Would it benefit society if we increased taxes on stock trades?

Great Debates
1

I have often wondered about the impact of the stock market on society. The following is my understanding of this topic so far:
[ol]
[li]Shares can be sold in IPOs or secondary stock trades. Initial Public Offerings are when a company sells shares to the public. Secondary trades are when individuals sell shares to each other.[/li][li]IPOs greatly benefit society. IPOs allow successful companies to raise capital to scale up their operations, so more high quality widgets are available to society.[/li][li]Secondary trades do not benefit society. Companies pay the same dividends regardless of who owns their shares. Secondary trades do not increase the number of widgets available, so society as a whole is not improved. Of course the buyer and seller of the share would not do so unless it is in their interest, so they benefit.[/li][/ol]

I realise there are exceptions to the above. However, I believe this covers the general concept, though not every minor detail.

My conclusion: Secondary trading produces two effects on society, one is detrimental, the other beneficial.
[LIST=4]
[li]Detrimental effect on society: Secondary trades do not benefit society, so it follows that any effort expended on this activity is a deadweight loss.[/li][li]Beneficial effect on society: IPOs are not possible without secondary trading. People will only invest in IPOs if they will be able to cash them in at some point.[/li][/LIST]

The question: Do the benefits of IPOs outweigh the resource consumption of secondary trading?

If not, maybe we could improve the situation by discouraging secondary trading. An example would be to tax any trades on shares held for less than 1 year at 100%. This would result in fewer IPOs, but less resources consumed on secondary trading. Alternatively, maybe we should reduce capital gains tax to encourage more secondary trading and hence IPOs.

It would be great if anyone could refer me to a study or book that deals with this question specifically. Given the nature of this question I would be doubtful anyone would have the time or space to lay out the necessary train of logic here. Though I would definitely welcome any attempts.

Well thanks for reading my very long question! I can’t wait to learn more about this topic.

2

This premise is demonstrably false.

Without a secondary market for shares, there would be no liquidity and therefore no motivation to invest in an IPO. Why would I buy shares if I can’t sell them later when I no longer wan them? It would also be impossible for companies to engage in share buybacks or stock-swap mergers. It would make figuring out market capitalization, and therefore a fair price for subsequent offerings or acquisitions, totally impossible.

The premise that leads you to this conclusion is wrong. A secondary market is both necessary and beneficial.

3

Well, a 100% tax on anything that can reasonably be bought or sold is absurd in my view. And capital gains is another matter, partly because people buying and selling shares should be able to offset their capital losses against their capital gains.

However, I think there is a case for a turnover tax on share trading, but at a very low rate (say 0.1%).

4

I still don’t know why net capital gains aren’t taxed at the same rate as ordinary income. The double taxation argument is moot, since they are already taxed. The only question is, why are they not considered ordinary income?

5

Since this question will involve much more than factual answers, let’s move from GQ to Great Debates.

samclem

6

  1. There is a difference between taxes on capital gains and taxes on stock trades. Which one is being discussed here?

  2. Short term capital gains (when you hold the stock for less than a year) are taxed as ordinary income. Long term capital gains are taxed at lower rate. Can you think or a reason why?

7

One country (I want to say the Dutch, but I am not sure) tried. It was a disaster and the taxes were dropped.

8

I asked first.

9

Japan had one that was later eliminated. But it was gotten rid of in an effort to revitalize their stock market after the collapse of the Japanese asset bubble. Which was a disaster, but not one that had anything to do with the tax (indeed, if anything, the tax lessened the size of the bubble).

