A Transaction Tax to Reduce Liquidity on U.S. Markets? Terrible Idea

Why is it that people with no understanding of financial markets feel compelled to offer solutions to what they perceive as problems?

This recent New York Times opinion article suggests that a transaction tax to reduce liquidity of US markets would be a good thing. Not so. People from all over the world use the US markets precisely because of the high liquidity and small transactional costs, ultimately to the benefit of the American economy. The stock exchanges, brokers, market participants, retirement funds, large investors, and mom-and-pop investors all reap the rewards of one of the most welcoming markets in the world. Clearly, the long term consequences of a transaction tax have not been considered. With this transaction tax, all investors, from the large institutions to the mom-and-pop hundred share lots, would pay more upon buying and receive less upon selling.

As an example, compare three or four stocks that trade between 100,000 to 500,000 shares per day with stocks that trade 5 million shares per day. First, you will notice that the bid and ask spread is much larger and thinner in the lower volume stocks. Second, you will find that when there is a large buy or sell order, the price of the stock moves proportionately further than with the higher volume stocks. Obviously, those in favor of the tax have not realized the magnitude of this indirect transactional cost. Even scarier, the stress of these additional costs to investors could drive their interests to the markets of other countries. New York is already faced with stiff competition from London and other locations that would love to have the markets we now enjoy. Do we really want more layoffs and higher office vacancies in New York City? How about Chicago?

I am also troubled by the notion that participating in the markets is a nonproductive activity. It's akin to saying that a journalist is engaged in a nonproductive activity or being a soldier is a nonproductive activity. Providing companies with easy and inexpensive access to working capital is, in my mind, extremely productive and crucial to a healthy capitalist economy. The increased cost to those investing in American companies would also be passed to the consumer, yet another negative economic consequence not mentioned in the Times opinion article.

What we need now is an intelligent discussion of how we can increase wealth in this country without taxing business sectors out of existence, especially businesses that lubricate the wheels of wealth building to promote capitalism. If we destroy what is left of the free market in the United States, what will be left to pass along to our children besides mountains of debt?

Let us not be so quick to “tax the other guy” as we all know what goes around comes around in an environment that is seeking to punish someone else.

Comments

[robert.b.fe...:]

While in my opinion the author is absolutely correct that this is an incredibly dumb idea he never mentioned who exactly was pushing for it. If this is just another blow hard idiot from the NY Slimes I wouldn't get too worked up about it. On the other hand if this is one of our elected idiots there is legitimate cause for concern after all they haven't met a tax they didn't like and think stocks are only traded by rich people.

Jan 15 01:16 PM

[tiananman:]

I registered (for free) to read the article in question, and it turns out it's the guy that's running this place:

www.cepr.net/index.php.../

The Center for Economic and Policy Research. Not exactly economic though. He makes Keynes look Austrian.

Jan 15 01:54 PM

[robert.b.fe...:]

tianman: Welcome. If you are an avid trader/investor two other free forums that I have found helpful are motleyfool.com and tickerspy.com.

Jan 15 01:58 PM

[Lew Warden:]

This is a splendid idea! And it can be collected automatically by the same computer the SEC uses to support its functions. The only marketeers affected by this measly 1/4th of 1% will be day traders and arbitragers. Check the internet for the APTTax (automated payment transaction tax). If this takes hold you can junk the Income Tax and annual returns. Just tax the flow of money, not people. But keep the percentage small.

Jan 15 06:21 PM

[nosajio:]

Have not read the article but I would guess that the attempt is to reduce the volatility. Applying a tax treats the symptoms, not the disease; the latter being the market has become a gambling casino, not a place for long-term investments. A ban on programmed trading and daytrading would be a better start.

Jan 15 08:15 PM

[tiananman:]

But this is not a replacement for the income tax, and you're foolish to think that the Federal Govt will ever repeal the income tax just because they have another tax to replace it. This is an additional tax - and the "measly" 1/4% is the camel's nose.


On Jan 15 06:21 PM Lew Warden wrote:

> This is a splendid idea! And it can be collected automatically by
> the same computer the SEC uses to support its functions. The only
> marketeers affected by this measly 1/4th of 1% will be day traders
> and arbitragers. Check the internet for the APTTax (automated payment
> transaction tax). If this takes hold you can junk the Income Tax
> and annual returns. Just tax the flow of money, not people. But
> keep the percentage small.

Jan 19 09:56 AM

[Trader60611:]

Here’s what would happen if the “transaction tax “ succeeds. Remember: the goal was to stop all those “evil traders” who make “fast money” in the last hour, so that capital can be “more productive”.

