Investment in American financial markets forms the bedrock of the nation’s long-term economic trajectory. How the federal tax code treats these investments directly impacts the after-tax returns realized by savers, fundamentally influencing how and where Americans choose to allocate their capital. For decades, disparate tax treatments across different fund structures have acted as an unintended barrier to domestic investment.
To address these structural inequities, lawmakers have introduced the Generating Retirement Ownership Through Long-Term Holding (GROWTH) Act. Championed in both chambers of Congress by Senator John Cornyn (R-TX) and Representative Beth Van Duyne (R-TX), the legislation aims to harmonize the tax treatment of investment funds, encouraging American savings by allowing investors to defer capital gains taxes on qualifying reinvested distributions until they ultimately liquidate their fund shares.
Main Facts: Understanding the Fund Structure Disparity
At the heart of the debate are two of the most popular vehicles for retail and institutional investment: mutual funds and exchange-traded funds (ETFs). While both investment vehicles are subject to the same foundational tax rules as regulated investment companies (RICs), they operate and process redemptions in fundamentally different ways. These operational differences produce vastly divergent tax outcomes for ordinary shareholders, even when holding virtually identical portfolios.
To understand the disparity, consider a conventional mutual fund that owns a stock purchased for an underlying cost basis of $20, which has since appreciated to $100. If a shareholder decides to redeem $100 worth of mutual fund shares, the fund may be forced to sell $100 of its underlying stock to generate the cash payout. This transaction realizes an $80 capital gain.
Crucially, under current law, that net capital gain is distributed directly to the fund’s shareholders rather than being taxed within the fund itself. This means that remaining, non-selling shareholders suddenly owe capital gains tax on the appreciation—even though they did not sell a single share of their mutual fund.
In stark contrast, exchange-traded funds operate under a distinct mechanism. Retail ETF shareholders typically sell their shares to other investors on secondary markets rather than redeeming them directly from the fund. When large institutional investors—known as authorized participants—redeem blocks of ETF shares, they generally do so through "in-kind" redemptions, exchanging shares for a basket of underlying securities rather than cash. These in-kind redemptions do not trigger capital gains realizations that would otherwise be distributed to remaining shareholders.
Consequently, an investor can own identical portfolio holdings and earn the exact same gross investment return, yet face drastically different current tax liabilities based solely on whether their capital is parked in a mutual fund or an ETF. Real-world data confirms this structural penalty: average capital gains distributions are markedly higher for mutual funds than for ETFs, systematically eroding the after-tax returns of mutual fund investors.
Chronology of the Legislative Push
The introduction of the GROWTH Act represents the culmination of years of scrutiny by financial economists, tax policy experts, and lawmakers regarding the disparate treatment of index funds, mutual funds, and ETFs.
- Pre-2025 Analyses: Academic institutions and policy think tanks, including the Brookings Institution and the Investment Company Institute (ICI), repeatedly highlighted the tax inefficiencies embedded in conventional mutual fund structures. Studies demonstrated that mutual fund investors faced phantom tax liabilities on undistributed, reinvested capital gains, creating an artificial bias against traditional fund vehicles.
- Early 2026 Modeling and Development: Economists at the Tax Foundation and other modeling organizations began constructing specialized general equilibrium models to assess the budgetary and distributional impacts of a potential capital gains deferral mechanism for reinvested fund distributions.
- Current Congressional Session: Senator John Cornyn and Representative Beth Van Duyne officially introduced the Generating Retirement Ownership Through Long-Term Holding (GROWTH) Act in both the Senate and the House of Representatives. The legislation was designed to close the gap between mutual funds and ETFs by allowing investors to defer recognition of qualifying reinvested capital gains until they sell their fund shares.
Supporting Data and Budgetary Projections
The GROWTH Act would alter the timing of tax collections, introducing near-term revenue reductions for the federal government that taper off into a stable, long-run steady state.
According to the Tax Foundation’s General Equilibrium Model, the proposal is estimated to reduce federal revenue by $37.7 billion from 2027 to 2036 on a conventional basis.
