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

Great Debates
21

Wrong.

There is still consumer surplus, even if GDP is not increased.* This is formally equivalent to saying there is no consumer surplus sells his home to another private individual—after all, after the transaction, there’s no increase in the housing stock. But plainly there must be a surplus due to trade for both parties as a result of a voluntary transaction: sellers only sell when they value the purchase dollars more highly than the item conveyed, and buyers only buy when they value the item conveyed more highly than the purchase dollars.

*As it happens, when calculating GDP for a given year, economists do not count the purchase prices of new-construction homes in that year. Instead, they estimate “imputed rent,” or what the equivlaent in rent would be for all occupied homes in that year. Investment securities are not counted in consumption spending, so this doesn’t directly apply. What it does show, however, is that merely increasing the number of items to be bought and sold on the market is not the only way to increase the economy’s productivity (as measured by GDP). And so it is incorrect to say, because this activity (secondary trading) does not create a new item to be bought and sold on the market, it therefore has zero economic benefit for society as a whole.

Your “simplifying assumption,” which goes astray on this point, is actually an assumption that secondary trading is, by definition, unhelpful to the macroeconomy in terms of productivity. But as shown above, there is no reason to say that creation of new tradeable items is a necessary predicate to increased productivity. Given your assumption, it is no surprise that you are able to derive your desired conclusion from it. However, as it illicitly assumes the proposition it purports to prove, your syllogism has no probative force.

22

Good point, I had a feeling I could have formulated that better. What I am trying to express is that there is a relevant difference between trades of secondary shares, compared to trading other goods such as houses: Shares have no utility. A house or any other good is being allocated to whoever could make best of use of it, so increases the welfare of the seller and buyer. But secondary shares are unique in that they cannot be used for anything, so nobody is gaining any benefit from this trade.

I hope the above explains the assumption better. Maybe you could suggest a more correct way to word this?

For the record I didn’t claim to have reached a conclusion, desired or otherwise. Though I admit the numbers used in my example came out supporting the outcome which I suspected :slight_smile: Also, if we change the numbers (eg delta TSB = $100 b, delta TSM = $50b) the result changes, so I believe this is not a syllogism.

23

That’s still a pretty odd assumption.

Pension funds, endowments, and anyone that has seen their money grow in a retirement account have surely found utility in owning shares of stock - either through capital appreciation or dividends/distributions.

24

Well, how does that differ between making deposits in a savings account?

Secondary trading is, by and large, a store of personal and institutional savings placed in an investment vehicle that generates larger returns that a savings accounts (because they are riskier than savings accounts). There is a small measure of speculation, which serves the function of promoting the liquidity of securities and allowing price discovery.

Would you impose a tax on bank account savings and withdrawals as well? After all, CDs cannot be used for anything, so they have no (consumption) utility. Your chief objection seems to be “Why do banks and investment firms make so much money? They don’t make anything, after all.” They make this money because consumers want to avail themselves of the savings vehicles they provide. If consumers in the aggregate feel that this is a good tradeoff, why should we gainsay them?

What you want is to promote consumption spending. It is true that during recessions this is the area that needs to be assisted. Both Keynsians and monetarists have typical solutions and both are normally employed. Keynesians advocate for increased government spending as a booster shot to consumption and monetarists advocate for loose money to depress interest rates and make all saving less desirable. Your approach targets only one kind of saving, which would simply distorts saving vehicle choices away from what they would be in the absence of this tax.

25

It sounds like we’re in general agreement. That 41% of all U.S. domestic corporate profits come from the financial sector seems, to me, more than a “bit” high.

The huge amount of speculation today can be destabilizing. (Google this yourself. Even sites arguing the other way agree that such trading can exaggerate other destabilizing events. Some crises, e.g. LTCM, resulted from excesses. The big bubble-bursts had other causes but resulted in part from the same culture which over-emphasized financial trickery.)

And profits from the speculation is largely at the expense, direct or indirect, of retail customers. (The typical retail customer has trading performance significantly worse than average. Admittedly, HFT may be only a small part of the reason for that.)

A transaction tax on stock trades of perhaps 0.05% to 0.10% would be much less than taxes in effect in other countries, reduce some excesses, and raise revenue.

That said, Panjandrum seems to have misconceptions and I will leave it to others to fix those. :cool:

26

Is there really a huge amount of speculation destabilizing markets more now than any other time, though? I agree that speculators can exaggerate price moves on occasion. I don’t know of a way to stop that without completely changing what markets are. Is the price of natural gas being held down too low because of all the speculators that are short of it? Maybe, but how do we determine that in any way other than in retrospect?

Cite? If anything, HFT is beneficial to retail/long term investors.

[QUOTE=Gus Sauter, Vanguard’s Chief Investment Officer]
Sauter said that there might be a small percentage of high-frequency trading that is manipulative, but that overall this is a type of trading that benefits long-term investors like Vanguard’s customers. “Most high-frequency traders in our view are essentially electronic market makers or they’re statistical arbitrage players. In both cases, they’re working to tighten spreads and enhance liquidity. If that’s the case, then we as investors in the marketplace benefit by getting lower transaction costs when we go into the marketplace to invest for the long-term.”

