Sunday, March 01, 2009

Congress Proposing Transaction Tax On Stock Trades

Now how does instituting a tax on stock trading help and who does it really hurt? Congress and Obama have embarked down a very dangerous path.

Unintended Consequences of Levying a .25% Stock Transaction Tax
by Ron Rowland

Congress is considering legislation to impose a securities transaction tax of 0.25% on every stock trade, which of course is equivalent to 0.5% for each round trip. It’s known as H.R. 1068: Let Wall Street Pay for Wall Street’s Bailout Act of 2009.

As currently written, the bill amends the Internal Revenue Code of 1986 to impose a tax on certain securities transactions. The authors presume it will produce enough additional revenue over time to recover the cost of the $700 billion Troubled Asset Relief Program. Representative Peter DeFazio, D-Oregon, authored the bill.

This bill takes the “law of unintended consequences” to new extremes. You and I did not create the problems of Wall Street. You and I did not receive any Bailout Dollars. As taxpayers, you and I are already paying for the TARP. To start charging us 0.5% for each round trip trade is only adding insult to injury.

If you have portfolio turnover of 100% per year, then this tax represents a 0.5% per year burden. If you are a more active trader, perhaps with an average holding time of 25 days, then it robs you of 5% per year. If you do multiple trades a day, then forget it - you are out of business.

If active traders are removed from the market, what happens to volume? It will dry up, of course. Then you and I will be paying more for each transaction in the form of an increased bid/ask spread. The bill claims to recoup the cost of TARP, but I bet they did not factor in the severe volume reduction that the bill would create.

This proposal has a host of other problems, many of which are highlighted in a great article by James Ramage for Traders Magazine entitled Industry Fears Proposal in Congress Would Destroy High-Frequency Trading and Liquidity.

This bill will hurt too many people, and they won’t be the people it is intended to hurt. A ground-swell of opposition is already forming, but with the public’s current anti-Wall Street mood H.R. 1068 could still slip through. If you see the folly of this idea, let your Representative know how you feel.


14 comments :

Chris said...

Would you be more receptive to some flat rate like $1/trade? Or are you dead set against it?

David Templeton, CFA said...

Chris,

Generally,I am against a tax like this. Why would we charge an investor any tax if, let's say, he buys shares in Procter & Gamble? Why punish the investor in P&G? Truth be told, the government simply needs to stop the bailouts.

David

Chris said...

My only thoughts why it could be helpful, is to avoid the market manipulation and the trading that I think is doing more harm than good. You are supposed to be buying shares in companies and investing in them. ( I am not saying that is necessarily true, but just the original concept of the stock market) I don't know if daily trading helps anything. I know people do it and some are successful. I am young and idealistic and I just wonder if we could avoid the bubbles in equities markets as well as the crashes if we could limit the minute by minute trades of trading programs and such. I am not sure if I wold vote for that, but I did want to further the discussion.

David Templeton, CFA said...

What would help the markets the most would be to reinstitute the "up tick" rule. For the life of me, I do not know why this has not been done.

Chris said...

I was reading this speech by Charlie Munger at UCSB economic department and this section made me think of this discussion.

"There are, of course, enormous vice effects in economics. You have these bubbles with so much fraud and folly. The aftermath is frequently very unpleasant, and we’ve had some of that lately. One of the first big bubbles, of course, was the huge and horrible South Sea bubble in England. And the aftermath was interesting. Many of you probably don’t remember what happened after the South Sea Bubble, which caused an enormous financial contraction, and a lot of pain. They banned publicly traded stock in England for decades. Parliament passed a law that said you can have a partnership with a few partners, but you can’t have publicly traded stock. And, by the way, England continued to grow without publicly traded stock. The people who are in the business of prospering because there’s a lot of stock being traded in casino-like frenzy wouldn’t like this example if they studied it enough. It didn’t ruin England to have a long period when they didn’t have publicly traded shares. Just as in real estate. We had all the shopping centers and auto dealerships, and so on, we needed for years when we didn’t have publicly traded real estate shares. It’s a myth that once you’ve got some capital market, economic considerations demand that it has to be as fast and efficient as a casino. It doesn’t. "

http://www.marketfolly.com/2009/02/charlie-munger-speech.html

EMD said...

This is the most STUPID and
RIDICULOUS proposal ever. Ordinary
people have already been hurt
enough in their 401Ks without this
outrageous tax proposal. Traders
will be absolutely SCREWED royally.
Traders will be taxed on the value
of their trades regardless of whether they make a trade or not.
This will only make markets less
liquid but drive the business outside of the US. Another dumb ass NAFTA where we push jobs and
business to other countries.

