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Balanced Budget to Cure It and a Tax to Kill It

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Angela Merkel and Nicholas Sarkozy met today. Here is what they came up with.

They put off the idea of a Eurobond. They have proposed that Herman Van Rompuy become the Head of Euro Council,. The debt brake will be anchored in German and French law-so now they have taken over the other Euro countries. All Euro countries will have to put deficit limits into their constitutions by summer 2012. They are committed to a strong Euro currency. They will try to harmonize corporate taxes by 2013.


But the big news is they will propose a transaction tax on financial transactions.

The market fell out of bed after the conference since virtually everything they proposed is more bureaucratic nonsense, and then  the added "benefit" of a tax.

The fall out from the conference looks to be three fold.

First, Greece will get gently booted out of the Euro. They should have never been allowed in, and instead of pruning from the top down, they are pruning from the bottom up. Greece will be jettisoned, banks will take a hit and the country of Greece will see massive inflation once the Drachma is brought back.

Second, they will rely on bureaucracy to solve their problems. The 17 nations will have to get their budgets under control. Additionally, the corporate tax harmonization was a shot across the bow at Ireland. Ireland has a low corporate tax and Europeans hate it. Will Ireland be able to continue to fight to keep it’s tax rates low? Time will tell. If I were Ireland, I might rather leave the EU than raise taxes.

Third, and the biggest bombshell, a financial transaction tax. This impacts the NYSE ($NYX) since they are merging with the Deutsche Borse. It also impacts the NASDAQ ($NDAQ) because they own European exchanges. Of course, banks ($GS, $MS, $C, $BAC) will collect the tax and pass on the cost to consumers. Don’t think for a minute that they will pay it.

Transaction taxes are like a willing, sexy women at the bar. She looks so appealing. You take her to your room, and you wind up with a disease that you can never get rid of.


Transaction taxes are taxes on liquidity. Every time a trade is placed, a tax is paid. That makes it more expensive to trade. Market participants have to widen the bid/ask spread to account for the tax. This damages the market and costs consumers more than they actually realize.

Suppose that the US enacted a transaction tax. A tax was originally included in the Dodd-Frank bill before it was wisely dropped. The spread on US Treasuries would widen significantly. A one tick rise in the spread is worth from $6.25 to $31.25 depending on the maturity. The tick value on a ten year note is $15.625. They are traded in $100,000 increments. To do a billion, you’d have to do 10,000 contracts. A .05 cent tax would cost $500. In its Treasury futures, the $CME does 2.6 million contracts per day. In theory, a five cent tax would bring in $130,000 per day, or $28.6 million per year. The total take just from CME if volume continued to average what it has would be $198 million per year. (ADV=18M)

As a market maker, forced to pay a tax I would decrease the volume that I traded. It would force more discipline on my trading style and force me to pick my spots. I’d be a lot more careful. The tax changes risk reward ratios. Multiply that by the thousands of people trading and you will get significantly less volume than you have today. Sounds good to a lot of people. “Let’s get those greedy Wall Street bastards!”

Less volume means it’s a lot harder for pension funds and mutual funds to transact business. They get worse prices. That decreases the rate of return they can pay the people that are invested in them. Glad you got those Wall Street bastards?


Follow the logic even further. If spreads widen in the ten year US Treasury market, it will cost you $15.625 for every tick they widen. Currently our debt is 14 trillion. Averaging out the tick value of the Treasury contracts, you get around $17.60. For every $100,000 you increase the debt, you pay an extra $17.60 per tick. To give you a rule of thumb, spreads before futures contracts were initiated on Treasury debt were around 12-15 ticks wide or roughly $250 bucks. Today they are a tick wide, but after a tax they would widen for sure. ($ZQ_F, $ZT_F, $ZF_F, $ZN_F, $ZB_F, $GE_F)

Because a tax on transactions is a tax on liquidity, bid/ask spreads will have less volume on each side. This means that when a large trade hits the marketplace, there will be what market pros call “slippage” in the market. Prices will get even more volatile and costs go up. Slippage decreases the return on investment that funds return to their investors. Aren’t you glad they went after those greedy traders now?

A transaction tax will add trillions to the cost of issuing US debt. That increases your tax liability. The increased cost will artificially increase interest rates. That increases corporate borrowing costs, and forces consumers to pay higher prices for goods and services. A crushing debt load will turn each and everyone of you to a slave to government, not working for the betterment of your family.

Aren’t you happy you got those greedy bastards now?

Applying the same logic to Europe, Sarkozy and Merkel just made everything significantly more expensive($CL_F). They increased costs dramatically, and guaranteed slower growth. They just lifted trillions in Euros from the pockets of anyone using the Euro. Not only that, but capital will flow away from the European marketplace and into markets that tax less. Asia and the United States ought to benefit from those capital flows. More money will plow into the Swiss Franc($CHFUSD, $6S_F).


The cost of commodities will be more expensive in Europe. Brent Crude ($ICE) now faces a transaction tax that will artificially push up the cost of energy. This increased cost will filter through everything in Europe.

Sarkozy and Merkel just shot themselves in the foot. They guaranteed slower growth and dimmer prospects for the future. Let’s hope that US officials don’t borrow the same stupid logic

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