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10 November 2011

Financial Transaction Tax Will Punish Main St., Not Wall St.

Here are some numbers that show who would bear the brunt.

Rep. Peter DeFazio (D-Ore.) is at it again. With support from Sen. Tom Harkin (D-Iowa), DeFazio will be introducing a bill to propose a tax on financial transactions.

DeFazio tried to propose a similar tax a couple of years ago but the proposed bill never gained much traction. But now that the European Union has proposed its own financial transaction tax, DeFazio is hoping that his proposal can gain more support.

Their argument is that this tax would generate a substantial amount of revenue at the expense of Wall Street, which can easily bear the tax. But upon closer examination, who does this tax actually punish?

In theory, this tax would raise a substantial amount of revenue. However, it would come with some substantial costs, the most significant being a decline in market liquidity. Market liquidity refers to a stock’s ability to be sold without substantially impacting price.

The majority of our market liquidity is provided by market makers. These market makers (some being high frequency trading firms) have very small profit margins. A modest transaction tax of 0.03 percent (which is being proposed) would have drastic effects on the market making business. Let’s take a quick look at the math.

Many of our most highly traded stocks have bid-ask spreads of 1 cent. A stock that is trading at $25 would have a transaction tax of $0.0075 per share ($25 x 0.0003). If a market maker were to buy this stock at $25 and sell it at $25.01, he would make 1 cent per share but would have to pay 1.5 cents per share in tax (they have two transactions, the buy and the sell). Therefore he would lose 0.5 cents on the transaction.

So in order to remain profitable, the market maker would have to widen his spreads to a minimum of 2 cents and possibly more (as market makers aren’t always profitable on every trade). Wider spreads mean more price impact for institutional traders as they make trades and this added expense comes right out of the pocket of the individual investor who invests in the fund that is trying to transact.

The bottom line is that market makers (some being high frequency traders) are still going to make money, they are just going to trade with wider spreads to do it. This is an indirect cost to Main Street, not Wall Street.

The direct cost is that the institution transacting would have to pay the transaction tax as well. So another 0.03 percent comes out of the pocket of the individual investor investing in the fund every time the institution makes a trade. This number may sound small but imagine an institution that trades 200,000 shares of a $50 stock. The transaction fee on that transaction alone would be $3,000. Many actively managed funds trade much higher volume than that in a single day.

These costs would quickly add up, again punishing Main Street.

What would naturally happen is that institutions would become hesitant to trade and may hold on to a position they would otherwise sell just to avoid paying the transaction fee. This, in turn, could lead to large losses in positions that may have otherwise been liquidated. Who would bare the brunt of these indirect costs? Main Street, again.

The benefit to this tax would come in the form of the revenue generated from the tax. But trading volumes would drop substantially as traders and institutions seek to avoid excessive taxation. This makes any projected revenue raised by the transaction tax much less than what would be raised on today’s current market volumes. The revenue raised from this tax would pale in comparison to the costs mentioned previously.

So I would argue that Wall Street would not beae the brunt of this tax. Wall Street traders will simply evolve to the new environment by widening their spreads. In the end, Main Street will pay.

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5 Comments to "Financial Transaction Tax Will Punish Main St., Not Wall St.":
  • Missing

    10 November 2011

    For another view on this see my post this summer on my Forbes blog:

    Would slower trading, or passive management, improve returns at funds? 

  • Missing

    10 November 2011

    Dennis, nice try, but you are so far off base.  1st off, I am totally against the tax, however that is because I am against taxes period.  But please don’t try and tell me that it would hurt institutions because “The majority of our market liquidity is provided by market makers. These market makers (some being high frequency trading firms)” LOL!!!! 1st off, the street has wised up and the old premise that volume is liquidity, has been debunked. 2. HFT’s and market makers are not one in the same; once again, thankfully, the majority of the street has had their eyes opened to that myth as well. 3. Oh my god, really with wider spreads it would hurt HFT and therefore hurt the institutions. Ha Ha that’s a funny one.  Yes it would hurt the HFT’s and all the other front running scumbags, but contrary to your premise that it would hurt me, it would be beneficial, think for a minute, if I didn’t have to pay you or the rest of your ilk when you get in-between me and another natural I’m way ahead. 4. the predatory  HFT’s would NOT still be in the market, because the wider spread would cause to much risk, I mean think about that, it is much easier to front run somebody when your risk is a penny, widwn that out and the risk becomes to great.   5. Although I agree that it would make it more expensive to trade for the institution, nobody would hold a bad position because they wanted to avoid the trade tax, are you a moron, lets see, I won’t save a million on my position because I don’t want to spend a thousand on the tax!  Once again the only people it would slow down would be the HFT’s and that would be a good thing.  6. I do agree with your last point on taxes, and the projected revenue would be less then the actual revenue generated, and that is why I don’t want a tax.  But please, spare me the sob story that it would us because it would hurt you.  We don’t want you, we don’t need you and all we need is a different way to get RID of you and the rest of your blood sucking prop trading HFT’s. 

  • Comment_dick__dennis

    10 November 2011

    Sorry to disappoint you Kurt.  But our firm is not a high frequency trading firm.  In fact, our firm has been critical of much of the abuses of high frequency trading.  I actually launched a website two years ago discussing high frequency trading abuses.  But if you think this tax will stop high frequency trading, I tend to disagree.  There will still be high frequency trading in our markets, it will just evolve.  In the end spreads will widen and everyone will lose.  There are better ways to regulate high frequency trading.

  • Missing

    10 November 2011

    If you noticed I refered to the preditory HFT's and yes, the more expensive you make it for them the less there would be, yes some  would  evolve and change there strategies, of course, but none the less, as a whole they would be reduced.  As for wider spreads hurting everyone, that might be you opinion but one that I would greatly disagree with, so please dont say it like fact and that everyone would be hurt.  I could give a million reasons why  A wider and deeper mkt., is and alwas has been, better then a small and tighter mkt.  Although some sheep have been lead down the proverbial road to hell and believe a fragmented, small 100 share mkt is better, I tend to think on my own and have been doing this for 20 years actually understand that 100 share bids/asks although tighter, have created fragmentation, whitch inturn helped spawn more algo's, which created more day trading scumbags and HFT's. When spreads widen, there risk goes up, there margins go down and they go out of buisness.  Not sure how long you've been in the business, but when spreads were wider and depth was bigger, actual pricing was better.   Yes there was always scalpers, but less of them and less is good.

  • Missing

    10 November 2011

    also, see't-feel-a-thing

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