Why dont we tax the earmarks of all
Congressmen and Senators at this same rate....out of their own pockets!!!!!

Then we consider this outrageous
transaction tax.

EMD said...

My comment reads:

"Traders will be taxed on the value of their trades regardless of whether they make a TRADE or not"

should read...."regardless of
whether they make a PROFIT or not"

Yngvai said...

This is a terrible idea.

I trade for a living and this tax would kill my ability to make a living off trading.

I might put $3K - $5K into a trade. Thus, I would be taxed $7.50 - $12.50 per trade. If I do 20 trades per day, that's $150 - $250 that I'm taxed per day. Some days I may not even make $250 of money. And some days I might lose. This tax would hit me even on a losing day.

And that's not to mention that I'm already taxed on any profits I make.

This is such a horrible, horrible, horrible idea.

Anonymous said...

Hello David,

I have two questions regarding the proposed "Trader-Tax" HR 1068, which I cannot seem to find answers to.

My questions specifically pertain to how this proposed tax might apply to an individual who trades open-ended mutual funds:

1. "Would an individual who daily trades open-ended mutual funds (such as Rydex, Profunds, or Direxion -- shares priced at 4pm daily) be subjected to this proposed tax? And if so, what minimum holding period would be required to avoid this proposed tax."

2. "Would trading open-ended mutual funds in a tax deferred account (IRA, 401k, or Variable Annuity) be subjected to, or exempt from, the proposed trader tax? (i.e. funds cannot be withdrawn from such tax-deferred accounts until age 59 1/2)."

Also, in general, I would appreciate your opinion on whether this proposed Trader-Tax HR 1068 legislation is likely to pass.

Thanks very much. Jim

David Templeton, CFA said...

Anonymous,

My best guess is open ended mutual fund trades would not be subject to this fee. The reason being open ended funds do not trade on an exchange like Nasdaq, etc. The trades that are impacted are those subject to any transaction to which subsection (b), (c), or (d) of section 31 of the Securities Exchange Act of 1934 applies.

In regards to the likelihood of this law passing? Normally I would say low; however, one party does control Congress and the White House so anything is possible.

Richard said...

I think a simple 3 cents per share for each share of stock PURCHASED would make good sense. No tax on a sale which might indeed be a loss.
Ten cents per short seems right. This kind of trade should never have been allowed, but now that the skunk is out of the bag, let's us its cents for building America as opposed to betting against it.

Richard said...

Reading all the screeds in the WSJ and elsewhere that the world will come to an end if we impose a tax as discussed here, makes me think of how the mandating of seat belts would destroy the automobile business, this and any other mandated innovation, while the fact has been that doltish managements from Charlie Wilson forward didn't know what the hell they were doing and destroyed their companies.
The WSJ only ever (in my recollection) favored and even provided strong investigative journalism on the tobacco industry. That was likely a personal and emotional issue for someone or someones in the upper floors. Had it not been it would have been another evident oppression of the great "free" market built on corporate welfare.

James Krieger, M.S., M.S., no B.S. said...

Richard,

3 cents per share???? Are you serious? Do you realize that's more than the commissions a trader might pay per trade?

One of my brokers charges me .006 per share per trade as my commission. Combine that with ECN fees, I usually pay about .008 - .009 per share. And you're advocating paying a tax that is over 3 times what someone pays in commissions?????? That is ridiculous.

Do you trade at all? I often find it's the people who have no experience trading who are advocating these ridiculous taxes. Do you realize how much 6 cents per share would cost a trader? It would put the vast majority of traders out of business, particularly since you would be adding that 3 cents per share on top of the commissions that traders already pay.

And what do you mean by "this type of trade should never have been allowed"? Are you referring to short trades? Do you realize that research has been done on the elimination of shorting and that it would completely mess up market dynamics? When the SEC passed the temporary ban on shorting of financials back in 2008, it was found that it had a harmful effect on market liquidity and price stability.

James Krieger, M.S., M.S., no B.S. said...

***********
Reading all the screeds in the WSJ and elsewhere that the world will come to an end if we impose a tax as discussed here,
**************

Richard, why don't you go look at the countries that have already tried a trader tax. Almost all of them eliminated it after trying it. Why? Because it had a harmful effect on the markets.


Did you also ever consider that the vast majority of traders are NOT on wall street? The vast majority are your average retail traders and investors. Why do you advocate punishing these people with a tax when they've done nothing wrong?

You're talking about "personal and emotional issues", yet you're clearly arguing from an emotional standpoint rather than providing an argument on logical and evidential grounds.