Tuesday, 19 March 2019

Financial Transaction Taxes - the ghost in the machine

Not many believe in the existence of an FTT. It's the ghost FTT question. Does it exist or not? Should it?

The existing Financial Transaction Tax on publicly traded US equities raised a little under two billion US dollars last year.

Many market professionals know this. Most of the public does not.

To put that in context, Virtu, one of the bigger HFTs, had adjusted normalised net income for the December 2018 quarter of $127M. The existing FTT is already taking in more tax than one of the biggest HFTs made in income last year.

And yet, it is seen to be politically popular to demonise the Wall Street caravan by suggesting ludicrous taxation schemes at unrealisable levels. Far from building a wall around Wall Street to protect the public, such taxes will simply make the US inefficient and push transactions offshore.

One bill introduced to Congress by Rep Peter DeFazio and Sen Brian Schatz puts forward,
0.1% Wall Street Tax Will Curb Dangerous High Frequency Trading And Bring In More Than $777 Billion In New Revenue Over 10 Years
Today, U.S. Representative Peter DeFazio (D-OR), U.S. Senator Brian Schatz (D-HI), and U.S. Senator Chris Van Hollen (D-MD) will introduce legislation to create a new progressive tax on financial transactions that would generate billions in revenue, while addressing economic inequality and reducing high risk and volatility in the market.

“High-frequency traders front-run the market and drive up prices for individuals, pension funds and other value investors,” said Rep. Peter DeFazio (OR-04) “Some days high-frequency traders trade billions of shares that they sometimes hold for only seconds or less. They reap enormous financial benefits for themselves and their privileged elite investors but add no value to our economy."
The imbecilic naivety of DeFazio's comment beggars belief. Front running is illegal. In general, the private trading firms that make up most of the market making HFT don't have customers. Market making HFTs tend to stabilise prices due to earning the spread with mean reverting tendencies. DeFazio wouldn't know a negatively autocorrelated tick tendency if it tasted his toosh.

$777 billion is a slightly silly suggestion. As you can see from Virtu's bottom line the idea that a lazy, unproductive $77.7 billion a year is lying around is supercilious.

This is caravan-like demonising at its crudest.

Sweden's 1984 transaction tax is the oft-quoted poster child example in this space. The tax pushed trading off to London. Tax revenue forecasts were not met as the transactions moved. It was a disaster for the country but things normalised when the tax was finally removed. From Wikipedia,
"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."
"By 1990, more than 50% of all Swedish trading had moved to London."
Sweden received minimal revenue from fixed-income securities and the gain in equity transactions was offset by losses from capital gains taxation,
"As a result, revenues from these 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.[3] 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."
Rep. DeFazio may be correct in the reduction of inequality thesis. Perhaps not in the way he would like though. Such an onerous tax is likely to shift income to other countries from the US. The hegemony of the US in finance may finally be challenged. This may indeed be seen as a generous and globally charitable step for the US Congress to take in reducing inequity by putting America last. Smart? No. Generous? Yes. Perhaps this could help London under hard Brexit conditions. Personally, I'm not sure the planet needs more cigar chuffing bowler hat clad pin-striped suits, nor cliched stereotypes.

A 2010 policy overview by the Institute of Development Studies, "Is a Financial Transaction Tax a Good Idea? A Review of the Evidence", acknowledges that an FTT may increase rather than reduce volatility, as I suggested above,
"...the reductions in market trading and liquidity could result in an increase, rather than a decrease, in volatility"
Though IDS still, foolishly IMHO, suggests a Tobin Tax on Sterling is a good idea. Bah, Humbug.

Why an FTT is a good idea


Should this spectre exist? All of this meandering may lead you to think I'm against an FTT. I'm not. I'm against stupid FTTs.

An FTT may impede efficiency, breed complexity, and push transactions into unintended places, or worse, unintended consequences.

I like the idea of user pays for many aspects of life and governance. If an FTT raises funds to regulate an industry that may not be so bad, right? That is exactly what the somewhat misguided existing FTT on US public equity transactions does right now.

Let's meander over the SEC's FTT.

The SEC is mostly funded by an FTT, or Section 31 Transaction Fees if you want to be formal:
"The SEC does not impose or set any of the fees that investors must pay to their brokers. Instead, under Section 31 of the Securities Exchange Act of 1934, self-regulatory organizations (SROs) -- such as the Financial Industry Regulatory Authority (FINRA) and all of the national securities exchanges -- must pay transaction fees to the SEC based on the volume of securities that are sold on their markets. These fees are designed to recover the costs incurred by the government, including the SEC, for supervising and regulating the securities markets and securities professionals."

The SEC is required to "balance" its FTT to only garnish funds commensurate with its budget. On 22nd May 2018 the SEC's rate dropped to $13.00 per million dollars due to the market's increased turnover. In April 2019 the fee is going up to $20.70 per million dollars. The way it works is the SEC is appropriated a budget by Congress and is expected to raise a similar amount in revenue for the US Treasury. Generally, the SEC raises a lot more than its budget when the fines, ex-restitution, and fees are all taken into account. Don't assume this means it is efficient though ;-)

Here are some extracts from the SEC's "Agency Financial Report, Fiscal Year 2018":

As described further below, the SEC’s finances have several main components:

• An annual appropriation from Congress;
• Securities transaction fees, charged in accordance with Section 31 of the Securities Exchange Act, which offset the agency’s annual appropriation;
• Securities registration, tender offer, and merger fees (also called filing fees), of which $50 million is deposited into the Securities and Exchange Commission Reserve Fund (Reserve Fund) each year. The Reserve Fund may provide resources up to $100 million to pay for SEC expenses, and are not subject to annual appropriation or apportionment;
• Disgorgement and penalties ordered and collected from violators of the securities laws, some of which are then returned to harmed investors and thebalances are transferred to the Treasury; and
• The SEC Investor Protection Fund, which is funded through disgorgement and penalties not distributed to harmed investors, and which is used to make payments to whistleblowers who give tips to aid the SEC’s enforcement efforts in certain circumstances, as well as to cover the expenses of the SEC Office of Inspector General’s (OIG) Employee Suggestion Program.

