Opinion: Let's Not Tax Trading Out of Existence

Bad policies will result if we don't resist the desire to place blame and seek revenge on the investing community.
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There is an editorial in the New York Times today by Bob Herbert that suggests that a good way for the government to raise some revenue is to impose a "small fee -- ranging up to, say, 0.25% -- on the sale or transfer of stocks, bonds and other financial assets including the seemingly endless variety of exotic financial instruments that have been in the news so much lately."

Supposedly this would raise $100 billion or so annual which is "money that the government sorely needs". Maybe if the government wasn't so busy giving away so much money to banks that didn't spend it, then it wouldn't sorely need to raise taxes. But that is a whole different discussion.

The first problem with this "transaction tax" is the idea that the level of transactions will stay where they are. Trading will simple stop in many cases and some of these "exotic financial instruments" will simple fail to exist. It won't take more than a very small tax to have a big impact, and you can be sure the law of unintended consequences will soon be at work. Wall Street is already losing business to foreign exchanges, and you can bet it will lose even more as trading moves to more friendly, less socialistic, tax environments.

However, what is even more suspect than this overly simplistic economic argument is the idea that a tax is a good thing because it will help discourage nonproductive speculative activity. In other words Mr. Herbert wants to impose taxes because it encourages buy and hold type investing and helps to eliminate all those pesky traders that are moving in and out of the market so quickly.

I certainly question whether 'buy and hold' investing should be promoted to this degree. I also wonder who is going to be paying all these taxes if you eliminate speculative activity? I guess that would be all the long-term investors who are struggling to rebuild their 401(k) accounts, which were destroyed by 'buy and hold' investing?

An even more interesting economic question is: What is the value of the liquidity provided by speculative trading?

If markets are less liquid, the general level of prices is likely to fall. That is because when longer term investors are forced to sell, which will happen quite a bit even if they are in for the longer term, there won't be those speculative traders around to sop up the shares that are being dumped.

Just imagine if the daily trading volume in

General Electric

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,

Exxon Mobil

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e,

Google

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,

Microsoft

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and other stocks was reduced by 30% or 40% or more. The likelihood is that a longer-term owner who has to sell will see a lower price than he would have received if those 'unproductive speculators' were there..

The longer term investor will be at the mercy of other longer term investors who are far less likely to provide a ready market for shares that need to be sold. Price-earnings ratios will likely contract and the level of prices will fall if the only folks who are left to buy shares are forced to have longer holding periods.

I'm sure some academic studies can shed further light on why markets operate more efficiently when they are not heavily taxed, but the problem is that Wall Street is now considered a deserving target.

A lot of folks want the industry to pay for the damage that has been done to the economy, so we see proposals like this. Unfortunately, these sorts of policies are likely to be embraced simply due to the propensity of many to place blame and seek revenge.

Let's be hopeful that some real thought and study is done before this idea takes root in Congress. Given the current environment, it won't take much for politicians to tax trading out of existence.

James "Rev Shark" DePorre is the author of

Invest Like a Shark: How a Deaf Guy with No Job and Limited Capital made a Fortune Investing in the Stock Market

. He is founder and CEO of Shark Asset Management, an investment management firm, and he also operates

sharkinvesting.com, an interactive online community that serves and educates active investors. DePorre holds business and law degrees from the University of Michigan, is a member of the Michigan Bar Association and a former tax attorney and CPA. He lives in Anna Maria Island, Fla., with his wife and two children. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Rev Shark appreciates your feedback;

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