A 400 Percent (and Higher) Excise Tax

Michael S. Rozeff

The Wall Street Journal brings more bad news. A headline reads "Lawmakers Weigh a Wall Street Tax." The first mention of this was in October. The proposal has not died as Congress seeks new ways to finance its profligate spending. Both houses are considering legislation.

The tax would fall on financial exchanges of all kinds. It is not a tax on Wall Street. It is a tax on anyone who buys and sells securities.

James Tobin originated the notion in the 1970s. Larry Summers supported it. Robert Kuttner supports it. That’s three Keynesian economists right there. It must be a bad idea.

The tax seeks to raise $100 to $150 billion by taxing the value of every financial trade. The rate on stocks would be 0.25 percent. That does not sound like much, but it’s actually huge compared to what investors pay today when they transact. The brokerage cost of transacting is as little as $7 for a $10,000 or a $100,000 or even a $1,000,000 transaction. That’s 0.07 percent, or 0.007 percent, or 0.0007 percent, respectively. The transactions tax would be $25 or $250 or $2,500 on these transactions, respectively. That’s $25 added to $7, $250 added to $7, and $2,500 added to $7.

Due to the quirks of influence-peddling, the proposed tax would be 0.02 percent on options, futures, and other derivatives.

In the 1960s it was quite costly to transact in stocks. Commissions are part of those costs, and they were 1 percent or so. After a few decades of hard work, the industry got the costs down considerably. A well-known broker charges $7 a trade in any size and provides a more than satisfactory complement of other services. If a 0.25 percent tax goes in, the cost of a $10,000 trade becomes $32. The tax is 3.57 times the brokerage cost of $7. This is an excise tax of 357 percent on this size trade. For a $100,000 trade, the cost is $257. The tax is 35.7 times the cost of $7. The excise tax rate is 3,570 percent.

With such a tax in place, far fewer transactions will occur. Short-term trading will be severely curtailed. The revenues from this tax will not be anywhere near the estimates. They assume that the number of transactions will not decline, but trading will drop off a cliff.

The proposed law taxes U.S. investors who trade overseas. That escape route will be closed off.

This tax is as bad as a capital gains tax. The latter discourages investors from moving capital around freely. It discourages risk-taking. It discourages moving out of less and into more productive projects. The tax on financial transactions does the same.

This tax makes markets far less liquid. There will be fewer buyers and sellers. Bid-ask spreads will rise steeply.

Lawmakers probably do not realize that a large fraction of the capital stock of corporations is carried by short-term speculators, due to the uncertainties of business. Turnover is high on many stocks because of unwillingness to hold long-term positions under conditions of high uncertainty. If short-term speculators are driven from the market, as this tax will do, then long-term speculators will have to take and hold the stock. They will demand a higher risk premium as they are made to depart from their preferred portfolio holdings. This will drive up capital costs to corporations. This will slow down capital accumulation and growth. This will lower employment and wages.

Low transactions costs bring both uninformed and informed investors into the market. But the uninformed tend to be weeded out because they lose money. With a transactions tax in place of this size, the informed traders will also be far more reluctant to trade. The bounds within which prices trade will become that much larger. They will become all the worse as signals of value to corporate managers. Investors who attempt to buy and sell in quantity or rapidly will find prices changing due to their own trades, even if they possess no special information.

Some of us engage in stabilizing speculation. We buy when prices are falling too far too fast in our judgment, and we sell when prices are rising too far too fast in our judgment. If we are right, we stabilize prices. If we are right, we buy at times when prices are dropping without good reason and we sell at times when prices are rising without good reason. Those of us who are right in these judgments make money, and we come to be the marginal traders in stocks. We see to it that prices are more rational. This operation is risky. The selling and buying power of stampedes of uninformed investors can be exceedingly large. It takes nerve and knowledge to go against these tides. The role of stabilizing speculation in price-setting will be vastly diminished.

The Journal article dutifully reports a mass of lies and totally erroneous ideas of the advocates of the tax:

"Congressional advocates describe the new tax as a matter of fairness: Taxpayers bailed out Wall Street, so Wall Street must help rebuild the economy and shore up the government’s shaky finances. Some experts say the tax also might help reduce market volatility."

Is it fair to tax innocent investors and brokers who have worked to bring down costs? Is it fair to label them as "Wall Street?" Is it fair for the government to have paid off big banks and the likes of Goldman Sachs in the first place? Is it fair to turn around and then tax investors as if they were the ones who were responsible for doing something wrong? Can such a tax rebuild the economy?

This quote contains nothing more than baloney and claptrap designed to generate support for yet another Congressional grab.

The article goes on with more big lies:

"Supporters say the hit for typical individuals and even most institutional investors is likely to be light, thanks to the tax’s relatively low rates and generous exemptions...The rate for stock trades would be 0.25%, or $250 on a $100,000 transaction."

This is a very heavy tax rate, as shown above. Even a smaller speculator who is speculating as a business can easily do $50,000 to $100,000 of trading in one day. A stabilizing trade might go as follows. Buy $100,000 of stock that has fallen 4 percent in one day because one estimates that the selling has gone too far too fast. Sell it the next day after a rise of 1.5 percent for the opposite reason, that the buying is going too far to fast. Gross Profit: $1,500. The transactions tax is $500 of this profit or 33 percent of the gain. In addition, there is the short-term capital gains tax that is perhaps 28 percent. Then there are the inevitable losses that this speculation faces.

It is safe to say that droves of speculators will be driven out of the market in the face of a 0.25 percent excise tax on the value of financial trades.

Another sop is this:

"The law would provide a $250 tax credit, effectively exempting everyone from the first $100,000 of all stock trades."

One day of moderate trading uses this up. This exemption is meaningless.

America seems to be on the verge of mass insanity as Congress comes up with increasingly bad legislation. Can nothing stem the irrationality of American society and government?

December 21, 2009

Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. He is the author of the free e-book Essays on American Empire.

www.lewrockwell.com