 417bln in 2001 to € 185bln at the end of March, 2011, while mutual funds based abroad (diritto estero) increased from € 130bln to € 268bln. Funds managed by non-Italian fund managers increased from € 27bln in 2000, 2.7% of total assets managed (risparmio gestito), to € 217bln at the end of March, 2011, 21.6% of assets managed (risparmio gestito). As well as the growth of foreign managers, Italian banks were moving funds offshore.
So how much has Italy lost as a result of this? For the gain to the Treasury I will use the figure of € 141mln per annum, which I’ve seen quoted in Il Sole. Over 10 years, so I will say € 1.4bln. I will estimate the loss as a result of Italian fund managers moving funds moving abroad as 0.1% per annum, the administration fee, of the funds abroad, currently € 175bln. With the growth in funds abroad over the years, the total is probably around € 1.2bln. And if the Italian investor pays 1% per annum to the foreign fund manager on the funds they manage, the total outflow has been around € 13bln. And a further € 2bln will be lost every year. So far, there has been a gain of around € 1.4bln for the Treasury, but a loss of around € 14bln to Italy, ten times the gain.
In short, make sure taxes are properly designed. Like do not put a super-bollo on savings accounts at a time when you need to attract savings to fund the government debt.

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