Dump the income tax, tax securities instead.

Great Debates
1

I have spent the last week being frustrated with trying to figure out how much taxes I owe and whether, because of a side business Mrs Boxcar is involved in, we are going to have to pay estimated taxes. If you have never done this before, you don’t know the fun that you are missing.

Instead of complaining, let us do something about it.

Tax stocks, bonds, traded commodities and the like.

The US Budget for 2001 included receipts of $994.3 billion from income taxes and $694.0 billion from Social Security and retirement. Total receipts expected by the government for 2001 were only $1,991.0 billion, so the income tax and social security make up almost all of the government’s income.

The NYSE reports its dollar volume in 2000 (a record) was $11,060.0 billion. I couldn’t find a yearly volume for Chicago Mercantile but they reported a single day (March 7, 2002) of trading that involved some $2,600 billion in contracts.

This doesn’t even include the volume traded on the other exchanges.

My suggestion: Let’s revoke the 16th amendment (the one that let congress get it’s paws on our income in the first place with a promise that “Only the wealthy will have to pay.”:rolleyes: ) and replace the income with a tax on the security exchanges.

If the numbers are as large as they appear to be, a sales tax on securities in the 8% range should cover the majority (if not all) of the revenue produced by the income tax and maybe even social security, allowing us to do away with this repugnant intrusion into our lives.

Advantages:

  1. It gets the government out of our personal lives.
  2. It returns to the economy the millions spent on tax preperation each year in both time and real dollars.
  3. It increases the spending power of all Americans for goods and services.
  4. It ties government income to the economy, providing an incentive for sound fiscal policy.
  5. Even if an income tax has to remain in place, it should be easier to limit the tax to those who are wealthy by the standards of today, say the $10 million a year range or more rather than those in the $1 million or less club.

Issues:

  1. It will devalue the stock market.
    Yes, but the stock market has been devalued before (see the drop after the WTC attack) and has bounced back. If the tax was brought in incrementally (and then adjusted on a yearly basis to reflect the needs of the treasury) investors would have time to prepare. My instinct is that investors will wait for the changes anyway so might as well just take the hurt once. In addition, people like myself, in the $30000 - $60000 income range, will have more money (my income taxes this year were about $4000) for increased spending on goods or even stocks which should speed the market’s recovery.

  2. The income tax savings would go to the rich.
    Well, yes, if you are paying some $100,000 a year or more in taxes you will get back more than the guy paying only $100 or so per year. The real culprit for regressive taxes are the other payroll taxes (social security, medicare, unemployment insurance), but that should be a separate debate. Anyway, even at $100 wouldn’t you prefer keeping that instead of turning it over to the government to spend?

  3. Rate of return will drop.
    A dangerous argument, but since the tax is paid only when the commodity or stock changes hands, would it really hurt the rate of return that much over the long run? Folks who make their money with high volume - low margin trades would be hurt most but would that really hurt the market and average investors? Isn’t the capital gains tax aimed at short term holdings already?

  4. People would hold stock/commodities rather than trade them.
    Is this a problem? I would think that the holding of stocks would cause their value to rise because there would be fewer available in the marketplace. Wouldn’t that be a good thing?

Granted, I know next to nothing about the financial markets, but it seems that if folks will pay a sales tax on goods in the 6-8% range than so will the traders.

So, market specialists, what are the drawbacks to this system and how do we beat them? Would this system work?

Please keep you answers simple enough for a liberal arts major to understand.

Thanks

Boxcar

Sources:
http://www.whitehouse.gov/omb/budget/fy2003/bud34.html
http://www.nyse.com/pdfs/02_STOCKMARKETACTIVITY.pdf
http://www.cme.com/news/shownews.cfm?NewsItem=0004F303-0928-1C89-9A3280EDBEFB071D

2

I had a system crash and lost a long post, so I’ll give you the quick answer.

Inflation adjust returns for the S&P 500 are IIRC about 6.5% for the past 40 years. Government insured bank rates are more like 2.5% (you can google S&P historic returns). 8% tax is outrageously high, and provide an average negative return. You slap that on and trade volume will drop something like 99%, so it won’t make any money for the government, and companies will no longer be able to efficiently raise capital.

Are you going to tax bank savings? If not, why not since you want to tax treasury bonds, which are effectively the same thing.

Just my 2 cents, but just maybe you should take an econ or finance class to round out that liberal arts education you’re picking up.

3

Uh, why would you conclude that?

I am willing to pay 6% sales tax because I need food and will pay whatever it costs to get it. Regardless of the size of the transaction tax, I will still get what I want out of my groceries. So I’m relatively oblivious to the size of the tax.

