The Gulf Time Newspaper One of the finest business newspapers in the UAE brought to you by our professional writers and editors.
It’s a good conservative principle that where possible, the government should recover the cost of its services from the people who use them, rather than from taxpayers at large. It’s also pretty uncontroversial that the government must oversee financial markets, to ensure that they are free and fair.
It thus makes sense that the government should charge a user fee for financial transactions. So why has the idea encountered so much opposition?
It’s not as if this were radical socialism. Hong Kong, perennially rated the world’s freest economy by the conservative Heritage Foundation, has had a 0.1% tax on financial transactions for years. The levy has had no discernible negative effect on its economy, though it might be responsible for a relative lack of high-frequency trading. Many other countries have financial transaction taxes, including the UK, Switzerland and Taiwan.
Opponents of the tax offer two main arguments. First, they say the burden will fall mostly on small investors. Second, they say it will undermine the ease of buying and selling that makes US markets so attractive, and impair those markets’ ability to determine the proper prices of securities.
The idea is that regular folks mostly invest through mutual funds, which trade a lot and hence will get hit hard by tax. Specifically, in a letter to legislators, the Investment Company Institute estimated that the tax would impose a 60% average cost increase on investors in equity index funds.
That calculation is specious at best. It implies that typical investor holds an index fund for less than six years. According to ICI, this is based on purchase and sale data from 2018 — a year in which funds experienced large redemptions from retiring baby boomers and vast inflows from investors looking to reduce their fees.
Actually, people who invest in index funds for their retirement tend to be long-term buy-and-hold investors. An investment at age 35 might be withdrawn at 65, which suggests a holding period of about 30 years. Given that horizon, the average tax per year is less than one-hundredth of one percent, which would increase the typical index-fund fee by only 8%. The tax on the funds’ own trading might add a little to this, but not much.
What about liquidity? True, the tax would put the brakes on the high-frequency outfits, proprietary traders and hedge funds whose chief mission is to profit by launching swarms of lightning trades at the expense of slower-moving “whales†such as mutual and pension funds. But that should be good for retail investors. It should also be good for markets more broadly, reducing the threat that high-frequency algorithms gone wrong will cause a systemic crisis — as they almost did in the “flash crash†of 2010.
The benefits of a tax on trading far outweigh costs. It would generate much-needed revenue. It would favour longer-term investors over speculators. It would put a little useful resistance into financial system, preventing it from overheating or spinning out of control.
So why do the tax’s opponents make mountains out of molehills, exaggerating its burdens and dangers? It’s hard not to conclude that they’re really trying to protect their already ample profits against any and all constraints. That’s completely understandable, but a terrible foundation for making policy.
—Bloomberg
Michael Edesess is chief investment strategist with the mobile financial-planning software company Plynty and a research associate at the EDHEC-Risk Institute