Tax on stock trades being considered

[samclem]

It looks like several legislators are working on a proposal to tax equity trades.

House Democrats are clashing over a draft bill that would tax financial transactions in an effort to raise $150 billion per year.

Democratic Reps. Carolyn Maloney (N.Y.), Mike McMahon (N.Y.) and Debbie Halvorson (Ill.) are circulating a letter opposed to the stock transaction tax idea. They're squaring off against the tax's main supporters, including Reps. Peter DeFazio (Ore.) and Ed Perlmutter (Colo.).

The 0.25 tax would be levied on stock, futures, derivatives and other transactions. The financial industry strongly opposes the tax and argues it would hurt the economy as it begins to recover.

Here's more.
I assume the "0.25 tax" is really 0.25%. There's no indication in the article of whether mutual funds and ETFs would be included in such a atax.

Anyway, this is at the very early stages and it probably won't happen. But it's an indication of things to come. I expect taxation of non-wage income to become a new growth industry.

 

[W2R]

Ugh. Sounds like that might impact actively managed funds. I am thinking that perhaps if the managers' stock purchases within the funds were taxed, the costs would be passed on.

I hope this idea gets dropped like a hot potato.

 

[youbet]

It looks like several legislators are working on a proposal to tax equity trades......................I expect taxation of non-wage income to become a new growth industry.

Not to be morbid, but......... I sadly expect:

1. Higher tax rates on ordinary income.
2. Elimination of "breaks" on passive income such as LTCG rates and qualified dividend rates.
3. Wealth taxes, such as real estate tax and personal property tax, to be expanded to include monetary assets.
4. The AMT to impact more people.
5. State and local taxes to increase.
6. More means testing for entitlement programs such as SS and Medicare.

 

[yakers]

per youbet:
Not to be morbid, but......... I sadly expect:

1. Higher tax rates on ordinary income.
2. Elimination of "breaks" on passive income such as LTCG rates and qualified dividend rates.
3. Wealth taxes, such as real estate tax and personal property tax, to be expanded to include monetary assets.
4. The AMT to impact more people.
5. State and local taxes to increase.
6. More means testing for entitlement programs such as SS and Medicare.

I would add, increased sales/VAT.

There may be better or worse ways to do things but there is a lot of debt to pay off and taxes will have to be raised somehow.

 

[traineeinvestor]

Several countries have this sort of tax already - usually called stamp duty - on property transactions and securities transactions. In HK we pay 0.1% on the sale and purchase of shares.

 

[samclem]

The legislation to tax stock transactions is apparently moving ahead. It was introduced last week in the House, and a version is being drafted for consideration by the Senate.

Here's one take on the likely impact of the legislation from a couple of people many here know: Malkiel and Sauter.

In part:

The financial crisis was primarily a liquidity crisis and a credit crunch, and the major problem with collateralized mortgage-backed bonds was that they declined significantly in value and became illiquid. A transactions tax that would have reduced trading and made repurchase agreements more costly, could have made the problem even worse. Moreover, "Wall Street" would not foot the bill for the presumed $150 billion tax. In fact, the tax would simply be added to the cost of doing business, burdening all investors, including 401(k) plans, IRAs and mutual funds.
Some argue that high-frequency traders, who reportedly execute 70% of the equity market trades, would pick up the lion's share of the bill. But high-frequency traders are not villains—indeed, they play an important role in improving market efficiency.
Often mischaracterized as speculators, high-frequency traders scour markets for minor mispricings and arbitrage trading opportunities. They buy and sell stocks in an instant, hoping to earn pennies on a trade. Far from destabilizing or creating volatility in the market, their actions significantly increase trading volume, reduce spreads, promote price-discovery, and ultimately reduce transactions costs for long-term investors. Such trades might not be doing God's work, but they are socially useful.
. . .

Transactions taxes would make most current high-frequency trades unprofitable since they depend on the thinnest of profit margins. Trading volume would collapse, and there would be a dramatic shortfall in the tax dollars actually collected by the government. Market liquidity would decline, bid-offer spreads would widen, and all investors would pay significantly higher costs on their trades.


The U.S. has the broadest, deepest, most liquid and efficient capital markets in the world. This is why it can continue as the world's premier reserve currency nation despite consistent trade deficits. People are attracted to the our financial markets because of their high liquidity and low transactions costs. Efficient capital markets also benefit all individual investors who save and invest through 401(k)s, IRAs and other retirement programs. The transactions tax would gravely wound financial markets. It is hard to imagine a piece of legislation that would have more damaging unintended consequences.

