CBO on Tobin Tax - "Don't do it!'

The Congressional Budget Office (CBO) explored the consequences of a Tobin tax, after it was asked to throw in its two cents in regarding proposed legislation, H.R. 3313 / S. 1787. The proposed new law has a very catch title:

“Wall Street Trading and Speculators Tax Act”

Who wouldn't like something like that? For a country that (A) is desperate for revenue and (B) whose populous hates financial fat cats, speculators, monstrously paid bankers, and ridiculously paid hedge fund execs, a transaction tax is an easy sell.

I’ve taken grief on these pages with my position that taxes are a necessity. “Zero” is not the right number. The only questions are who pays and how much. With that said, it’s hard for me to push against a transaction tax. But I’m against this. The costs will outweigh any benefits that are created. I think the CBO agrees. Some bits from the report (Link):

For a transaction involving a stock, bond, or other debt obligation, the tax would be 0.03 percent of the value of the security.

Gee! Only .03%! Hardly worth noticing! Actually it is. Based on recent turnover  the cost of the tax would be $1.7mm every day for those trading AAPL. For GE and BAC, it comes to a rake of $327k and $425k, respectively. That’s real money.

The argument will be put forth that the tax is only a few pennies. A long-term buyer of AAPL would have to pay a total of only 24 cents to buy/hold/sell a share. For BAC, it's only 3/8th of a cent (.0032).

The transaction tax on Government bonds will only be applied to maturities over 100 days and not applicable to any new issuance. So if you were looking to park $100k in T notes for a year, you could avoid the tax by participating in the government’s auctions. That’s stupid. No one will do that. People will call their brokers and it will cost them an extra 30 bucks to own the Note.

The US bond market is very complex. It has nothing to do with retail demand. A substantial portion of the $10T of Treasury plus $7T of Agency paper is in perpetual float. I estimate that at least one third of the outstandings have no permanent home. It sloshes about the globe based on a variety of macro forces. How many times do they  “slosh” in a year? Much more than you might think. The number is a minimum of 5Xs. (I think it is around 7Xs, it could be as high as 10Xs) Using the low estimate, the annual float turnover impacted by the tax equals $25T. That teeny weeny tax would therefore suck $8 billion out of the market. That’s a very big deal. The CBO sees this pretty clearly:

Securities that are traded frequently, such as Treasury securities, would be more affected than securities that are traded less frequently.

The proposed transaction tax would lay waste to the HFT crowd. Their spreads are far too small and their volumes too high, to not have their business models get crushed by a Tobin tax. Many will cheer, myself included. But a sudden death of the algo computers would be very destructive.

The tax would also decrease the volume of transactions and would make some types of trading activity—such as derivatives transactions to manage risk and computer-assisted high-frequency trading—unprofitable.

This is about the money and how much one keeps. So every effort will be made to divert trading activities outside of US tax jurisdictions.

Traders would have incentives to avoid the tax either by trading offshore or by creating new financial instruments that were not subject to the tax.

As the trading activity goes outside of our borders,  so will all those traders and their high paying jobs. Also would go the thousands of back office/ support staff that goes with this.

As foreign holders of U.S. securities moved their transactions abroad, more of the market could go with them, which could diminish the importance of the United States as a major global financial market

All taxes have consequences. A Tobin transaction tax would be no exception:

In the short term, imposing the transaction tax would probably reduce output and employment.

Beyond the first few years the tax’s net impact on the economy is unclear.

Unclear? This is pretty clear:

The transaction tax would raise the costs of financing investments to the extent that it made transactions more expensive, financial markets less liquid, and management of financial risk more costly.

A net change in the amount of investment would in turn affect GDP and employment. In the short term, a decrease in investment would lower demand for goods and services and thus reduce output and employment.

Reduce output and employment? Just what we need.

These consequences are not the ones that worry me. I’m concerned with liquidity. What will happen when 50% of short-term trading is eliminated? The CBO has an answer for that:

The tax might discourage short-term speculation, which can destabilize markets and lead to disruptive events (such as the October 1987 stock market crash and the more recent “flash crash,” when the stock market temporarily plunged on May 6, 2010)

How might the markets welcome a transaction tax? I say this would get a huge thumb’s down. If you believe that wealth in 401Ks drives the economy (I do), then this will bring (another) recession. The CBO agrees, sort of.

Initially, the transaction tax would reduce the value of existing financial assets, because investors would not be willing to pay as much for assets that had become more costly to trade. That reduction would produce an immediate—though probably small—decline in wealth for people who owned financial assets when the policy was enacted.

Note: The CBO are a bunch of bean counters. They have not the slightest idea what the markets may do if this tax was enacted. When they say the consequence to assets values will “probably be small” they are making it up. (A Wall Street broker is not allowed to say things like this. The outcome is not predictable)

This is not a tax on speculators and guys who wear white spats on Wall Street. This will impact all the pension and savings plans:

The transaction tax would also affect the funding of state and local pension plans ($3 trillion as of June 2011). Besides initially reducing the value of their existing assets slightly, the tax would raise transaction costs for pension plans. Both of those effects would increase required contributions to the plans.

Note: There’s that “slightly" thing again. Shame on the CBO for soft peddling the risks.

I wouldn’t be surprised to see that a transaction tax becomes a political football in the next election. Obama will support it. The Republican candidate will oppose it. If the election were tomorrow, Obama would handily beat either Newt the Fool or Mitt the Suit. Unfortunately, I think a transaction tax, and all the bad things it will bring, is in our future.
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