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.