On the other hand, I am not willing to pay a 6% tax on an investment because I buy an investment solely out of the desire to get money out of the investment. If I have to pay a 6% transaction tax, you’ve just made it a whole lot less likely that the investment will ever net me a profit and taken away my whole incentive for buying the investment. A 6% transaction tax on securities would effectively destroy the stock, commodity, money, and spot bond markets, leaving only high-yield long-term bonds being sold to be held until redemption (the transaction tax effectively preventing any trading), and perhaps some high-dividend stocks held solely for dividend income. Such a tax would make raising capital virtually impossible (the principal means that companies use to raise capital being initial public offerings and the sale of bonds) and would bring the economy to a screeching halt.

Any tax on securities that will not have these effects will either have to be extremely small (i.e. fractions of a percentage point) or else be structured such that it is effectively not distinguishable from a capital gains tax. Any tax that converts profit to loss effectively destroys the investment value of a security.

4

It’s interesting to wonder what would happen with an 8% tax on securities transactions.

There are a lot of possibilities, but you can be fairly sure there would be a massive drop in the volume of taxable securities transaction. As pointed out by other posters, the vast majority of securities transactions simply would not make economic sense with an 8% tax.

I imagine that 99% is a pretty good estimate.

This would deprive you of most of your hoped-for revenue.

5

IIRC revoking the sixteenth amendment won’t get rid of the income tax. There were income taxes prior to the sixteenth amendment. The sixteenth amendment was intended to be a clarification of the governments ability to tax after a somewhat bizarre SCOTUS ruling excluding a landlords income from rentals from the category of taxable income.

I will try to hunt up a cite but lunchtime is just about over so I may have to wait til tonight.

6

First off, this is nothing like a sales tax, because sales tax is designed to be a once-only type of tax, not a everytime-it-changes-hands tax. Secondly, I don’t think that it would greatly reduce trading. Instead, it would reduce taxable trading. I’m sure that lawyers would be able to come up with shennanigans to get around it.

7

China Guy – I was just pulling 8% out of the air, but I’ll drop that down a bit, say 3%. That might make bonds a bit more attractive as long as they are held for more than a year.

KellyM are you saying that most transactions are looking at movements of pennies on the dollar to make money? That was my biggest objection but I didn’t find any info on that. If the highest volume of the trades involve people moving commodoties or stocks everytime they jump just a fraction of a percent than this whole plan could be in trouble. If Great Big Mutual Fund (GBMF) is going to buy 1 million shares of stock at $50/share and then turns around to sell them as soon as they move $1 then those transactions are going to stop because they aren’t cost effective. Would that be good or bad for the market as a whole? Wouldn’t that decrease supply, increase demand and raise prices? Or, if those are the bread and butter trades of the day, would it have the opposite effect?

MMI – I thought the Constitution as originally set up required taxes to be levied on the states based on the number of citizens. It was up to the states to collect and remit the tax. The 16th amendment let the Congress go after this directly and cut out the states as middleman.

Look, there are trillions of dollars floating around in the American financial market. Buyers and sellers are paying transaction fees, commissions, and other costs so expenses above the base price are already involved. Taxes would just add another layer to the cost of doing business. We tax profit on investment income already, why not just hit people up when they buy and let them keep whatever the rest of the profit might be?

Even a 3% tax on the NYSE alone could bring in almost as much money as all other sources of revenue except Social Security and income taxes so there is probably room to play with the amount once all the market values are brought into play. I thought a percentage of the exchange would be the least damaging, especially for lower cost stocks, and like the different tax rates on long and short term capital gains would reward people who hang on to their stocks longer.

You would still have some tax dodgers out there, but every system is open to that argument. How much income is left untaxed because cash transactions are hard to trace or people simply don’t file or report earnings because they don’t understand the current system?

If done right, you really aren’t moving more money out of the economy, just shifting the tax burden to the financial market. The moneys collected would replace or reduce the income tax so consumers will have more money to spend on goods, services, or to put into savings/financial markets. Wouldn’t increasing these benefit the financial markets and off-set a large part of the tax itself?

Politically, this would be quite a win. Consider:

  1. It is an indirect tax, the best kind because the tax payer doesn’t think about it.
  2. Appears to be a tax on the rich.
  3. Allows politicians to claim to be giving money back to the people.
    4 Vote against it and the campaign commercials will talk about how you are beholden to big business special interest instead of helping the little guy.
8
  1. A 3% tax on a 6.5% average yield is effectively a 44% tax.
  2. Your plan would massively distort the markets. People, for fear of incurring the transaction tax, wouldn’t sell their stock in companies that are doing poorly. Similarly, they wouldn’t buy stock in companies that are doing well.

