Monday, November 18, 2013

Financial Transactions Tax

Talking about potential Government money grabs ...

Former labor secretary Robert Reich wants to see a 0.5% financial transaction tax (FTT) imposed on all stock market trades. This FTT has been proposed before by several politicians and just never seems to go away. The quick skinny is it's bad law and won't provide the benefits that supporters purport. Here's why.

As a private equity manager, when I make a stock trade my broker charges me 0.5 cents commission on every share of stock traded. So if I buy a stock that costs $50 per share, the brokerage earns 0.01% commission on that transaction ($0.005 / $50). In return for the commission, the brokerage executes and clears the trade through the exchange, pays any exchange fee, provides trade and accounting reporting, provides real-time market data, provides trading platform software, and provides technical support. All those nice services for just 0.01% commission per trade.

Now Reich and others want Government to impose a tax that amounts to 50 times what brokerages work their asses off to collect for the transaction!!! I'll repeat that because it's important. The Government wants to impose a tax in an amount that is 50 times greater than the total money that all brokerages collect for processing the transaction. Sorry, but in my opinion that's beyond draconian. More importantly, however, the tax won't increase revenues as planned. The problem is you can't just impose a tax and expect everybody to behave in the same manner. Imposing a huge 0.5% tax each trade will eliminate all short- and medium-term trading, not just the so-called "high-frequency" or "day-traders". These type of trades amount to at least 75% of all trading on the exchanges.

Why would the 0.5% tax dramatically reduce the amount of trading? Well, quite simply if you had a strategy that made 12% annual profit and changed the portfolio just once each month, under the proposed FTT you would now make 0% profit since the FTT is imposed on both the buy side and sell side (0.5% x 24 = 12% hurdle). Why would anyone continue trading a strategy that doesn't make any money?! So if all the day-traders, short- and medium-term traders are obliterated, then the amount of commissions & profits collected by the brokerages and exchanges will be reduced significantly which will then result in lower corporate tax and/or personal income tax payments to the IRS. So yeah, technically the FTT would gain revenue off the transactions, but that would be offset by the reduced taxable revenue collected from the brokerages, exchanges and their employees.

However, the results would be even more chilling as thousands of private equity managers and proprietary traders would be put out of business since their trading strategies wouldn't be able to produce gains after the tax is imposed. So the government would lose out on income taxes of their revenues in addition to those of their investors. Additionally, with reduced commissions & profits, the brokerages and exchanges would likely have to lay-off some employees. These are not the 1% type either, we're talking about IT people, customer support, etc, which would also result in reduced income tax payments to the IRS. The reduced trading on the exchanges would widen the bid-ask spread and increase transaction costs for those who are still trading on the exchanges, which of course those costs feed through to anyone owning an IRA or 401k.

Proponents of the FTT want to penalize the financial industry for causing the financial collapse of 2008-09 and want to create a mechanism to slow trading on the exchanges so that there is less volatility. Well, this is horrible thinking IMO. By imposing the tax they are penalizing people and firms that had absolutely nothing to do with the financial meltdown of 5 years ago and creating all sorts of other problems as stated above. Moreover, there is no evidence that reducing algorithm or high-frequency trading on the exchanges will reduce volatility. In fact, the volatility in the last decade with the growth in electronic trading has been no different than the trading over the previous 80 years. If the government wants to prevent another financial collapse there are better avenues ... like limiting the leverage banks & financial institutions may utilize when purchasing derivatives. Leverage kills. That's why the SEC wisely restricts leverage to 2x equity balance on overnight stock holdings, which means if you have 100k in the cash account you can own 200k of stock. In contrast, the institutions that collapsed in the financial meltdown had leverage ratios over 30x in 2007 owning derivatives. Well, if you utilize 30x leveraging power than what is actually in your equity account and the derivative drops just 3.3% in price, then you've just lost all your money!

Sorry, but the financial transactions tax is an over-reach and will accomplish nothing but curtail freedom. What's next, a transaction tax every time you deposit and withdraw money from your bank?

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