The report mentions the Section 31 fee decrease:
Section 31 fee revenue increased primarily due to a substantially higher dollar amount of covered sales during FY 2018. As a result of this increased transaction volume, the Section 31 fee rate was reduced from $23.10 to $13.00 per million transacted, effective May 22, 2018.
This is the table of SEC earned revenues:
(click to enlarge)



with Total Budgetary Resources for 2018 being around $2.3 billion:
(click to enlarge)


SEC program costs were $1.8 billion for their year:
"Total Program Costs were $1.8 billion for the year ended September 30, 2018, a decrease of $197 million, or 10 percent, comparedto FY 2017."
The fees are collected by the SEC for Treasury, rather than being owed to the SEC, and this is offset the budget appropriation. That is, "as the collections come in, the appropriated authority is returned to the U.S. Treasury General Fund." A summary of the budget authority versus the Section 31 fees is as follows:
(click to enlarge)
In summary, it is a user pays system in a kind of round-a-bout way. I would argue that it is a bad, antiquated way, but at least it seems somewhat appropriate. When you include the fines the SEC sends to US Treasury, the SEC tends to improve the US Government's coffers quite a bit. SEC regulation raises money for the taxpayer. There is no Wall Street nor LaSalle Street burden on the taxpayer.

It could be a worse situation. States could introduce their own FTT which may reduce their population base and other income by driving out those seemingly unwanted higher income jobs. I'm looking at you Illinois, "Illinois lawmakers make case for financial transactions tax,"
Illinois state Rep. Mary Flowers, D-Chicago, has been the standard bearer for a state-based financial transactions tax for a number of years. She brought Matt Harrington, a self-described financial expert, to explain how the financial transactions tax “could help bring prosperity to our economy.”
Yeah, that'd work just dandy, ya dopes,
"Representatives of the finance industry have warned that such a tax would cause entire markets to leave the state, which they said would be as simple as moving data to servers elsewhere because most trading is done digitally."

It'd be funny if it wasn't real life.

Economic ignorance is not a modern disease. We are yet to find a way to vaccinate our legislators.

A good FTT


In conclusion, I would say I'm not opposed to an FTT to assist in regulating an industry. It's already worked OK for many decades. Not many people even notice.

Size matters. I'm opposed to introducing inefficiencies into a market place. You'll only disadvantage your economy if you try something crazy like the DeFazio/Schatz 0.1% outsized fee ridiculousness. Congress needs a moron tax as a priority it seems.

If I was dictator for a day, after I'd merged the CFTC and SEC, I would proceed to ensure a broad-based FTT funded the balance of the not-so-super agency's appropriations after other fee collections.

It's not just the size of it. It's the way you use it. I'm opposed to private equity transactions, such as Uber share transactions, skipping the fee collection process. Are you? To my simple mind, the fee burden should be commensurate with the regulatory burden. For example, it feels wrong the growing private company sector of the economy doesn't pay its fair share for transactional oversight. The last thing the economy needs is another excuse to prevent Jane Public from having access to equitable equity investments. Congress should worry more about that inequity.

Similarly, other transactions, bilateral or multi-lateral OTCs, such as bonds, fx, swaps, CDOs, CLOs, et cetera could have the light touch of an FTT commensurate with their regulatory burden. Such an FTT would be fairly negligible, virtually zero, given their largely private contractual status. Still, it would be better to look at this as a multilateral exercise, say G20, to navigate the furtive flightiness of such capital ideas. You have to be careful what you wish for.

Even with a zero FTT, the tax flows eventually if you keep the jobs and industry. That ain't so bad.

That is, as a zero FTT results in eventual taxation, you should double down on the carefulness of your thoughts regarding the propensity for an FTT's economic inefficiency to induce both capital and labour flight. A nett reduction in taxation and jobs is not the badge a legislator should aspire to wear for an additional FTT burden. The Swedes have already sacrificed for our edification.

A small and properly targeted tax would have limited impact. Indeed a properly targeted FTT may even have the nett effect of reducing Section 31 fees. A reduction in fees on public market equity transactions with regulations' cost burden fairly shared seems an equitable equity to me.


Happy trading,


--Matt.

____________

PS: SEC Section 31 fees are rising again in April 2019:
"Consequently, each SRO will continue to pay the Commission a rate of $13.00 per million for covered sales occurring on charge dates through April 15, 2019, and a rate of $20.70 per million for covered sales occurring on charge dates on or after April 16, 2019. The fee rate for fiscal year 2019 compares similarly to the fee rates in years prior to 2018. As noted in the last advisory, the lower rate in 2018 was in part the result of a substantially higher dollar amount of covered sales."
Fee Rate Advisory #2 for Fiscal Year 2019

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