As most of Washington spent the end of 2009 focused on health care legislation, some members of Congress were busy floating a misguided proposal aimed at the heart of our financial markets: a new tax on securities transactions.
The populist appeal of such a tax is understandable — it’s easy to score points by bashing Wall Street these days. Yet beyond political posturing, the proposal represents a genuine threat to our still recovering financial system. The negative implications of a transaction tax would ripple throughout the economy, harming average investors and the very companies being counted on to create jobs.
So far the idea is little more than a trial balloon. It should be shot down — quickly.
Give its Congressional authors credit: Their proposal is cleverly packaged, with one iteration entitled the Let Wall Street Pay for the Restoration of Main Street Act. What this bill ignores, however, is that despite the public’s generally low opinion of the financial industry, the connection between Main Street and Wall Street has never been clearer.
Just three decades ago only 20 percent of adult Americans owned stock. Today the figure is more than 50 percent. The democratization of financial markets has been one of the greatest generators of wealth in U.S. history. Markets provide the investment opportunities Americans need to start a business, save for retirement, purchase a home or send their children to college. Imposing a transaction tax would make it more difficult for middle-class families to realize these goals. According to the Investment Company Institute, if a similar transaction tax had been in place last year, the 90 million Americans who own shares in mutual funds would have seen their returns reduced by $48 billion. So really the bill should be dubbed the Let Main Street Pay for Economic Restoration Act.
Assurances that any transaction tax would be refunded for holders of retirement and college savings accounts are not persuasive. The reporting requirements alone — involving millions of trades across tens of thousands of accounts — would add expensive layers of complexity to an already byzantine U.S. tax code. Even if it were possible to allocate tax liabilities for trades within mutual funds, the funds themselves would still have to pay — by slashing returns or raising fees or both. Either way, Main Street, not Wall Street, will bear the burden.
From a macroeconomic standpoint a transaction tax will dramatically increase the cost of capital in the U.S., which will impede economic recovery by deterring investment. Capital is the fuel of the economic growth engine, providing the resources needed to build new plants, invest in new technology and research new drugs — exactly the kind of economic activity we should be encouraging to transform a fragile recovery into one that promotes job growth.
The cost of capital will increase in part because of a widening of spreads between bid and ask prices. Spreads have tightened substantially in recent years, making U.S. markets the most liquid and efficient in the world. Today the average spread on high-volume New York Stock Exchange stocks is less than 10 basis points. The proposed transaction tax is more than 2.5 times this amount and would increase the average spread across all NYSE-listed issues by 50 percent.
Furthermore, a transaction tax would encourage a move by investors to more-opaque trading venues — just as regulators are encouraging the opposite. The tax would also create a powerful incentive for companies to raise capital and list shares overseas, damaging U.S. economic leadership. Already the U.S. share of global equity market capitalization is down significantly owing to the rise of strong markets in other parts of the world.
U.S. political leaders, including House Speaker Nancy Pelosi, have insisted that any transaction tax be coordinated internationally to prevent capital formation from being driven overseas. Following her lead, the European Union’s European Council has called on the International Monetary Fund to consider a global tax on regulated financial transactions. International leaders such as U.K. Prime Minister Gordon Brown and German Chancellor Angela Merkel have also urged governments to join together in implementing the tax. But in reality such a globally coordinated tax is nearly impossible to imagine. Even if the U.S. and the EU were to agree, it is highly doubtful that every country would follow, creating opportunities for regulatory arbitrage.
Last, lawmakers are deceiving themselves in thinking that a transaction tax is an effective way of raising revenue. History indicates that transaction volumes will fall more than supporters of the tax understand, bringing in a lot less money than Congress expects.
In the end the proposed transaction tax isn’t really a Wall Street tax at all — it’s a savings and investment tax that will be paid mostly by individual investors. It’s also a tax that the recovering American economy, the U.S. capital markets and a still-to-be-restored Main Street cannot afford right now.
Duncan Niederauer is chief executive officer of NYSE Euronext.
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