Of course, what would these guys know about the stock market . . .

 

[jimnjana]

Several countries have this sort of tax already - usually called stamp duty - on property transactions and securities transactions. In HK we pay 0.1% on the sale and purchase of shares.

Stamp Tax..."Stamp Act" doesn't that ring a bell... This will be fun to watch over the next year or so, right up to the next election cycle.

 

[eridanus]

The legislation to tax stock transactions is apparently moving ahead. It was introduced last week in the House, and a version is being drafted for consideration by the Senate.

Here's one take on the likely impact of the legislation from a couple of people many here know: Malkiel and Sauter.

In part:


Of course, what would these guys know about the stock market . . .

These high volume traders are exactly the reason that the exchanges increased their fees and added new cancellation fees. The black-box platforms were slamming the exchanges with their bids and withdrawals and were overtaxing (har!) the systems. So, in effect, these traders increased trading costs for the average trader already.

Let's not be Chicken Little. The world won't end if these types of traders go the way of the dodo.

 

[ziggy29]

If this winds up hitting pension funds, AARP and the unions will kill it.

 

[samclem]

These high volume traders are exactly the reason that the exchanges increased their fees and added new cancellation fees. The black-box platforms were slamming the exchanges with their bids and withdrawals and were overtaxing (har!) the systems. So, in effect, these traders increased trading costs for the average trader already.

Let's not be Chicken Little. The world won't end if these types of traders go the way of the dodo.

If the exchanges instituted appropriate fees to cover the extra costs of these trades, then they aren't costing me anything. Like Vanguard's fees on briefly-held shares--hey, if the fees cover (or more than cover) the costs, then these folks are welcome to trade like demons and thereby reduce the costs to me.

Market efficiency is ultimately good for everyone. Taxes on trading reduce market efficiency. There may be offsetting "goods," but the case needs to be made. And if the evidence is "those people can afford it," then the whole idea needs to be closely examined.

 

[eridanus]

If the exchanges instituted appropriate fees to cover the extra costs of these trades, then they aren't costing me anything. Like Vanguard's fees on briefly-held shares--hey, if the fees cover (or more than cover) the costs, then these folks are welcome to trade like demons and thereby reduce the costs to me.

Market efficiency is ultimately good for everyone. Taxes on trading reduce market efficiency. There may be offsetting "goods," but the case needs to be made. And if the evidence is "those people can afford it," then the whole idea needs to be closely examined.

The fees apply to everyone, not just the trading demons. If you, or your mutual funds, trade, you're paying the additional fees. The options cancellation fees didn't exist until the trading computers got out-of-hand. Now they affect everyone.

It's also questionable whether we want the "efficiency" that high-volume algo trading gives us. Google the VWAP study done by Quantitative Services Group. VWAP was pushed by Goldman, among other banks formerly called I-banks.

Finally, Warren Buffet supports the transaction tax. Of course, what does he know about the stock market...


(The transaction tax, as proposed, would be refunded for mutual funds.)

 

[samclem]

Finally, Warren Buffet supports the transaction tax. Of course, what does he know about the stock market...

WB has been in favor of lots of taxes lately. Since he now has more money than he can count, he's apparently decided the government can take some. He doesn't actually send them anything extra voluntarily, you understand, he just wishes they'd write laws to take it from him. And us.

 

[M Paquette]

For what it's worth, the bill, H.R. 4191, can be read here.

The bill imposes a transaction tax of 0.25% on stock trades, and 0.02% on futures, options, swaps, and credit default swap contracts. No tax is imposed on transactions in retirement accounts. No transaction tax is imposed on the purchase or sale of mutual funds (Sec 851 regulated investment companies) or fund derivatives.

The first $100,000 of stock transactions per year may result in the purchaser receiving a tax credit of the aggregate tax paid or $250 ($500 for joint returns) whichever is lesser. That is, you get your transaction tax refunded. (The transaction cap should really be inflation adjusted. Oh well...)

There's a clause to take the tax on transactions in facilities outside the US. No NASDAQ Grand Caymen...

 

[clifp]

I am dubious that this would collect a lot of money, because as the drop in volume would probably be substantial. That said I have heard worse ideas for increasing revenue which seems to be inevitable.

