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posted on 17 September 2016

This Is The One Place Where We Actually Need More Taxes

by Michael E. Lewitt

Special Report from Money Morning

I'm all for radical tax reform: getting rid of tax deductions, ending estate taxes, and most of all, drastically lowering income and corporate tax rates. Read this if you don't believe me.

But there's one section of the economy where we need more taxes.

This is it.

We Need a "Sin Tax"... on Derivatives

Toward the end of 2009, proposals were floated in Congress to impose a modest tax on certain types of securities transactions. One proposed piece of legislation, titled "Let Wall Street Pay for the Restoration of Main Street," would have imposed a 0.25% tax on the sale and purchase of stocks, options, derivatives, and futures contracts. Wall Street is unalterably opposed to any such tax, but it is a good idea for a number of reasons:

  • Tax policy should be used to create the proper types of economic incentives and to discourage types of behavior that damage the economic system and society at large. One of the indisputable lessons of the 2008 financial crisis is that far too much capital is being devoted to speculation and far too little is being channeled to productive investments. Increasing the cost of speculation is a logical and economically efficient way of discouraging unproductive activities.

  • The U.S. government is running unsustainable deficits and is desperately in need of revenue. In addition to ending egregious tax breaks for financial interests such as the "carried interest tax" on private-equity profits and permitting hedge fund billionaires to defer their taxes for periods of as long as 10 years (a boondoggle that was finally terminated), the government should be raising revenue from socially unproductive activities. The financial industry can easily afford to pay a tax on its speculative activities. Moreover, a significant amount of securities trading today is not for the purpose of providing growth capital for corporations but is merely done to churn financial profits. By 2015, approximately 75% of daily trading activity had nothing to do with fundamental investing but was instead tied to high-frequency trading and exchange-traded fund (ETF) trading strategies that contribute little to capital formation or the productive capacity of the economy. Accordingly, a tax on these activities would be a perfectly reasonable and economically harmless way to raise revenue.

Transactions such as credit default swaps and leveraged buyouts and recapitalizations have extremely wide profit margins built into them by Wall Street dealers and can easily bear the type of tax proposed here. As someone who has worked in these markets for more than two decades, I can assure readers that Wall Street arguments to the contrary are both self-serving and false. One of the points of such a tax would be to make Wall Street firms and their clients think twice about engaging in speculative activities that contribute nothing positive to society, and force them to give something back economically if they are hell-bent on engaging in such activities.

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Rather than a flat 0.25% tax on securities trading, I would propose a sliding-scale tax rate applied to the face amount of the following types of transactions:

  • Naked credit default swaps if they are not banned entirely (1.25% tax)

  • Debt and preferred stock issued in leveraged buyouts, leveraged recapitalizations, or debt financings used to pay dividends to leveraged buyout sponsors (0.60%)

  • Quantitative trading strategies (0.35%)

  • Equity derivatives (options, futures contracts) (0.25%)

  • Large block trades (0.25%)

  • All other stock, bond, and bank loan trades (0.15%)

Coupled with other measures aimed at reducing systemic risk (i.e., increasing capital adequacy at financial institutions, increasing collateral requirements, and imposing listing requirements for credit default swap trades, and so on), such a tax would impose a cost on activities that add little in the way of productive capacity to the economy and increase systemic instability. Obviously any such tax would have to include provisions to prevent forum shopping so investors and traders could not avoid the tax by moving their activities abroad.

Such a tax regime would also contribute to the progressivity of our tax system by asking those who benefit the most from our economy to pay a little more in the way of taxes. The tax should not be imposed on stock, bond, and bank loan investments in retirement accounts under $1 million in size (IRAs, 401(k)s, etc.).

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