Transaction tax floated, again

January 29, 2016 03:35 PM

Yesterday the New York Times Editorial Board wrote an piece supporting a tax on trading, which would include stocks, options and futures. Such a tax has been bandied about for years and has gained traction in Europe and elsewhere following the financial crisis and numerous trading scandals.

The editorial titled “The need for a tax on financial trading,” opened, “A financial transaction tax — a per-trade charge on the buying and selling of stocks, bonds and derivatives — is an idea whose time has finally come.”

The editorial is troubling in the complete lack of understanding of the impact such a tax would have on markets and in assumptions regarding trading.

First off, we should point out that such a tax/fee already exists. The Securities and Exchange Commission’s budget is covered through Section 31 fees. Section 31 of the Securities Exchange Act states: “The Commission shall, in accordance with this section, collect transaction fees and assessments that are designed to recover the costs to the Government of the annual appropriation to the Commission by Congress.”

On multiple occasions, similar fees on futures trades have been proposed in both Democratic and Republican administrations. In fact, it had become a rite of spring for me to ask then Congressman John Boehner (R. Ohio) (prior to him rising to Speaker of the House) about the proposed fee, while he was speaking at the Futures Industry Association conference in Boca Raton Fl. Boehner, along with several other members of Congress, were often the guest of the Chicago Mercantile Exchange and Chicago Board of Trade at its Washington outlook event on the last day of the conference. (The idea of lobbyists footing the bill for members of Congress to speak in a sunny locale and perhaps take in a round of golf has since been discouraged.)

I would ask about the proposed fee and Boehner would assure all of the futures industry big wigs in attendance that the proposed fee would be killed.

It was beaten back based mainly on two arguments. One that futures are more of an institutional product serving a valid economic function and it is appropriate for the government through the Commodity Futures Trading Commission (CFTC) to ensure futures markets remain orderly; and two, there already was a user fee administered by the National Futures Association, the self-regulatory organization (SRO) that does much of the regulatory heavy lifting for the CFTC. The entire NFA budget is covered by such fees.

The argument that such a fee would create an incentive for competition overseas was also raised.

However, the most recent push for a transaction tax is not based on the reasonable argument that an industry should cover the cost of government oversight but as a more punitive measure against bad actors. It seems to be based on a couple of things: These guys are rich, these guys are bad (causing financial crisis) and high frequency trading is bad and needs to be curtailed.

The editorial makes weak arguments based on false assumptions.

It starts: “The burden of this tax would be concentrated at the top, because that’s where the ownership of financial assets is concentrated.”

If as noted it is based “per trade” the burden falls on the most active traders, the markets makers and high frequency traders who also provide liquidity (while some can make the argument against some HFT practices, the act of scalping will be more expensive and the market will become less liquid). Those costs will be passed to the market through wider bid/ask spreads; which brings up their next misguided point:

“…individuals who buy and hold investments, including those who invest in index funds that trade infrequently, would be largely unaffected.”

These folks may not face much pain from the transaction fee but since the market makers will be widening bid/ask spreads to make up for the fees, these folks will certainly be negatively affected.”

The next one is really fun:

“Pension funds that devote a portion of their portfolios to speculative trading, often through hedge funds, would be hit, but some pension funds have already stopped using hedge funds because the returns do not justify the costs. A financial transaction tax that encouraged other pension funds to follow suit could actually benefit pension participants in the long run.”

See, this would be for our own good; so that pension managers don’t allocate to those evil hedge fund managers. The assumption on hedge fund returns has been made for some time and is a bit dangerous. I do not want the New York Times Editorial Board making my investment decisions. And I certainly don’t want this false narrative to cause my portfolio to lack alternatives after a seven-year bull market that appears to be coming to an end. Hedge funds are not supposed to outperform index funds in a bull market, but investors should have exposure to alternative investments that can produce positive returns in bear equity markets. Especially now!

The editorial also makes the popular “everyone else is doing it argument,” to offset claims that it will push business overseas. While a comparable transaction tax across global markets would have the benefit of possibly avoiding regulatory arbitrage, there will always be someone that cheats. And regulatory arbitrage is not the only risk; less liquid markets would be the big drawback.

Given how often the transaction tax has been pushed in recent years, it is disappointing that the Times Editorial Board makes such a week case.

 

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.