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

by: Robert Weinstein

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.