10

The revenues from taxes were disappointing; for example, revenues from the tax on fixed-income securities were initially expected to amount to 1,500 million Swedish kronor per year. They did not amount to more than 80 million Swedish kronor in any year and the average was closer to 50 million. In addition, as taxable trading volumes fell, so did revenues from capital gains taxes, entirely offsetting revenues from the equity transactions tax that had grown to 4,000 million Swedish kronor by 1988.
…
Even though the tax on fixed-income securities was much lower than that on equities, the impact on market trading was much more dramatic. During the first week of the tax, **the volume of bond trading fell by 85%, even though the tax rate on five-year bonds was only 0.003%. The volume of futures trading fell by 98% and the options trading market disappeared. **On 15 April 1990, the tax on fixed-income securities was abolished. In January 1991 the rates on the remaining taxes were cut in half and by the end of the year they were abolished completely. Once the taxes were eliminated, trading volumes returned and grew substantially in the 1990s

11

Doing away with the secondary market altogether is a very bad idea. What some propose is to increase the transaction tax. This would raise revenue and, perhaps more importantly, dampen the hyperactivity we see in today’s financial markets. Speculative activity in the secondary markets is good: it provides liquidity and improves pricing, but the hyperactivity we see today is well past the point of diminishing returns. In today’s stock market, much of the trading is between automated software, with little advantage except to Wall St. profits.
This was discussed in another recent thread.

The proper size of such a tax is unclear and would have to vary by security type. Short-term notes should obviously have a much lower transaction tax than stocks. According to Wikipedia the present U.S. tax on stock trades is a tiny 0.0034% which raises almost $2 billion annually. Increasing this to a still-tiny 0.034% would not produce a full $18 billion additional for the Treasury, but would help curb some excesses without impacting retail investors

12

The whole stock market is set up as a sham. That is the basic problem. The problem isn’t the idea itself but the way it is executed. IPO’s are obvious and necessary but they are hardly ‘public’ as the last letter of their abbreviation outright states. Those shares ares sold to wealthy and influential people or institutions as a near sure huge return on investment. They tend to be very undervalued when they hit the secondary market so the people who are lucky enough to get those IPO shares can walk away with a quick return thanks to the fictions of the secondary market. Two out of three parties just made their money: the company itself and the people that were privileged enough to get the IPO shares.

The only thing that is left are the secondary investors. At that point, the stock has almost nothing to do with the company itself any more than an Honus Wagner baseball card from 1909 has to do with major league baseball today. Apple doesn’t get anything when you buy or sell their shares except very indirectly because they also own some of their own stock and can sell it when the price is right thanks to the same fictions.

This relates to the OP because stock market trading is like legalized gambling except it is usually a positive return game rather than a negative return game. Additional taxes would tend to make it a negative return game and Wall Street people are a lot smarter than Las Vegas gamblers so they would no longer play. That would bring the system to a screeching halt with disastrous economic consequences.

The better way to address to problem isn’t to make it a game that people don’t want to play at all, it is to make it a more fair and legimitate game but that would take a lot more thought and cooperation from the people who have no interest in doing so.

13

Not all companies are going to pay dividends. If the company feels it is better to reinvest their profits in growth, or hold on to cash in expectation of future cash-flow problems, or whatever, they’re not going to pay dividends. The only thing which makes their stocks valuable is the secondary market in such a case.

14

Indeed. Few, if any, new companies (the real engines of growth) don’t offer dividends.

15

“Don’t offer” or “offer”??

Start-ups rarely do… the few that become succesful may at that point.

Small businesses (the real engine of growth?) rarely form as C-Corporations these days.

16

What’s your evidence that there is a problem with the current state of automated trading?

Most automated trading is not done by Wall St. The Too Big To Fail banks would prefer high frequency firms not exist. They cut directly into Wall Street’s profits.

17

Scratch the “don’t” in that.

Few, if any, new companies (the real engines of growth) [del]don’t[/del] offer dividends

18

I think I’ve debated this and related topics in previous threads, probably with you. I’d focus on “the big picture” rather than a semantic like whether stock trading firms based in midtown-Manhattan can be lumped with “Wall St.” :dubious:

To that aim, I’ll answer your question by posing three of my own:
[ul][li] Was the 2007 credit crisis a good thing or a bad thing? (*)[/li][li] Is it good that the U.S. financial sector, which “never earned more than 16 percent of domestic corporate profits” from 1972-1985, had as much as 41% recently?[/li][li] Did the “strength” of that financial sector alleviate the 2007 crisis or exacerbate it?[/li][/ul]
I realize these questions seem unrelated to yours. I’d like to compare our overall stances before descending into details.

