Exchange-traded funds are under fire — and the industry is pushing back.
A proposal to end a key tax break for ETFs is "just bad policy," Investment Company Institute President and CEO Eric Pan told CNBC's "ETF Edge" on Monday.
The bill, put forth by Senate Finance Committee Chairman Ron Wyden, D-Ore., suggests closing a tax loophole tied to "in-kind" transactions, which allow ETF managers to swap their underlying holdings without being taxed each time. It exempts ETFs in tax-deferred retirement accounts.
"This is exactly the wrong type of policy that we need right now," Pan said. "It's going to punish investors. People who are trying to invest for the long term are going to see tax bills every year. ... This is going to discourage them from doing long-term investing."
"Senator Wyden ... is actually going to make it more expensive for these people to save for the long term and that has real consequences," Pan added.
Wyden has said the plan will impact only "taxable accounts of the wealthiest investors" and companies.
"The big picture point here is that pass-through and partnership taxation are a mess," Wyden said Wednesday in an email to CNBC. "The IRS Commissioner testified that the agency is completely overmatched when it comes to policing tax avoidance schemes in these areas."
"Congress never intended for this loophole, and this particular proposal simply applies the same rules already in place for corporations to regulated investment companies, so wealthy investors can no longer avoid all tax on their gains," Wyden added.
He said the proposal exempts retirement accounts, which is generally how middle-income people are invested in the funds. "We're only talking about the taxable accounts of the wealthiest investors — 96 percent of the total value of these funds is held by the top 5 percent," he said.
ICI said the plan could impact roughly 12 million U.S. households that own ETFs. The median annual income for those households is $125,000, and 92% make less than $400,000 a year, according to Pan.
The change would go against President Joe Biden's campaign promise to avoid raising taxes on those with less than $400,000 in annual income, he said.
It could also discourage the 33% of millennials and 29% of Gen Zers who own ETFs from keeping their money in the market, he warned.
"These are the youngest Americans who are just starting to save today. They're the ones who are going to be paying these taxes. So is it going to raise money? Sure, it'll raise money. Should we be raising money this way? No," Pan said.
"Taxes also affect behavior," he said. "It's about policy and whether or not we want Americans to invest and that's why it's dangerous."
Those saving for the future are at particular risk, ETF Trends and ETF Database CEO Tom Lydon said in the same interview.
"It's not good news for Wall Street," he said, adding that the bill's passing would be a "travesty" for the ETF industry.
"If we were thinking about people like Jack Bogle, he'd be rolling in his grave," Lydon said, referring to the late pioneering Vanguard founder who invented the index fund and preached buy-and-hold investing.
"When you think about our kids who are saving for the future who are going to live longer and they can't really count on Social Security, ... this is going to be a big blow if it goes through," Lydon said.