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My Comments on the Trader Tax

There is a bill being drafted by Representatives DeFazio (Ore.) and Perlmutter (Colo.) called the ""Let Wall Street Pay for the Restoration of Main Street Act." This legislation would charge a percentage tax to help fund the cost of the Bailouts in 2008. At first glance, this seems like a knee jerk populist reaction, akin to limiting pay for a certain unsavory bunch of suits.

I'm going to step through several points in which any reasonable citizen will see the lack of logic and morality behind the bill. As I am a speculator by profession, I would like to note that I do have a bias regarding this legislation, but the points remain solid regardless.

The Legislation is Not implementable

There are entirely too many problems with a 0.25 percent tax. 0.25 percent of what? If you're trading futures, odds are you are on a margined account, and if you are playing short term you only need a small amount of capital available. So do we charge a tax on the face value of the future, or only on the margin borrowed?

What about market makers, who in the option market exist to facilitate trade? Do they receive an exemption to this rule so that they may help larger funds manage risk? By adding a tax, it would remove that incentive, and firms may be exposed to even more risk by not having the ability to transfer it to a different party.

The legislation also plans to exempt retirement accounts and pensions. Define "pension."

Also, how will you actually execute this plan? Will you monitor all exchanges, even offshore exchanges? What about US citizens that trade on the ASX or the TSE? There are privacy and international regulations to deal with now.

As you can see just from a few questions that the technical feasibility of this plan strikes a large blow against it.

This Legislation Removes Liquidity

There are always two sides to a trade. Aside from the transfer of capital, we also have the transfer of risk. That is an important part of the equation to the financial markets that many miss. The markets exist to transfer risk from one party to another for a particular premium. When markets are liquid, you can get a fair trade to transfer that risk.

If this tax is implemented, then liquidity will be sucked out of the system. If there is no liquidity, spreads will open up, and firms in "the long run" will get poorer fills. Yes, this also includes your retirement and pension funds with which the congressman perceive to have higher value.

Also, you have transition firms, who exist solely to get their customers (pensions) good fills on large positions. They do that by trading in and out of futures and baskets of stocks to help hedge against market risk when entering these trades. These firms would no longer have an incentive (unless they had a deal with the Government) to be in business.

The Underlying Blame Implied by this Legislation is False

There is an assumption underrunning the bill: that since the players in the financial markets caused the crash and then have to be bailed out, then they should help to pay for it.

This is categorically false. Ideally, if there were firms that took on too much risk, then they would go bankrupt. Obviously this didn't happen, and the loans from the government came with certain attatchments. That does not mean all firms should subsidize the folly of the few.

But if we are to continue on this track, then we should also create a tax for other transactions that helped bring us to where we are. For example, a national sales tax could be levied on home sales to help subsidize the losses seen from subprime. Clearly the speculators in the housing market that drove up home prices should help pay back, so it seems reasonable, right? Yes, the analogy holds.

We could also look at some other entities. Perhaps there should be an extra surcharge for profits generated by FNM and FRE. Since they helped to subsidize the credit crisis, then they should help to pay us back.

Yes, I'm going to keep going. Since the carry trade in the forex markets helped to exacerbate the problem, the US could forcibly widen the bid/ask spread in the market and they keep a portion of the spread. Since the carry trade unwinding helped to cause this mess, then clearly we should have currency speculators pay for this.

And finally, we have the Federal Reserve. The low interest rates artifically forced on the markets by the Fed caused firms to chase risk, make bad decisions, and blow up the credit bubble to extraordinary proportions. Therefore I propose a tax on any profits that the central banking system makes should help to subsidize the losses that the American people suffered in this crisis.

As you can see from the past few examples, it's populist bullshit and not founded on reason.

The Legislation is Immoral

But this is where the point hits home for me. The bill makes the assumption that the players in the financial system do not provide value to the economy and society, so it only makes sense to help them clean up the mess they made.

Whether trading creates societal value is not the point here. The point here is that you have a few men deciding what is valuable to a larger group of people and imposing their will through financial strongarming in their position. This is wrong, immoral, and unconscionable that this premise could even be brought up in our country.

Since this is only a draft, there is not much to be done. But if it makes it to any committee or the floor, please call your congressman and tell them to vote against this legislation.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/