Taxing Trades Called A Bad Idea

(Dow Jones) While it is hard to resist the name of a new bill that would tax stock trades, tax analysts say legislators would be smart to resist making it law.

The "Let Wall Street Pay for the Restoration of Main Street Act of 2009" was introduced Thursday by U.S. Reps Ed Perlmutter (D., Colo) and Peter DeFazio (D., Ore) and would tax financial transactions by large banks and other financial institutions. It would affect trades of stocks, futures, swaps, credit default swaps and options.

The lawmakers sounded a populist note, saying the tax would be "first and foremost" to pay down national debt. Perlmutter sees it as a brake on "casino-like gambling of the largest Wall Street financial institutions engaged in excessive speculation, high-volume short-term trading."

Tax analyst Bob Willens sees it as an attempt to put a sales tax on trading, and simply a bad idea. The reason: Investors would look for ways around it, which would disrupt markets.

Kenneth E. Bentsen, executive vice president, public policy and advocacy at the Securities Industry and Financial Markets Association, said the tax would likely result in a stalling of the stock market.

The idea of such a tax isn't unusual. Ameek Ashok Ponda, a partner in the Boston office of law firm Sullivan & Worcester LLP, and an adjunct professor in Boston University's Graduate Tax Program, says proposals for others like it "get kicked around a lot."

Nobel laureate James Tobin, for example, proposed a tax to be levied on currency trades. Britain and many of its former colonies have so-called stamp taxes, which are essentially transactional taxes. Opposition to stamp taxes helped trigger the American Revolution.

The U.S. itself had a similar tax: The Revenue Act of 1914 imposed a 0.2% levy on all sales or transfers of stock. In 1932, Congress more than doubled the tax, to 0.4%, to help overcome budgetary challenges during the Great Depression and World War II. The tax was in place until 1966.

One idea behind such transaction taxes is to create a counterbalance to the effects of cheaper and more frequent trading caused by improved technology, according to Ponda. Most economists like it when transaction costs go down, saying this improves markets by matching counterparties at ever lower costs. But some think declining costs encourage speculators to make big bets more cheaply.

For his part, Ponda says he doesn't like this kind of tax.

"I think it is a hard tax to administer and police, because it is tough to draw the lines in the right places," he says. The tax could drive transactional trading offshore, and help foreign financial centers eclipse American ones, he added.

The bottom line, according to Ponda: Tax laws are too crude an instrument to go after harmful speculation while leaving beneficial transactions alone.