The EU Transaction Tax-Capitalism Killer

Posted by Jeff Carter
on February 24th, 2013

The EU is going full bore and will tax financial transactions in Europe. This is not a novel idea. As a member of ($CME) CME Group’s political action committee, we fought this tax every year no matter which President was in office. Some bureaucrat programmed it into the budgeting software. Every year, the tax was taken out, but it required time and money spent by the industry to talk to various officials to make sure it came out. Politicians from both sides of the aisles understood how damaging a financial transaction tax on trading could be.

Even Obama is against this tax. That’s how misguided it is.

Most people don’t understand what it’s all about. They simply see the estimates of how much money the government expects to collect from the tax and then angrily shake their shoulders and say, “Those dirty bankers ought to pay it.”.

I wasn’t a dirty banker. My trading operation was just like a Mom and Pop neighborhood drugstore. It was me against the world, trying to make a buck. Based on the taxes proposed at at various times in the US, my annual cost based on the volume I traded would have been $110,000 per year.

That’s prior to me making any actual profit on trades. Trading is extremely risky business and is no guarantee you will make money. Otherwise, everyone would do it.

Based on the EU tax of .01% per derivatives transaction, my cost would have put me out of business. Eurodollars have a $1,000,000 notional value. I used to trade 100-500 spreads at a crack. That’s 200 to 1000 total contracts.

One of the reasons cited for the tax is high frequency trading (HFT). Any long time reader of this blog knows I have some reservations on HFT, but it doesn’t have to do with speed or the volume they trade. Structuring the marketplace differently would change the economic incentives causing the HFT players to reprogram their algos to approach the market differently.

The simple fact is bureaucrats and politicians lack the political will or market knowledge to change the market structure because it will drastically affect business models of some very very big players in the market.

It’s amazing what happens to your volume and decision making when you have to assume more risk or have the same information as the rest of the marketplace.

The Economist cited an old Bank of Canada study on transaction taxes,

A Bank of Canada analysis of the effect of previous FTTs found that they tend to harm market quality, by increasing volatility, reducing volumes and raising the cost of capital. The early effect of a French equity FTT that was introduced last summer was to hit trading in the shares of smaller firms. Without a co-ordinated global approach, the taxes are also likely to be circumvented by savvier investors, leaving retail investors to pick up the bill. After Sweden levied an FTT in the 1980s, 60% of trading volume in the most actively traded share classes moved to London; the tax was repealed in 1991.

Even worse, this is an attempt to tax citizens that aren’t even in the EU.

buying a share in Siemens, say, would incur the tax even if the counterparties were two American firms in Chicago. The proposal is not the only attempt to extend the laws of one state into the jurisdiction of another.

Don’t we pay enough in taxes already without sending money to the EU to pay for their problems? Talk about taxation with no representation!

Let me attempt to put the effects in layman’s terms to the people that hate the big bankers.

Today if you put gas in your car, a gallon of gas costs you $3.78. There is a lot that goes into that gallon, but the base price is set in the futures market on CME Group’s NYMEX exchange. Right now, the cost to trade 1 contract for a professional trader is .45, plus commission at the FCM which is roughly .05. $.50 all in.

What happens if I simply add a straight tax that’s not as onerous as the EU Tax of say, $.05 per transaction?

Now it’s .$55 to trade. Doesn’t seem like a lot does it? However, you just increased trading costs by 10%. How would you like to pay a 10% sales tax on everything you bought?

The behavior of traders will change. They will trade less with the tax than without the tax.

“No big deal”, you might say. Those dirty traders are stealing anyway. But what happens when there is less volume to trade in the market?

The bid/ask spread between prices has less volume on it. That heightens the amount of risk to trade at any point and time. If you have bought Crude Oil ($CL_F) futures, and need to unload your position, it is much harder to exit. If you have bought the futures, and they are going your way, less volume means it’s going to take you longer to get out of a winning position. When you are getting out, there is a chance the market could move against you, eliminating your gain.

The only choice is to trade less.

Wider bid/ask spreads increase the cost to trade. Right now, the spread between the price to buy and sell crude oil is $10. The “all in” cost of trading is $10 plus the fees. With less volume, the spread will widen. If it widens by only 1 tick, the tax actually increased costs to trade 110%.

“No big deal”, you still say.

However, those increased costs to trade mean it’s tougher for the market to discover the price of a barrel of oil. Markets become less transparent. It takes longer. The tax will cause some people to exit the market and do something else with their capital. That creates an even thinner marketplace.

Thin markets become even more risky. That increases the overall price. It increases the volatility in the marketplace and makes the price “less sure” and more random. There is no telling how much the tax would affect the end price of a gallon of gas, but suppose it was only $.20 cents?

If the average car goes 12,000 miles per year, and the average mpg of those cars is 21.5 gallons per mile, you’ll pay $111.63 more at the pump each year. That may not seem like a big number. But add that tax to everything you consume or use-wheat, corn, rice, barley, cheese, milk, pork, beef, coffee, sugar, cocoa, orange juice, paper, natural gas, heating oil, lumber, palladium, platinum, silver, gold, interest rates, currency, stocks….it never ends.

The tax not only hammers you, but hammers your pension, your bank, your state and local government, your place of business.

Now, how do you feel about that transaction tax designed to get the greedy bankers? You are paying for it in every facet of your life. Living just got more expensive, by a lot.

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.