Taxation is self-correcting---the rate will be adjusted in response to deficits, creating an optimal instrument.
Libson ’21 [Adi and Gideon Parchomovsky; February 2021; Assistant Professor at the Bar-Ilan University Faculty of Law; Robert G. Fuller, Jr. Professor of Law at the University of Pennsylvania Law School and Professor of Law at the Hebrew University Faculty of Law; Texas Law Review, “Reversing the Fortunes of Active Funds,” vol. 99]
Our proposal offers three potential advantages over competing mechanisms aimed at bolstering engagements by shareholders. First, tax incentives constitute a far more effective tool for encouraging the growth of active funds and active participation in corporate matters than legislation or regulation that forces passive funds to become active. If a passive fund has no interest in assuming an active role in the management of a company, it is highly doubtful that legal mandates forcing engagement would achieve their desired goal of meaningful engagements. Worse yet, mandatory measures would necessitate significant expenditures on monitoring and enforcement. Tax benefits, by contrast, allow each category of funds, active and passive, to act as it prefers, while maintaining a stable market equilibrium between the two groups. Furthermore, tax instruments are flexible and dynamic. Unlike binary regulatory mechanisms, a tax benefit can be keyed to multiple performance indicators and can be adjusted to fit the changing magnitude of the positive externalities generated by sophisticated investors. 17
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Louis Kaplow & Steven Shavell, On the Superiority of Corrective Taxes to Quantity Regulation, 4 Am. L. & Econ. Rev. 1, 7-10 (2002) (emphasizing that the price element of taxes provides the government with vital information that can be utilized to optimize the tax instrument). The price element of taxes can also serve as a mechanism for revealing information to the parties. See, e.g., Brian Galle, Tax, Command ... or Nudge?: Evaluating the New Regulation, 92 Texas L. Rev. 837, 848 (2014) (explaining that prices reveal information about the subjective valuations of parties).
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