Trading Tax: Dumb And Dumber

November 08, 2011

Plans to tack a 0.03 percent tax on all financial transactions are the latest example of Washington politicking at its worst.

Even a cursory glance at the numbers will tell you it’s insane.

In case you missed it, Sen. Tom Harkin (D-IA) and Rep. Peter DeFazio (D-OR) are proposing that the federal government impose a tax on all financial transactions of 0.03 percent on the dollar.

This isn’t the first time the pair have called for this action in the name of shrinking the gaping hole in the U.S. budget deficit. The two blithely claim such a tax would be easy for Wall Street to digest, but they’re completely insane. Just read on and you’ll see why.

The problem here is that this time their proposal is receiving special attention. That’s because France and Germany made similar proposals for the EU in meetings in September. The EU bill calls for a 0.1 percent tax to be implemented in 2014, amid claims it would raise an estimated $78 billion a year.

A little history lesson is in order. While early markets—even in the United States—had transaction taxes, they’ve been largely abandoned by the industrialized world, as most regulators have come to realize that they are both hard to implement and rarely effective.

Worse, they can have disastrous knock-on effects.

Swedish Disaster

The best-known example comes from Europe—or Sweden, to be exact—which probably explains why the European proposal has met with such strong opposition. From 1984 to 1991, Sweden implemented a series of taxes ranging from 0.5 percent on equities to fractional basis points on certain bond trades.

The results were disastrous. As any sane person might expect, trading volumes plummeted in Sweden as investors moved their money to more lubricated markets. Within six years, the options market vanished entirely, futures volumes fell 98 percent, and 50 percent of equity trading moved offshore. Even bonds, which had fractional basis-point taxes, suffered an 85 percent reduction in trading volume.

That was in the late ‘80s, when global markets were smaller and much less liquid than they are today.

You need only look at the relative ease with which savvy futures traders move their exposure between ICE futures, CME futures and negotiated swaps to imagine what might happen today. Investors will vote with their feet, and exchanges like NYSE Euronext and ICE have made clear that they will vote with their feet too if transaction taxes are imposed in Europe in a serious way.

The United States has made clear, in carefully worded statements, that it won’t back a proposal to implement the EU bill globally.

It’s true that Harkin and DeFazio’s tax proposals call for a much lower rate of only 0.03 percent. That may sound better, but the bill is extraordinarily strict, allowing for no exceptions. A quick look at the numbers suggests that this no-exceptions rule would quickly make a mockery of the global financial markets.

Beyond The Bobs Of The World

Let’s start with Bob. Bob has a $100,000 portfolio, 20 percent of which he trades each year. If his portfolio returns 9 percent a year—the average equity-marker return for the past 20 years—he’ll have a nice nest egg of $560,441 in 20 years.

With the new tax, he’ll only be slightly less well off—$559,760. That certainly doesn’t seem like much, which is probably the logic Harkin was using when he stated that, “Quite frankly, I bet no one would feel it.”

But let’s face it: Modern financial markets aren’t really about Bob. They’re about enormous institutions.

Let’s look at a single ETF. The last day I checked, SPY traded about $35.5 billion in a single day. That means each day’s trading would generate $10.7 million in taxes. I bet someone will feel that. Over the course of a year, that’s over $2.7 billion going into the government coffers, just from SPY alone.

What about the whole ETP space? Again, a spot-check on all U.S. ETP volume last week showed about $90 billion traded per day. That’s $27.2 million in taxes for the day, or nearly $7 billion annually, just from ETF trading.

How about all equities? On Nov. 3, U.S. equity trading volume topped $274 billion. That would have generated $82.4 million in taxes, per day, or about $21 billion a year.

But that’s small potatoes.

 

 

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