Transaction taxes on trading rear their ugly head every year in the Presidential budget, no matter who is in charge. It must be part of the software package. Or, some bureaucrat with an agenda sneaks it in.
A tax on trading seems like nirvana to a lot of people that don’t understand the unintended consequences of that particular tax. The tax wouldn’t just ensnare the darned greedy speculators, but it would ensnare every single American consumer in a variety of under the radar ways.
Markets exist for a variety of reasons. When one thinks about the stock market, the market exists for the firm (shareholders) to build and preserve capital. It’s a source of funding for continuing operations. When one considers commodity markets, the market exists because producers and consumers of those goods need to manage and differentiate risk.
Speculation occurs in markets, no matter where they exist, and even when there isn’t a cash incentive. Speculators are to markets what grease is to engines. They make it run a lot smoother, quieter and efficiently than it normally would. Just like the engine, without enough speculators, the market would seize.
Currently, the way the distribution system in the stock market is set up is wrong. The economic incentives aren’t aligned with shareholders. A lack of understanding of that distribution system contributes to statements like, “Tax the greedy bankers.”, or “garnish their wages”, or the rants of Occupy Wall Street. Independent traders, many fund managers and others know the system as it is presently constructed breaks down. It doesn’t function correctly.
Part of that is due to technology, and the speed at which information travels. However, most of the imbalance and imperfection is due to really, really poor legislation and regulation going back to the 1990's. Futures markets are very different than stock markets, and the way they operate are very different as well. They have a different set of operational problems today. To be clear, the Democrats and Republicans are both at fault.
But a transaction tax will adversely affect both stock and commodity markets relatively the same, and cost you quite a bit of money out of your pocketbook.
If a tax is enacted, no matter how small, it will affect what’s known as liquidity in the marketplace. When you open up a browser window at a brokerage website and get a quote for a stock, you get a bid, an ask, and a price. The bid is what people are willing to buy the stock for, the ask is what they are willing to sell for. The price is the last traded price. There is a quantity number on that bid/ask spread which shows how many shares someone is willing to buy or sell at that price. With the advent of dark pools, electronic trading, internalization, and payment for order flow, the amount of shares on the bid/offer that the public sees have declined over time. This has increased the amount of volatility in the marketplace. Increased volatility means higher costs and less returns for pension funds, mutual funds and places people put money to create wealth or security for themselves. A transaction tax will cause the bid/ask to be even smaller, creating even higher costs for average people on the street.
With regard to a commodity market, the easiest example might be in crude oil or interest rate futures. The principles are the same, there is a bid, an ask and a price. However, the function of the marketplace is very different. Instead of building a store of wealth, the participants want to get rid of risk. For the oil company, any drop in the price of oil causes their profits to drop. They are sitting on inventory and there are costs to that. They sell oil futures to hedge against a price drop. Refiners of oil need to buy oil. A rise in the price of oil makes them less profitable. They buy oil futures to hedge that risk. If there are less contracts bid or offered in the market because of a tax, their costs go up. That translates directly into higher prices at the gas pump. It might only be a few pennies per gallon. But in a macroeconomy, that’s billions of dollars of extra cost to transport goods and services around the country. Consumers will pay.
Interest rate futures offer banks and mortgage lenders the chance to hedge their borrowing and mortgage portfolios. The fact they exist with deep and liquid markets mean Americans pay a lower mortgage interest rate than they otherwise would with a tax. Tick the mortgage rate up a percentage point and it leads to a lot of unnecessary money leaking from the consumer wallet.
The Federal government auctions off Treasuries to pay for its debt. Buyers of those US Treasuries turn around and sell US Treasury futures to hedge themselves against adverse moves in interest rates. Deep and liquid futures markets save the US government trillions in interest rate costs. If the rate of interest the US had to pay were artificially raised by a transaction tax, American taxpayers would pay.
This same logic applies to grain markets, meat markets, energy markets, food and fibre markets. The cascading domino effect of a tax causing less liquidity in the marketplace works its way right into the consumer wallet. The cost for everything you consume will go up.
There are certainly things that we need to do today to fix market structures that are broken. But a transaction tax is the fools way out of a complex problem.
UPDATE
None other than that great economist and believer in free markets Ralph Nader called for a transaction tax in today’s WSJ. Good thing no one listens to Ralph.
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