1) The government immediately loses a years’ worth of short-term capital gains tax revues.
2) Any long-term capital gains revenue (if it happens at all) will be far less, because of a one-two punch of lower, less leveraged returns, and lower cap gains rates for long-term trades
3) For every “evil short-term trader” you successfully convert to a “good” long-term trader, you also, of course, lose the transaction tax on their trades, this reducing the very tax revenue you want to collect. You can’t assume the revenue will be steady. The horror would be “what happens to revenue if (heaven forbid) it succeeds?”. Furthermore, you are lopping off all of the tax money from the (now-nonexistent) high-volume trades that you wanted to tax! It’s like trying to get highway funds by taxing everyone driving over 85 mph. Of course…no highway funds!!
4) Also, plan for massive tax revenue reductions from the brokerage companies, data providers, investment services, mutual funds, business TV stations, etc.
5) Also, consider the “shift of assets to productive activities”. You’re saying a great short-term trader will make a great pharmacist? Landlord? Car salesman, maybe? You can’t be serious. The upshot? Misallocated resources lead again…to…you guessed it … LOWER TAX REVENUES.
6) Your 401-K will suffer for several reasons: there will be no short-term traders there to sell stock to your mutual fund when it needs to buy, and, the lower liquidity will make it more costly for your mutual fund to purchase shares and, of course, the transaction tax will eat away at your fund’s gains.
7) All those short-term traders who arbitrage the prices in the food chain will go way. That means a huge risk for the prices of all the grains, beef, oils, etc that you eat every day. Not to mention the fact that, with higher transaction costs, farmers may not be able to hedge their crops (remember, that’s a short term trade, not a long-term trade) . So, just maybe, there won’t be as much of a crop. That could lead to hyperinflation of food prices. Just what we need.
8) Most futures contracts expire, and have leverage. That means traders can make more short-term than they could, unleveraged, long-term, again, much less revenue for the government.
9) Our bond rates are already very low. With additional transaction taxes, foreigners just might stop buying our bonds, and head for higher, less-taxed returns abroad. Them we can’t finance all those nifty social programs.
10) Stock exchanges the world over are robust. The volume goes elsewhere.
11) Speaking of those “evil” last-hour traders: remember, the gains from those last-hour trades translate right into your 401-K. The close is the close. The market has to move sometime…usually whenever it wants to. It’s not a linear beast. If market-moving events can’t move the markets, investors may go on strike permanently.

Feb 01 07:11 PM

[Marianthi:]

Wow!! Now we know why progress is the opposite of congress. Peter Defazio (sp?) from Oregon (I think) is the main person pushing for this by adding it to a medicare bill. There is a petition on www.rallycongress.com/.../
Please let congress know that this item has been slipped into a completely unrelated bill and what a disaster this would be.

Feb 25 02:28 PM

[Random Idea:]

you can't make the weak stronger by making the strong weaker....this has to rank up there as one of the single worst ideas I've ever heard of economically.

It would cause a net tax loss, as 1) transactions would plummet, 2) cost of capital would escalate, and 3) New York would no longer be even among the top 10 economic centers. What an idiot.

Nov 06 03:05 PM

[GreenTraderTax:]

November 9, 2009

Financial-transaction tax is dead on arrival globally, which is good news locally

Many thanks are owed to U.S. Treasury Secretary Tim Geithner. At the G20's summit in Scotland over the weekend, he personally fought off the left-leaning powers that be – UK Prime Minister Gordon Brown and French Finance Minister Christine Lagarde – who support this dreaded tax. The Brits got caught up in local politics. The left in the UK is on its way out and used this tax as a populist rant on banks and to demonize Tories and their constituents. (Click here for more.)

The G20 is embarking on cooperation and coordination, thanks to the election of President Obama promising global consensus. None of the major G20 money-center powers (New York/Chicago, London, Paris, Germany, Russia, Nordic region, India, Singapore, Hong Kong, Shanghai, and Tokyo) will enact a transaction-tax if the other countries aren't following suit. Most leaders from these areas are against this tax; no one can afford to lose financial business during this precarious recovery.

However, some leaders do support a tax of this nature. Last month, Brazil’s government passed a 2-percent tax on foreign purchases of equities and fixed-income securities. Perhaps Brazil’s strong industrial and commodity economy will support experimentation with this tax, but the Brazilian government may change its mind after the effects of the tax set in.

The G20 is trying to make progress in the area of financial reform so it can move on to climate change before the end of 2009. There is little time to make agreements and then back track. It decided to wait for final word from the IMF, and the IMF confirmed it doesn't support a financial transaction tax. Hence, it’s dead on arrival in my book. As I discussed in earlier articles, Europe's left-wing politicians are losing to the right; recent statements regarding this tax were part of their last gasp efforts.

U.S. Treasury Secretary Geithner played his cards very well. He deferred to his old employer, the IMF — the global financial overseer — and he knew the IMF shared his views on using a more narrow approach, such as a bank bailout fund insurance plan. Secretary Geithner didn’t have to say no to this tax in order to defend U.S. financial markets, and he didn't have to subside his own party's (and the President’s) populist rants against Wall Street. As I have predicted, the Democrats will rail against Wall Street, but they will not kill the U.S. golden goose — our financial markets and industries. Hopefully, this may be a turning point from populist campaign rants toward productive policies that are fair and balanced. In my opinion, President Obama is looking smarter for selecting Tim Geithner as his Treasury Secretary, based on Geithner's good experience with the IMF - the brains of the G20 going forward.

Yes, left-wing fringe elements and progressives in the U.S. Democratic party will still try to raise transaction-tax revenue proposals to "pay go" for new spending plans such as transportation, health care, and more. But, I continue to believe that leadership will keep shooting down this shotgun "kill-many-traders" tax, as they have been doing to Rep. Peter DeFazio, D-Ore., and other similar plans. The left-wing progressives just don’t get it. They want to spend their way to recovery and fund the efforts by taxing small-business job creators. That shows their poor economic training.

I am writing an opinion piece on this tax for Active Trader magazine. I'd like to start my piece as follows: “Congratulations, you just hired yourself by becoming a trader. Too bad left-wing Democrats want to fire you.” It’s about small business jobs, jobs, and jobs! Traders hire themselves, and spend their days productively making a living for their families. A transaction tax will surely put close to a million traders out of business overnight. Most of these home-based and smaller hedge-fund traders lost their jobs before pursuing trading as a last resort business opportunity. Many have exhausted unemployment benefits. What safety net remains for out-of-work traders? Firing them in this populist rant against Wall Street is stupid and unfair. If you want to tax Wall Street, ask for a higher FDIC fee or a windfall profits tax if you have the guts to do so.

Much more to come soon in my opinion piece and this week’s conference call.

Nov 09 10:45 PM