If taxed, will day-traders trade at night?
by Fred E. Foldvary
With the federal budget deficit in the trillions for years to come, and with unemployment remaining high, Congress is seeking to spend money on a jobs program and pay for it with higher taxes. We can be sure that Congress will seek to tax anything except land. So now Congress is resurrecting an old idea, to tax financial transactions.
After all who buys shares of stock? The rich. So why not tax them when they buy and sell stocks? The richer guys buy more shares, so they would pay more. Plus, it is argued, once a stock has been issued, the trading does not provide any funds for economic investment by the firms. Stocks are just swapping owners, so why not tax this unproductive swapping? Taxing stock trades might even do some good, the argument goes, since it would dampen speculation and prevent stocks from zooming up too high, only to crash later.
A tax on currency transactions was earlier proposed by economist James Tobin, and thus called the "Tobin tax." The idea originated with John Maynard Keynes, the British economist who during the Great Depression founded the school of thought that advocates greater government spending to revive the economy. Keynes blamed speculators for the financial crisis of his day, and proposed a tax on speculation to reduce the speculators’ “animal spirits,” the emotions of greed, hope, fear, and panic that spin financial markets into frenzy.
Several representatives in Congress have introduced bills allegedly to make the financial industry pay back some of the bailout funds it got from the federal government. But a tax on the purchase of shares of stocks, options, and commodity contracts would not just get money from Wall Street; it would also be paid for by ordinary investors. Folks who earn wages from their labor and manage to have some savings after paying taxes seek to make their savings grow by participating in the long-run growth and profits of private enterprise. A tax on stock purchases punishes people for seeking to save and invest for their retirement.
New companies seek to get funds by “going public” and issuing shares of stock to the public. This too would be penalized by a tax on stocks. The tax would make it more costly to start a new company or to raise funds to expand the firm. Ultimately a tax on stocks is a tax on savings and on production and on economic growth and on technological progress. The TARP and other financial bail outs did not go to investors or small business, yet they would be punished, while Fannie Mae and AIG and the other firms that were rescued would remain happily subsidized.
The proposed tax is .25 percent of a stock purchase or sale. If one buys and later sells a stock, the total tax would be .5 percent. If the gain of a stock is five percent for a year, a $100 share would have a $5 gain and total tax on the purchase and sale would be 50¢, thus the tax would be ten percent of the gain. Of course, the longer the holding period, the less the impact of the tax, so the tax would be hardest on frequent traders. But trading stocks does not harm the economy or financial markets. Indeed, the traders help thicken the market by providing many ready buyers and sellers, so that if one wants to sell shares, one can do so immediately.
The tax on stock trades would wipe out frequent traders, especially the “day traders” who trade for very short periods. This would thin out the market, making it less liquid for those longer term investors who seek to sell. They would not get as good a price for their sales if they need to sell soon, and so it would be a double tax by reducing their gains.
On December 3, 2009, there was published “An Open Letter from Economists in Support of Financial Transaction Taxes.” In claiming that stock trades have little economic value, these economists ignore the benefit traders provide in thickening the market for longer-term investors. More importantly, they ignore the fundamental economic law of exchange: trade is mutually beneficial. When people swap goods or stocks, they do so for a reason, as the trade provides greater utility. If you would rather have cash instead of stocks, how dare these economists say this trade is without value!
If you think a stock has risen too high and it is time to sell, these opinions create a price for shares that reflects the information known about the stock. Stifling transactions destroys the information that the stock price provides, just as taxing goods distorts the information provided to producers and consumers by the price of the good. Prices provide valuable information. Distort the price, and the information gets blurred.
Am I shocked, shocked! by this letter? No. It’s the same old story. These economists could have signed a letter urging a national tax on land value, to replace taxes on production. A land-value tax shift would instantly make the economy recover by reducing the dead-weight loss and waste of current taxation, and the subsidy to landowner government provides by its spending on infrastructure and services.
The favoring of a tax on trade implies a rejection of a tax on land value, at least relatively, and so these economists favor a bailout of landowners while claiming to oppose a bailout of the financial industry that feeds on the land subsidy. Is your mind boggling? It’s the economics of animal spirits rather than of common sense.
This article first appeared in the Progress Report, www.progress.org. Reprinted with permission.
Dr. Fred Foldvary teaches economics at Santa Clara University and is the author of several books: The Soul of Liberty, Public Goods and Private Communities, and the Dictionary of Free-Market Economics.