 

[free4now]

Keep in mind that the bid/ask spread is typically in the same ballpark as this proposed tax. Most people conveniently forget that the bid/ask spread is eating away at their portfolio with every trade, so even though this tax might not profoundly change the frictional costs of trades, it would profoundly change people's perceptions of those frictional costs, which could lead to significantly fewer trades among the less sophisticated, while the sophisticated folks who know how to minimize bid/ask spread continue with business as usual. Probably not a bad outcome.

 

[clifp]

Keep in mind that the bid/ask spread is typically in the same ballpark as this proposed tax. Most people conveniently forget that the bid/ask spread is eating away at their portfolio with every trade, so even though this tax might not profoundly change the frictional costs of trades, it would profoundly change people's perceptions of those frictional costs, which could lead to significantly fewer trades among the less sophisticated, while the sophisticated folks who know how to minimize bid/ask spread continue with business as usual. Probably not a bad outcome.

I think the tax is considerably higher than the other transaction cost.

A typical trade for me is 1,000 share at $20 stock. My Schwab commission is $8.95 plus a few pennies for the exchanges fees call it $10. The bid ask spread most of the time is $.01/share and almost never exceeds $.02, even for mid cap stocks. So another $10 or $20 total. In contrast, .25% tax on $20K is $50.

If you have a $2 million stock portfolio (or ETF) and are primarily a buy and hold investor your may average 4 years holding period (roughly equivalent to Vanguard fund like Windsor or psst...) that is still $1 million in transactions and an additional $2,500 in taxes. However, the typical holding period for an active investor (or active mutual fund manager) is actually closer to 1 year. I know last year (in a very active year for trading) I bought and sold $1,500,000 which was roughly equal to my taxable assets. A fair amount of this was tax loss selling like selling a S&P 500 fund and buying VTI.

The bill project a $150 billion in revenue which is clearly large enough for Wall St to worry about, so I think this would have a big impact on the transactions/volume on the US stock exchange and we would see a rapid migration to other countries. Thus eliminating US jobs and an important export (financial services).

Since mutual fund trading is exempt from the transactions, I can see the creation of highly specialized mutual funds. E.g. a PC Operating system and application company fund, commercial airline producer fund, industry leading soft drink manufacturers, which would be bought and sold by sophisticated Wall St types,leaving the bulk of the taxes to be paid by unsophisticated folks like me and some other board members.

On the other hand if they did something like England with .1% tax and only charged you for selling not buying (similar to a conveyance tax) got rid of the mutual fund exemption than I might only scream a bit.

 

[bosco]

I realize that as Americans, we reflexively oppose all tax increases, and I don't like taxes any more than the next guy. But I think this bill has merit.

First, IRAs, Keoghs, etc. are exempted as I understand it.

Second, as I read the literature, the everyday investor (read you and me) is losing a lot more than .25% per trade due to high-frequency trading which this legislation opposes.

Are we so sure this is a bad idea? Most people on this forum don't strike me as frequent traders.

 

[harley]

So, if they don't want high frequency trading, why don't they just pass a law against it?

Implementing a tax to raise money is one thing. Implementing a tax to manipulate people's behavior is something completely different. Not to say it hasn't been done (ie. sin taxes), but I'm ALWAYS opposed to that kind of government interference. So if this is an attempt to raise money from the rich (or rather, people who trade outside of retirement accounts), fine. I'm against it, but whatever. It won't be the last. As long as the lawmakers build in exemptions for themselves (which they pretty much always do) or to placate their financial masters, I'll keep trying to take advantage of those opportunities to keep my money out of their hands. What else can you do?

 

[Kwirk]

Hey, you can't play poker in a casino without giving a little to the house...

 

[FIREd]

First, IRAs, Keoghs, etc. are exempted as I understand it.

I don't understand this. A tax on trading will raise mutual funds' expense ratios. Whether your own that fund in an IRA/401K or in a taxable account, you'll be indiscriminately nabbed by the tax.

 

[Independent]

I've read that "high frequency traders" execute 70% of the stock market trades.

The claim is that these traders help the long term investors.* I don't see how, but I will quickly admit very little understanding of what they actually do.

