H.R. 1068 The Tax on Asset Transactions

A new bill was introduced in the U.S. House of Representatives on February 13, 2009 and is currently in the Committee on House Ways and Means. Titled, “Let Wall Street Pay for Wall Street’s Bailout Act of 2009,” H.R. 1068 proposes a new tax on transfers involving stocks, options, and futures. If enacted, the long term growth rate of the economy, the stock market, personal retirement savings, and income will all be shifted downwards. Here is how:

The Bill and the Tax

The bill itself estimates the burden on investors and traders at $150 billion a year, or roughly $3 billion per week. This is no small sum. For perspective, as of this writing, the market cap of Burger King is roughly $3 billion. If enacted, every week this bill would tax the value of a Burger King, an Autodesk, or a Nordstrom right out of the market. The bill proposes to continue this tax until TARP has been paid for. TARP, so far, has committed $700 billion. Assuming the government gets half that back, or $350 billion, the cost would then be $350 billion and the tax would have to carry on for over two years to pay for just round one of the TARP. Let’s not forget the government has a hard time giving up income streams once they have been initiated.

However, a flaw can already be seen in the logic behind the bill. The $150 billion number is based on dollar volumes I just cannot figure up. For starters, the dollar volume for the NYSE group has declined from an average daily rate of $88.1 billion for the 12 months ended October 2008 to $50.5 billion in the four months since, per NYSE data off the NYSE website. If equity prices continue to decline, this trend downward will continue. Using the $50.5 billion number, multiplied by 253 trading days in a year, results in $12,776.5 billion per year in dollar volume and a tax of $31 billion. The Nasdaq allows me to view the dollar volume only year to date, so using the same line of calculations I yield a tax of $24.5 billion. The total tax haul, using NYSE and Nasdaq average dollar volumes in recent times, gives the government only $55.5 billion. I am not sure as to the size of the options and futures markets, but I venture to say they cannot make up the remaining $94.5 billion difference between these two exchanges and the expected $150 billion a year in revenue gained.

Early in the game, as it is, we have no idea what the TARP program is going to cost the Treasury. However, we do know anytime the government wants to spend $700 billion there are inefficiencies galore. From the bill, we also do not know what is considered a “cost.” Does the government consider the whole $700 billion as a cost, or just the money not received back from financial institutions who borrowed? No matter which, one can see this tax will need to be levied for a number of year, if the values of transactions affected remain the same and do not decline further.

The Implications For The Markets Affected

The harm done on markets will be two fold. First, there are many traders who make a living on small day trades and small trades in general, especially in times when volatility is high and holding stocks for longer periods can be damaging to a portfolio. With this I am not talking merely about those sitting at home and playing with their own money, but large institutional money managers will often move money in and out of stocks all day long.

At 0.5% total in and out, the taxes are sure to be burden on all those day trading, swing trading, or any other form of short term trade. A purchase of a $10 stock would require a stock to advance to $10.05 to cover cover the tax. Let’s say a day trader does well and can make $0.25 on a $10 stock. Already, the day trader is behind 20% of the profit, leaving only a 2% gain instead of a 2.5% gain. Compounded several times a week and the traders profits have significantly diminished. Gone would be the days were trading a stock for a few cents here and there will pay off.

More importantly, the longer term traders will have a reduced incentive. For longer term holders, let’s assume they average 8% a year real returns in the market and have an average hold time of 2 years. That’s a 16.6% gain in two years. Now one has to also subtract the new taxes for a 16.1% gain in two years. Not that big of a difference, perhaps, but the underlying theme is the competitiveness of the stock market as an asset class versus other asset classes. At 8% a year the stock market would offer a higher risk and a higher potential return than most asset classes, but not by a whole lot. With a decreased expectation of gains due to increased taxes, any perceived competitive advantage to investing in stocks over CD’s or interest bearing instruments has been reduced. The affects also compound with the number of trades. The penalty for being wrong on an investment and having to get out and take a loss is increased. So one must be right or pay the an automatic tax of 0.25% just to erase a mistake.

Conclusion: This Bill is Bad

Between long term and short term traders, the effects will be to decrease dollar volumes on the markets as less people find it advantageous to trade futures, options, and stocks. The bill will lower the expected return on any of these assets, causing all values of all financial instruments tied to market values to decline. Think of Berkshire Hathaway with its long term S&P calls. If the annual return on markets were to decline, then the premium assigned to these calls would decrease in size, in turn causing Berkshire to show a smaller amount of assets on their balance sheet and all the implications thereof.

The bill itself references instances of past taxes in an era largely free from complex financial instruments. The tax on stock, options, and futures transactions may have worked then, but today’s world is more interlinked than ever before with the expected return on financial markets. I implore Congress and others to look at the implications of slower growth for the markets, and thenceforth the economy and all things related. There are many ways to devise a tax, is this a good one?