You missed the biggest point of them all, despite the fact that KellyM, The Ryan, lucwarm and China Guy all mentioned it. Your plan, even at 3% instead of 8%, would make the stock market a considerably less attractive investment field than bonds, real estate, or even simple CDs from the local bank. If 44% of your return is being lost to taxes, The stock market would have to give average returns 44% higher than it currently does to be a worthwhile investment (stocks must always give higher returns than other investments to be worthwhile, because they are considerably riskier). And the stock market isn’t going to do that. The result will be that no one will invest in stocks. The market will crash and not only will you not get anywhere near the amount of tax receipts you expect, stock market crashes are Bad Things that cause things like recessions and Great Depressions.

Of course the taxpayer thinks about it. He’ll think about it all the time. It will utterly distort the taxpayers’ investment plans.

More than half of American households own stock. The majority of Americans will be negatively affected by the tax. And, of course, when the stock market crashes, everyone will be harmed by the resulting recession. And, of course, every person in America’s 401K plan will be worthless.

And destroying the people’s retirement nest egg in the process.

So the majority of American households is now a “special interest”? Last I checked, we called them the “majority.” Politicians like being beholded to the majority.

Sua

9

Let’s take the case of China, which has one of the highest stock transaction costs in the world. China does not have capital gains tax, and any tax revenue comes out of the transaction fees when buying and selling stock. The round trip transaction cost (eg, costs associated with buying and then selling a stock) is about 130 basis points or 1.3%. In Hong Kong, it is more like 60 basis points. Not sure what the US is. (For the US, take Instinet as a benchmark and not what a broker would charge you)

For mutual funds, you get charged from a no load of less than 50 basis points to a managed fund that can take up to 7% out of a round trip transaction. The people buying such mutual funds are generally fools as I pointed out earlier the inflation adjusted return on the S&P 500 is 6.5%. So, yes there are some people out there who would invest, but the percentage of investors now that buy mutual funds with such a high commission cost are few. If you added on a sales tax, then I’m not sure if anyone would buy such funds.

Supposing that the US did put on a high transaction tax and shut down all loopholes for avoiding that tax. The money would simply shift off shore and invest in other global stock markets. The result would be that American companies would become starved for capital and slowly wither away while foreign companies would be cash rich and increasingly dominate the market.

Since the US already has a capital gains tax, you would be double taxing investors.

Now, to answer your question, many countries do not have a capital gains tax on stock transactions. They have a stamp duty or some other form of government tax that runs something like 5-50 basis points per transaction. Now the US could get rid of capital gains and make it a transaction tax, and that would be a more fair system like a sales tax. The rich would be unable to have tax shelters to avoid the capital gains taxes, but those with less money would be paying a disproportionately high tax per stock transaction.

Remember, at the end of the day, the stock market is not really there to make people rich (although that is the carrot to intice investors to take on the risk), the stock market exists to raise capital to help fund companies. If you destroy or hamper that ability to raise funding, you’re going to do the underlying economy a whole lot of damage that is entirely different from a stock market drop as happend following 9-11 or Oct 87.

10

High-volume traders on Instinet pay an average transaction cost of $0.0004 to $0.0005 per share traded, or 40 to 50 cents per thousand shares traded. The average per-share price on NASDAQ appears to be about $15/share (to get this, I took the 10 most active issues on NASDAQ today and averaged their closing prices; this is therefore a rough estimate but probably pretty close), so a one-thousand share trade at $15/share would carry a transaction cost of 50 cents on a trade value of $15,000. This is roughly one third of a basis point.

I, as Jill Random Trader, pay between $15 and $20 per trade regardless of the volume of the trade for market orders and $0.01 per share for limit orders over 5000 shares. On a typical 100-share round-lot transaction (which is perhaps typical of the everyday investor) that means a commission of $15 on a $1500 trade, or 100 basis points. Please note that I rarely trade stock in large part because of the commissions involved; my money is invested almost entirely in a selection of no-load mutual funds, which have zero transaction cost (the costs are incorporated into the share price).

The OP’s proposal, even in its watered-down form, would quadruple my transaction costs on trades which I already avoid, and would turn the no-load mutual funds I in invest in from having yields in the 3 to 8 percent per annum range to being unable to show a profit at all.

11

Agreed, anything over 1% might be too much, although cftech.com reports AMX, NASDAQ and NYSE all take a 2-10%, negotiable, commission based on share volume, so I wonder how out of line it would be for the government to step up to the plate and take a chunk of that for themselves. High volume traders could pay a little more in tax since they are already getting a commission discount.

Did a little more web digging and found that transaction taxes, while not uncommon, are definitely small percentages. CFTech lists the world’s exchanges with their commission and other fees if anyone is interested in how the rest of the world handles these types of taxes. Looks like there is a fair combination of flat fee per trade and percentage based taxes.

As long as the US rate was not too out of line it looks like capital would not have many choices of places to avoid a transaction rate.