Table 1. Conventional Revenue Effects of the GROWTH Act Mutual Fund Capital Gains Deferral
Billions of Dollars, 2027-2036
| Year | Revenue Effect ($ Billions) |
|---|---|
| 2027–2036 Total | -$37.7 |
Source: Tax Foundation General Equilibrium Model, September 2026.
This cost is heavily front-loaded. In the initial years following enactment, reinvested amounts that were previously subject to immediate capital gains taxation suddenly qualify for deferral, yet few of those deferred amounts have been sold by investors yet. As deferred amounts are eventually realized and sold over time, the net annual cost drops significantly, leading to a lower steady-state cost just above $1 billion per year in the latter part of the budget window. Furthermore, analysts note that this conventional revenue cost may be overstated, as reinvested returns making up the deferred tax liability can themselves compound and eventually generate additional tax revenue—an effect excluded from standard static models.
Distributionally, the legislation provides broad, albeit modest, relief across the income spectrum. In 2027, the GROWTH Act would increase after-tax incomes by an average of 0.1 percent. By 2036, as the system reaches a steady state, the change in tax liabilities narrows, resulting in an increase of less than 0.05 percent in after-tax incomes across income percentiles.
Official Responses and Policy Perspectives
Proponents of the GROWTH Act argue that the legislation is a necessary step toward achieving tax neutrality—the economic principle that the tax code should remain neutral, allowing investors to choose investment vehicles and underlying assets based purely on economic merits rather than tax minimization strategies.
"Investment in American financial markets is a cornerstone of our long-term economic prosperity," supporters of the bill note. By eliminating the punitive taxation of phantom, reinvested capital gains within mutual funds, lawmakers hope to remove unnecessary barriers that discourage everyday Americans from utilizing traditional retirement and savings vehicles.
However, fiscal analysts and tax policy experts point out important trade-offs. By expanding the scope of tax deferral within the individual income tax code, the proposal inherently encourages taxpayers to slow down their pace of capital gains realizations—a phenomenon known as the "lock-in" effect. When investors hold onto assets longer solely to avoid realizing capital gains, capital can be trapped and prevented from flowing toward more dynamic, productive uses within the broader economy. To mitigate this concern, the GROWTH Act incorporates provisions preventing taxpayers from entirely bypassing tax obligations via loopholes such as the step-up in basis.
Broader Economic Implications
Beyond immediate revenue figures and fund-level equity, the macroeconomic implications of the GROWTH Act touch on national savings, gross national product (GNP), and market efficiency.
- Boosting National Savings: By increasing the after-tax returns on savings, the legislation creates a stronger incentive for households to set aside capital for the future. Over the long run, higher domestic savings rates can contribute to an expansion of gross national product (GNP), boosting the overall income earned by American residents.
- Financing and Net Economic Impact: The net economic benefit of the legislation depends heavily on how the resulting federal revenue loss is financed. If the $37.7 billion reduction in revenue is offset by additional federal borrowing, the corresponding increase in national debt could drive up interest payments to foreign investors, partially offsetting the domestic gains in American incomes.
- Horizontal Equity: From a fairness perspective, the bill successfully addresses a glaring horizontal inequity. Under current law, two investors holding identical portfolios can experience vastly different tax bites simply because one chose an exchange-traded fund while the other selected a mutual fund. The GROWTH Act ensures that identically situated investors face harmonized tax liabilities.
Conclusion
The Generating Retirement Ownership Through Long-Term Holding (GROWTH) Act addresses a subtle yet deeply impactful distortion in the U.S. tax code. By leveling the playing field between mutual funds and exchange-traded funds, the legislation removes a penalty on traditional mutual fund investors and fosters a more neutral, market-driven investment environment.
While the proposal entails a front-loaded federal revenue cost and introduces minor lock-in trade-offs regarding asset realization, its long-run benefits—improving horizontal equity, boosting after-tax savings returns, and aligning tax policy with economic reality—make it a targeted and constructive step forward in the ongoing evolution of American tax reform.
