Sunday, December 20, 2009

Rozeff: A 400 percent (and Higher) Excise Tax

America on the verge of mass insanity, says Professor Rozeff. The professor is talking about that stupid plan in Congress to tax all stock, option, futures transactions, which I have discussed on this blog here.

A 400 Percent (and Higher) Excise Tax
(Michael S. Rozeff, 12/21/09 Lewrockwell.com) [emphasis is mine]

"The Wall Street Journal brings more bad news. A headline reads "Lawmakers Weigh a Wall Street Tax." The first mention of this was in October. The proposal has not died as Congress seeks new ways to finance its profligate spending. Both houses are considering legislation.

"The tax would fall on financial exchanges of all kinds. It is not a tax on Wall Street. It is a tax on anyone who buys and sells securities.

"James Tobin originated the notion in the 1970s. Larry Summers supported it. Robert Kuttner supports it. That’s three Keynesian economists right there. It must be a bad idea."

The bill that has been introduced in the House would tax stock trading at 0.25% of transaction amount, and 0.02% on options, futures and other derivatives. I(it's not hard to guess who lobbied for lower tax for derivatives - Vampire Squid anyone?) The government's argument is that the tax is so small that ordinary investors won't be affected by it. I strongly disagree, as I've written in my previous posts, and Professor Rozeff also shows how costly this tax actually is:

"A well-known broker charges $7 a trade in any size and provides a more than satisfactory complement of other services. If a 0.25 percent tax goes in, the cost of a $10,000 trade becomes $32. The tax is 3.57 times the brokerage cost of $7. This is an excise tax of 357 percent on this size trade. For a $100,000 trade, the cost is $257. The tax is 35.7 times the cost of $7. The excise tax rate is 3,570 percent."

He notes that in the 1960s the cost to trade was very high, with commissions making up a large part of the cost (1%). After a few decades of efforts by industry participants, the cost to trade has come down significantly. But now the government wants to turn back the clock 40 years so that they can grab more from citizens.

The first $100,000 worth of transaction would be tax-exempt, according to the House bill. But guess what? Even a small-time investors/speculator can use up that exemption in one day, if not in one hour. How? Just by buying, say 100 shares of Google at $594, selling it the next day when it pops up to $620. Roundtrip transaction of $121,400 to net $2600 profit. Now you will have already exceeded your annual tax exemption allowance in just one roundtrip trade.

More importantly, though, Professor Rozeff points out the detrimental effect of the tax on stabilizing the financial markets:

"This tax is as bad as a capital gains tax. The latter discourages investors from moving capital around freely. It discourages risk-taking. It discourages moving out of less and into more productive projects. The tax on financial transactions does the same.

"This tax makes markets far less liquid. There will be fewer buyers and sellers. Bid-ask spreads will rise steeply."

"Lawmakers probably do not realize that a large fraction of the capital stock of corporations is carried by short-term speculators, due to the uncertainties of business. Turnover is high on many stocks because of unwillingness to hold long-term positions under conditions of high uncertainty. If short-term speculators are driven from the market, as this tax will do, then long-term speculators will have to take and hold the stock. They will demand a higher risk premium as they are made to depart from their preferred portfolio holdings. This will drive up capital costs to corporations. This will slow down capital accumulation and growth. This will lower employment and wages.

"Low transactions costs bring both uninformed and informed investors into the market. But the uninformed tend to be weeded out because they lose money. With a transactions tax in place of this size, the informed traders will also be far more reluctant to trade. The bounds within which prices trade will become that much larger. They will become all the worse as signals of value to corporate managers. Investors who attempt to buy and sell in quantity or rapidly will find prices changing due to their own trades, even if they possess no special information."

The professor then quotes a passage in the Wall Street Journal article which quotes the trading tax's advocates and calls it baloney and claptrap:

"The Journal article dutifully reports a mass of lies and totally erroneous ideas of the advocates of the tax:

"Congressional advocates describe the new tax as a matter of fairness: Taxpayers bailed out Wall Street, so Wall Street must help rebuild the economy and shore up the government’s shaky finances. Some experts say the tax also might help reduce market volatility."
"Is it fair to tax innocent investors and brokers who have worked to bring down costs? Is it fair to label them as "Wall Street?" Is it fair for the government to have paid off big banks and the likes of Goldman Sachs in the first place? Is it fair to turn around and then tax investors as if they were the ones who were responsible for doing something wrong? Can such a tax rebuild the economy?"

The answers are no, no, no, no, and big NO.

The article ends with these sentences:

"America seems to be on the verge of mass insanity as Congress comes up with increasingly bad legislation. Can nothing stem the irrationality of American society and government?"

I don't know, Professor. It's not just Congress either. The president wins Nobel Peace Prize for expanding a war, the Federal Reserve chairman is "the man of the year" for bailing out big banks around the world at the expense of the U.S. taxpayers.

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