I can imagine this scenario. A professional short term trader is responsible for tracking a list of 20-40 stocks. He is constantly watching news stories that might impact these stocks. If something happens that is positive for XYZ Corp, he immediately buys XYZ. Later in the day, other traders (that might include individuals) see the same story. It is just enough to nudge some fence-sitters into adding the stock to their long term portfolios, so they buy the stock. Since the st trader bought sooner at the lower price, he can sell to the slower-reacting group at a profit.

In this case, it seems that the st trader's profit comes directly from the long term investors.

BUT, I assume there are lots of other ways that the very active traders make money. Maybe some of them actually help the rest of us. Can someone give me some specific examples?


* Note: I'm assuming this article, by some well-known economists, is typical

Often mischaracterized as speculators, high-frequency traders scour markets for minor mispricings and arbitrage trading opportunities. They buy and sell stocks in an instant, hoping to earn pennies on a trade. Far from destabilizing or creating volatility in the market, their actions significantly increase trading volume, reduce spreads, promote price-discovery, and ultimately reduce transactions costs for long-term investors. Such trades might not be doing God's work, but they are socially useful.

Burton G. Malkiel and George U. Sauter: A Transaction Tax Would Hurt All Investors - WSJ.com

 

[M Paquette]

I've read that "high frequency traders" execute 70% of the stock market trades.

The claim is that these traders help the long term investors.* I don't see how, but I will quickly admit very little understanding of what they actually do.

I can imagine this scenario. A professional short term trader is responsible for tracking a list of 20-40 stocks. He is constantly watching news stories that might impact these stocks...

Oh, high frequency trading is much more bizarre than that. High frequency trading is done by computer, using algorithms (pre-planned strategies and tactics, basically) to hunt for "signals" (triggering actions, typically specific stock price and volume fluctuations) and execute trades in microseconds.

High frequency trades are so time-sensitive that the computers running the trading algorithms are co-located in the exchange's computer facilities, as the hundreds of microseconds of delay as data is routed and switched to corporate data centers in nearby buildings would delay the trades too much to let them be profitable. Renting this space is very profitable for the exchanges.

One of the more suspect tricks this permits is a form of front-running, or getting an order onto the exchange microseconds before a customer order so as to move the price to the detriment of the customer. That's something the SEC has been asked to look at.

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

Karl Denninger wrote up a nice explanation of how this works:

Let's say that there is a buyer willing to buy 100,000 shares of BRCM with a limit price of $26.40. That is, the buyer will accept any price up to $26.40.

But the market at this particular moment in time is at $26.10, or thirty cents lower.

So the computers, having detected via their "flash orders" (which ought to be illegal) that there is a desire for Broadcom shares, start to issue tiny (typically 100 share lots) "immediate or cancel" orders - IOCs - to sell at $26.20. If that order is "eaten" the computer then issues an order at $26.25, then $26.30, then $26.35, then $26.40. When it tries $26.45 it gets no bite and the order is immediately canceled.

Now the flush of supply comes at, big coincidence, $26.39, and the claim is made that the market has become "more efficient."

 

[M Paquette]

Oh, there's a nice graphic that the NY Times did that makes how this works more obvious.

 

[samclem]

Hmmm. That doesn't look like it should be legal. It's certainly not ethical if NASDAQ is deliberately taking steps to provide info about pending sales/purchases to some entities before they are even executed or available to others. It's not the same as a trader relocating a server closer or building a super-fast machine to look at the trades more quickly after they hit the market.

Oh, there's a nice graphic that the NY Times did that makes how this works more obvious.

 

[Gone4Good]

The financial crisis was primarily a liquidity crisis and a credit crunch, and the major problem with collateralized mortgage-backed bonds was that they declined significantly in value and became illiquid. A transactions tax that would have reduced trading and made repurchase agreements more costly, could have made the problem even worse.

This is kind of funny, and actually probably closer to 180 degrees opposite of the truth. The illiquidity was a result of poorly designed and highly leveraged transactions. Once a security is trading at 20 cents on the dollar, an additional $0.0025 charge isn't going to have much of an impact on whether someone is willing to buy it or not. But conversely, a $0.0025 charge on each of the various transactions needed to put one of these complicated deals together, may have prevented them from getting done in the first place. The reason that these deals used so much leverage is that the margins were skinny. They needed the leverage to make it worthwhile. A small tax like this may have totally depleted whatever margin was there and made them completely uneconomic from the start. So rather than making the crisis worse, the tax may have prevented it from happening at all.