Financial Transaction Tax Debate Heats Up

As the debate regarding a financial transaction tax heats up, Public Citizen has released a white paper that calculates the cost of such a tax to average investors to be “microscopic.

Recent talk about a financial transaction tax has increased, but the seriousness of that talk is in question.  In his most recent budget President Obama included a transaction tax proposal to fund the Commodity Futures Trading Commission, at the urging of outgoing CFTC commissioner Bart Chilton.


Financial Transaction Tax

Financial transaction tax: Recurring costs

The Public Citizen report notes that If an investor allocated the average 401K investment amount, $85,000, towards mutual funds they could experience $1,144 in hidden and disclosed costs – and that number could jump to $1,994 if a one percent front-end sales load was included.  By comparison, the fully disclosed proposed financial transaction tax would experience $24.48 to $49.48 in recurring costs.

“The costs to ordinary investors of a small FTT would barely amount to a rounding error, while existing fees are an albatross holding back existing returns,” Taylor Lincoln, research director for Public Citizen’s Congress Watch division and author of the report, said in a statement. “Those purporting to look out for ordinary investors could demonstrate their sincerity by steering people away from funds with outrageous fees instead of fighting an FTT.”

The issues raised in the Public Citizen report tend to be different from those who argue HFT is a necessary component of markets.

Losing HFT could reduce liquidity, increase costs, say proponents

The key concern with a transaction tax is that it would effectively eliminate the practice of directional high frequency trading (HFT).  A recent stream of dueling academic reports on HFT, some positive some negative, have attempted to influence the argument.

Arguments in defense of HFT say that the practice is positive for the markets and keeps the cost of trading low.  If HFT were eliminated, it would cause exchanges, which rely on HFT for a large percentage of their revenue, to increase costs.  Further, if HFT were to be eliminated it could reduce market efficiency and liquidity. In Tuesday’s ValueWalk we reported on the New York Federal Reserve saying that HFT had a positive impact on market efficiency.

Arguments against HFT say the practice is dangerous and without benefit to the markets, but typically don’t address the same issues raised by HFT proponents.

“Computerized trading poses an unreasonable danger to our economy”

Key concerns regarding HFT are that it can be used by traders using a millisecond advantage to manipulate markets at the expense of ordinary investors.

“High-volume, computerized trading poses an unreasonable danger to our economy. A tiny tax on financial transactions would help limit this volatile practice while raising needed revenue,” said Susan Harley, deputy director of Public Citizen’s Congress Watch division. “It’s far past time for Wall Street to pay its fair share. Taxing financial transactions is commonsense reform and we urge Congress to take swift action to implement such a tax.”

Those opposed to a transaction tax include the major exchanges where stocks and derivatives are traded, as well as those directly involved in the HFT industry.  Those supporting the tax notably include Nobel Prize-winning economists Joseph Stiglitz and Paul Krugman, billionaires Warren Buffet and Bill Gates as well as U.S. Sen. Tom Harkin (D-IA) and U.S. Rep. Peter DeFazio (D-OR.).

“Costs already borne by ordinary investors, both by those invested in institutional funds and self-directed investors in the stock market tend to be on the order of 12 to 25 times greater than those that might be added by implementing a financial transaction tax of 0.03 percent,” the report concludes. “If potential sales load fees are included, the ratio would be much higher.”