Anyone have any idea what the total dollar volume traded on the US financial markets is per year?

I looked for an analysis of the effect of transaction taxes but only found one from a site which seems to have an axe to grind for the Tobin Tax (taxes speculative international money trading) at globalpolicy.org but not sure I trust it as they offered only positive reviews and didn’t seem to have any arguments against in their links.

SuaSponte – I think you are giving your average American too much credit.

I would venture that most folks have no idea what their actual pay is per week. They tend to think about it in terms of take-home pay, after taxes, and few really notice how much of their paycheck disappears before they get their hands on it.

Ask folks who have regular contributions to their 401(k) or Roth IRA what their costs are in management fees and I bet they have no idea, either. They just know if the overall number goes up or down. Shoot, I’ll bet 3/4 of the folks who carry credit card debt and actually have to write a check each month have no idea what interest rate they are paying on that money.

People who make regular contributions to a fund would get used to that percentage of money disappearing and would eventually not even notice it. They’ll just expect to see a certain number show up as bought stock (if they even bother to track it) and as long as it is there they will be happy.

Agreed, my initial ideas of the amount to generate were too high and would endanger the markets. However, there is ample evidence that government transaction fees in general do not destroy a market. So if everything continues along tickety-boo, do most people look beyond the bottom line of their monthly plan statement or even know what they are invested in? I bet not. Most folks invest through retirement plans and can’t touch those holdings for decades. The day to day playing of the market is still seen as a function for the wealthy.

Not if done properly. If you replace income revenue with stock transaction revenue, the take home paycheck will be larger. This makes Joe Six-Pack happier.

Depends on how you see things. Who will be complaining about the tax most? Banks, Financial Institutions, Brokers; people and things seen as wealthy entities that are trying to make the little people pay taxes for them, especially if I am offering an income tax reduction after the new fees are in place. Perception is reality, especially in a one minute advert.

12

what your link did not show is whether these other countries have capital gains tax as well. I know for a fact that both China and Hong Kong do not have capital gains taxes.

It would help simplified the US tax code to exclude capital gains, and the distortions in trading that investors go through to try minimize the short and long term capital gains tax, and instead use a form of stamp tax. If the “right” level of stamp tax is selected, investors would probably think it’s a good idea. Certainly, it would make IRS reporting easier. Of course, that right level might be difficult but certainly not an insurmountable barrier.

13

ummm, not really (dont worry, i agree with you …but…). Two points:

  1. the tax would be applied only once(well, twice). So we are talking a TOTAL of a 6% tax: 3% when you buy and 3% when you sell. Assuming you buy and hold for 5 years, the total return, assuming 6.5% would be 37% vs 31%, for an average yield difference of 6.5% vs 5.5%, or 1%. Hold for shorter, less yield, hold longer, more yield.

  2. This tax is meant to be a substitute for other taxes, including, I assume, the capital gains and corporate sales taxes. Without capital gains, the above 1% yield difference decreases to .4% assuming 10% cap gains tax. Without corporate taxes, the s+p yield would increase from 6.5% to 9%, since the corporate income tax is a whopping 38%. This would make the final yield 8.1%, versus a yield for the s+p 5.9% when you factor in capital gains.

However, the tax would DEFINITELY decrease the sales volume, as there are many day/momentum/arbitrage traders who would simply stop trading if this were in effect. So while it would be an effective substitute given current trade volumes, current trade volumes would not be maintaned.

14

If you tax people for making an investment regardless of the return on the investment, then you are sometimes taxing people for losing money. Intuitively this is a bad idea, regardless of how large or small the percentage of the tax is.

The only thing that makes sense is to tax people on a positive return, and this is already part of income tax. If you have a tax on investments independent of the return, you will sometimes be taxing people for having a low (even negative) income. How can they afford to pay this tax?

The whole point of a tax is

  1. To tax people who should be able to afford to pay the tax.
  2. To incourage or discourage a certain sort of behavior.

If for some reason you think it is socially beneficial to discourage investment, especially investment of a significant amount of money, then it makes sense to tax investment transactions by percentage. So it would be like the government saying, “If you absolutely must make an investment, then we aren’t going to make it illegal, but we will levy a tax against it to discourage you.”

If you think about it, sales tax makes sense in this way – the government discourages us from buying things that we aren’t going to use. It makes it unprofitable to buy a bunch of stuff you don’t need from a commercial market.

In short, the proposed tax makes no sense. Trading securities is beneficial to society because it rewards those who invest money profitably. Those who invest profitably acquire more money, and get to make more decisions about where money is invested. Those who invest unwisely have their money taken away from them, and are not able to make more investments. Investment transactions are good – each one is a test of the wisdom of an investor – why tax them?

Andrew Wheeler