Talk of Transaction Tax on Stock Trading Is Back Again

The game is on again. Let's tax those greedy traders! We have to curve this, uh..what is it, High Frequency Trading, whatever that is, but since Wall Street guys are doing it it must be bad. (And incidentally it will dramatically increase the government's tax revenue.) Hard-working Americans win! Right?

The idea has been promoted several times in the past year, as a way to raise tax revenue for the increasingly cash-strapped federal government. This time around, it has a unique twist. The one who's pushing for it is AFL-CIO, the largest federation of labor union in the U.S. and Canada.

AFL-CIO, Dems push new Wall Street tax (Alexander Bolton, 8/30/09, The Hill)

"The nation’s largest labor union and some allied Democrats are pushing a new tax that would hit big investment firms such as Goldman Sachs reaping billions of dollars in profits while the rest of the economy sputters.

"The AFL-CIO, one of the Democratic Party’s most powerful allies, would like to assess a small tax — about a tenth of a percent — on every stock transaction.

"Small and medium-sized investors would hardly notice such a tax, but major trading firms, such as Goldman, which reported $3.44 billion in profits during the second quarter of 2009, may see this as a significant threat to their profits."

Oh really? The writer probably doesn't trade much on his 401K or IRA. Small and medium-sized investors would indeed notice significant increase in transaction cost. Who is he kidding?

Let's look at an example.

You are a small retail investor who watches the market and trades fairly frequently, say 2 times a week. You decide to buy 100 shares of AAPL (that's Apple, Inc.). It will be $16,600 or so at today's price. On top of this amount, you normally pay a commission to your online broker, anything from $0 to $13 per transaction, plus ECN fee. These days, the total transaction cost of online brokerages rarely goes above $15.

Now, AFL-CIO wants to impose 0.1% tax on your transaction. $16,600 times 0.1% equals $16.60. Add that to the normal transaction cost, and you now have to shell out between $16.60 to $31.60 for your purchase. That's a 111% to near-infinite (in case your transaction cost is zero) increase.

Suppose AAPL jumps in price after the announcement of new iPod or tablet notebook, and now it is $190. You decide to sell. Now, 0.1% of $19,000 is $19. Your total cost to sell AAPL is now between $19 and $34.

Without this tax on your transaction, your total cost of buying and selling AAPL is between $0 and $30. With this tax, your total cost will be between $35 and $65, of which this transaction tax is $35.

After one year of trading AAPL twice a week, you will end up paying $1,750 in additional tax, more or less, depending on the stock's price movement. The tax you are not paying at all today, and the money you could be putting to good use elsewhere. Instead, it will go to the government. Whether you make money or lose money, you will have to pay the tax on the transaction.

Now, back to this article:

"“It would have two benefits, raise a lot of revenue and discourage speculative financial activity,” said Thea Lee, policy director at the AFL-CIO.

"“The big disadvantage of most taxes is that they discourage some really productive activity,” she said. “This would discourage numerous financial transactions. People flip their assets several times in an hour or a day. They make money but does it really add to the productive base of the United States?”"

Now, why is it the business of AFL-CIO if people flip their assets several times in an hour or a day? Besides, what does it have to do with High Frequency Trading at all? People who flip their assets several times in an hour or a day are not Goldman Sachs or Citadel. They are more likely to be small, retail investors trying to recover what they have lost in the past year.

High Frequency Trading trades 100 times or more in a second.

So, confusing (intentionally or out of ignorance) the active retail investors and big financial firms that do High Frequency Trading, AFL-CIO, if it has its way, would actually punish the small investors who no doubt include AFL-CIO members whose 401K or pension fund has plummeted.

Back to the article:

"The AFL-CIO and some allied Democrats would like to cut down on the overall level of trading, or at least give the U.S. government a piece of the action, which would likely tamp down trading."

Give the U.S. government a piece of the action?? A-ha. But they already are active, through Working Group on Financial Markets, a.k.a. Plunge Protection Team. Or do they mean that the government should gamble taxpayers money in the stock market against the likes of Goldman Sachs, Morgan Stanley (who's hiring a lot of traders), and numerous hedge funds? Good luck with that.

Cut down on the overall level of trading?? Why don't they just shut down the stock market, then? Soviet Union didn't have a stock market.

Things are getting more hilarious by the day, on all fronts. What's next? That the government will decide the price of any publicly traded stock, as they see "fair" to whatever principle that they want to uphold?

I have a sinking feeling though, that this time around this idiocy will become law under the Obama administration. Unintended consequences that I can think of are numerous: stock market crash because the liquidity, however contrived and artificial, disappears; small investors are crushed, yet again, with their portfolios plunging in value and taxed when they try to get out of the positions; traders big and small desert the publicly traded markets, with big traders moving to dark pools, small traders stopping altogether; lack of transactions causes this proposed tax to collect far less than anticipated, and the government may actually lose money as it has to pay for the new bureaucracy to handle the new tax; the U.S. will lose the global financial center status.

Lastly, what has a trade union got to do with stock trading, you may ask. You've seen the news, I'm sure, but in case, here it is: the most powerful of the Federal Reserve banks, New York Fed, just announced that the president of AFL-CIO New York State branch will be the new chairman of the New York Fed.

New York Fed Names AFL-CIO Leader as Chairman of the Board (8/25/09 Washington Post)

AFL-CIO may be emboldened more than ever, as one of them presides over the most powerful Federal Reserve bank.

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