How much of a benefit does Sauter attribute to market developments in the past 15 years, which include decimalization, high-frequency trading, increased fragmentation, Reg. NMS and order handling rules? “We’ve measured our transaction costs and over the past 15 years, they’ve been cut by about 60 percent,” Sauter said. “That results in hundreds of millions of dollars a year in savings to investors in our funds.”
[/QUOTE]
The typical retail trader loses money because they probably have no idea what they’re doing. Trading is extremely difficult and extremely competitive. I wouldn’t expect a retail trader to outperform any more than I’d expect a beer league softball player to consistently get on base in the big leagues.

Maybe, but probably not. One thing I’d be almost certain of would be that the only people paying the tax would be retail customers. Like the stamp duty in the UK, banks and institutions would be exempt. Of the places that have tried it, I’m not aware of any situations where the positives have outweighed the negatives. Sweden, who tried a similar tax, is one of the most outspoken voices againstit now.

27

One reason is that with long-term gains, you have to account for inflation.

If I buy $1000 of stock today and sell it in 20 years for $2000, my nominal profit, which I have to pay taxes on, is $1000, but my real profit is much less. (Given average historical inflation rates, it’s actually probably negative in this example). So, as long as you’re comparing nominal dollars to determine the profit/loss, it makes sense to discount the tax rate. I’m not saying that a lower tax rate is the best way to solve that problem (I’m in favor of having the same income tax rates for capital gains, but figuring the profit/loss by using a CPI-adjusted cost basis), but making rates the same and not accounting for the effects of inflation on capital gains would make the effective tax on capital gains much higher than that on normal income.

28

I am pretty sure the only reason to confer a tax advantage is because we want people to make long-term investment plans. Otherwise we’d tax everything the same and just be done with it. Absolutely everyone is negatively affected by inflation.

29

Well, sure, but there are financial justifications for it, too.

Wages aren’t negatively affected by inflation the same way that investments are. There’s no way to have a real loss earning wages and still show a taxable income. That is true with capital investments.

30

The detrimental hyperactivity in today’s financial sector imay be a good topic for a separate thread. For now let me just point out that the expense reduction Vanguard’s man spoke of referred to all changes, not just HFT.

As to Sweden’s repeal of their stack transaction tax, note first that their tax was 0.5%, then 1.0% – exactly ten times what I mentioned, and mine might be too high. Moreover, Sweden’s complaint referred specifically to traders packing up and taking their business to London or New York. Of course in today’s tightly-knit world, policies would have to be coordinated across borders. But the difficulties that might present are not a reason to dismiss good ideas out of hand.

31

The UK does have a purchase tax on equities, called Stamp Duty. Currently 0.5%. It’s been in place for a long time (more than a decade IIRC). I wouldn’t say it’s popular but it’s certainly not been the “disaster” you claim.

32

To determine the impact on the wellbeing of society due to depositing in a savings account (or any other activity) we can use the same form of analysis: The net change in the total utility of society.

Every activity will have some subtasks that decrease utility, and some that increase utility. If the increase in utility is greater than the decrease, the total utility of society has increased and the activity has benefited society.

For the case of a retail bank this would be as follows:
Decrease in utility - Consumption of scarce resources to run the bank.
Increase in utility - The bank lends out deposits in the form of mortgages, business loans etc. The activities enabled by these loans increase the utility of society.

To answer your question, if we determined that the resources consumed by running banks outweighed the benefits of the services of banks, then I would support additional regulation of this sector. Not that I expect this to be the case, as I know that bringing together lenders and borrowers is essential for society to function.

Returning to the stockmarket, maybe it would be clearer if I frame my question in terms of utility rather than surplus. So the analysis becomes as follows:

Simplifying Assumptions
[ol]
[li]Non ST firms generate utility at a rate of 0.5 util / $ of revenue This reflects the fact that firms which sell to consumers will only do so if consumers derive wellbeing from the products. Again, I chose the 0.5 ratio to simplify our analysis.[/li][li]ST activities do not generate any utility directly (we will account for IPOs separately) This is not to say ST activities are inherently bad, the positive utility effect of the IPOs may compensate for this depending on numbers.[/li][/ol]

Using the above framework to assess the impact of the stock market on the total surplus of the economy:

[ol]
[li]Increase in total utility due to startup businesses This is the positive effect of the stock market. IPOs allow these firms to grow their revenues quicker, and thus generate more total utility. We will denote startup businesses’ contribution to the economies total utility as USB.[/li][li]Decrease in total utility due to secondary trading This is the negative effect of the stock market. The decrease in utility represents the human capital tied up in predicting share prices, instead of producing products, doing research etc. When resources are diverted from another sector to the SM, the total utility decreases by this amount, denoted USM.[/li][/ol]

Hopefully this now clears up the concept I am getting at. I know there are details that could be added to make this more accurate, but it’s good to start simple then refine.

The quantities we need to evaluate the above are as follows:
[ol]
[li]Ratio of utility to revenue for ordinary firms (I assumed 0.5, hopefully this is close)[/li][li]Projected revenue generated due to IPOs[/li][li]Revenue of the SM for a 10 year period[/li][/ol]

I’d be interested to hear if you agree with the above logic. The concept should now be clear, please let me know if there are better ways to express this. Also, can anyone suggest a source for the above data?

33

Here Here!

People greatly underestimate the importance of liquidity until/if they find themselves in an illiquid situation.

Liquidity is an extremely important, if not the MOST important function of stock markets! Therefore, the secondary market is VITAL or the whole thing will collapse.