Chapter Eleven Taxes and Mutual Funds The Power to Destroy

“The power to tax involves the power to destroy.” So wrote John Marshall, Chief Justice of the United States. While there was no federal income tax when he penned those words back in 1819, such a tax was instituted in 1913, and Mr. Chief Justice Marshall's warning was extended to include individual taxpayers. It would be wonderful to return to a world without income taxes, but that would be an unrealistic expectation. So this chapter will examine (1) the impact of taxes on the rates of return earned by investors, (2) some special tax considerations involved in owning mutual fund shares, and (3) some ways to defer or even to eliminate income taxes using investment programs readily available through mutual funds.


I shall begin this chapter with Table 11.1, which shows the powerful impact of taxes on the returns generated in the modern era by our three basic classes of financial assets. Over the long term, taxes have consumed as much as 25% of the nominal returns on financial assets. However, investors live today, and not “on average” over past years. The highest marginal federal tax rate was 25% in 1926. The rate reached 94% by 1940, was reduced to 70% in 1965, to 50% in 1982, to 28% in 1988, and then was raised to 31% in 1991. In 1993, the maximum marginal rate is expected to rise to 39.6% for investors with the highest incomes. We may not see rates as low as those in force from 1988 to ...

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