(* - This question is not facetious or rhetorical. Some Dopers seem to think that financial transfers from the gullible to the smart represent “wealth creation” and are a tribute to their laissez-faire philosophy.)

19

  1. Bad. The fact that the TBTF banks are even biggernow than they were before the crash, I find very troubling.

  2. Probably bad. I don’t know enough about how an economy of a country like the US should evolve in the global economic system. It makes sense to me that, given the lower costs of producing widgets in other countries, more of US GDP would come from “pushing paper around” compared to a few decades ago. What percent exactly? No idea, but 41% seems a bit high.

  3. Hmm. I don’t know how to answer that. The existence of a large financial sector is what allowed the credit bubble to exist in the first place. The credit crash would never have happened had the financial sector not been what it was.

20

Thanks all for the interesting posts, this has become an educational debate! Maybe by clarifying the OP in more precise definitions we can shed some light on the question.

Definitions
[ol]
[li]Producer surplus Producer surplus is defined as the price for which producers sell their goods, minus the cost incurred to produce them.[/li][li]Consumer surplus Consumer surplus is defined as the price that consumers are willing to pay for a good, minus the cost they actually pay.[/li][li]Total surplus Total surplus is defined as the sum of producer surplus and consumer surplus. Intuitively we can see it is good for society if people can pay a low price to get goods they consider valuable. Total surplus is a measure of the efficiency of the economy. [/li][li]Benefit society / increase efficiency of economy A new tax increases the efficiency of the economy if the total surplus increases as a result of it being implemented. This is a benefit to society. [/li][/ol]
Simplifying Assumptions
[ol]
[li]For non-ST firms the ratio of producer to consumer surplus is 50% For example, the car industry makes a profit on each car sold. Consumer also place value on each car bought. [/li][li]For Secondary trading firms, the ratio of producer to consumer surplus is 100% The revenue of the firms and individuals who engage in secondary share trades come from other sectors of the economy. As secondary trading does not directly produce any goods or services, the consumer (rest of economy) surplus is zero. Therefore, the contribution of the secondary market to Total surplus is the producer surplus of the Secondary trading Market.[/li][/ol]
Now consider the impact of the stock market on the total surplus of the economy.
[ol]
[li]Increase in total surplus due to startup businesses New startup businesses have been assumed to have 50% producer-consumer surplus ratio. IPOs allow these firms to grow their revenues quicker, and thus produce more total surplus. We will denote startup businesses’ contribution to the economies total surplus as TSB. [/li][li]Decrease in total surplus due to new secondary trading Recall our assumption that ordinary firms have a 50% producer-consumer surplus ratio. So when resources are diverted from another sector to the SM, the total surplus decreases by this amount, denoted TSM.[/li][/ol]
So using the notation developed above, my question can be more precisely phrased as follows: If we were to discourage seondary trading (by tax or otherwise) would the change in TSB > change in TSM?

To give an example scenario, say we imposed an 100% tax on trades held for under 1 year. I don’t know the relevant values so I am using dummy values to show how we could evaluate such a tax. Using a 10 year accounting period:

Before tax
TSB = $200 billion. That is, over 10 years startup businesses generate $200 billion of revenue.
TSM = $500 billion. That is, over 10 years the secondary market has $500 billion of revenue.

With tax described above
TSB = $50 billion. Due to reduced liquidity, IPOs are less popular and startups are not able to grow as fast. The change in TSB = $150 billion.
TSM = $100 billion. Due to the new tax, secondary trading decreases and the change in TSM = $400 billion.

Impact on society: Total surplus changed by + $400 billion - $150 billion = + $250 billion. Thus the tax improved the efficiency of the economy, and was a benefit to society.

To get a valid result from the analysis above, we would of course need the the correct values for TSB, TSM and how they would change in response to a tax. Can anyone suggest a way to determine these values, or let me know if the logic above is ok?