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Specializing in Services Exclusively for Day Traders: Taxes, Accounting and Business Structuring Advice

The "Robin Hood" Tax: Destroying American Investment?

The Robin Hood Tax is a financial transaction tax that is intended to "rob from the rich to give to the poor." This tax is also touted as a means of improving the stock market, reducing speculation, and fixing all manner of social ills. For traders, the institution of a Robin Hood tax would bring a number of negative consequences, but also create some new opportunities.

The latest iteration of the "Robin Hood" tax was introduced to Congress earlier this month under the name H.R. 6411, The Inclusive Prosperity Act [IPA].1

  • Stock transactions would be taxed at .5%.
  • Option transactions would we taxed at .005% on the initial sale/buy of the contract. If the option is then exercised, the resulting transaction would be taxed separately, at the rate of the underlying asset
  • Bond transactions, excepting tax free State & Local bonds, would be taxed at .01%
  • Derivative Financial Instrument transactions would be taxed at .005%.

In the case of any transaction cleared through the broker, the broker would pay the tax. In the case of direct transactions, the tax would be paid by the purchaser, unless the purchaser is a non-U.S. Person, in which case, the seller will pay the tax.

Traders that deal in options would face higher taxes than the average investor. The purchase of an option would be taxed .005%. Then, if the option is exercised, the underlying transaction would also be subject to this tax, resulting in a total tax on the transaction of .505%.

The biggest promise of the IPA is additional tax revenues of $350 billion each year, with the entire cost being born by the investment banks. This is patently absurd. Like every excise tax, the cost will inevitably be passed on to the end consumer. There is nothing in this act to preventing the Banks from passing this cost on to you through higher fees. The greatest damage will be felt by everyone who has a retirement account, with the tax bill compounding as the accounts are rebalanced and reallocated (current third party managed retirement funds generally have 100%+ turnover during the year).

In order to limit the effect of this tax on "lower income" taxpayers, a non-refundable personal credit in the amount of tax paid on these transactions will be allowed. However, this credit is only available to taxpayers with a modified adjusted gross income of less than $50,000 ($75,000 for married taxpayers filing jointly).

High-speed, high volume, computer driven trading has been identified as a primary target of this legislation. This type of trading has been singled out by the supporters of this tax as being little more than "churning" in order to generate fees. Tax proponents also point to several recent mini-crashes caused by these flash traders as evidence of their toxic effect on the market. A Robin Hood tax would effectively make this type of trade infinitely expensive, eliminating it from the marketplace.

The elimination of flash trading would stop the constant stock price rebalancing occurring as a result of flash trades. This would decrease market efficiency, reduce the symmetry of information, and increase the price impact of all market transactions. This happens because the elimination of flash trading will reduce daily trading volume, leading to lower price volatility. Market liquidity would decrease as a result of the volume decrease. This liquidity decrease, when coupled with the elimination of the constant stock price adjustments that were provided by these high volume trades, would lead to an increase in stock price volatility. This would make long-term holding strategies much less attractive in comparison to speculative trading, the exact opposite of the intended effect of this tax.

The American Financial industry would be severely reduced. Unless this tax was adopted on a global basis, increasing the cost of making trades in America would simply drive the investment abroad. In addition, if an American citizen were to purchase or sell stock through a foreign investment bank, the individual would be the one required to pay the tax. Investment banks would leave America for more tax advantaged countries, an especially worrisome scenario when you consider that investment makes up about 20% of America's GDP. This would have the additional effect of reducing the amount of revenue that could be collected by this tax.

Taxes of this type have been tried before. Sweden implemented a .5% financial transaction tax in 1984. Over the next six years, 60% of the eleven most commonly traded Swedish shares and over 50% of Swedish equities had moved to London. There is every reason to expect that the imposition of our own Robin Hood tax would result in a similar exodus from the American Financial sector.

A Robin Hood tax would also be harmful to America's economy as a whole. Increasing the expense of selling stock would make it correspondingly more expensive for companies to raise additional capital through the sale of financial instruments. This would have a negative effect on growth. The IPA does except initial issuances of financial instruments from the tax, which would hopefully mitigate this proposed taxes negative impact on growth.

When looked at as a whole, this tax burden would be passed on to individual investors, drive American investment abroad, decrease returns on retirement holdings, decrease American GDP, and increase stock market volatility. On the flip side, the increase in price volatility would create many opportunities for the savvy day trader to turn a profit, even with the added transactional cost. Proponents of the law hope to steal from the rich to give to the poor, instead they have crafted a tax that would severely damage the American financial sector and give almost nothing to the poor.

1 H.R. 6411, 12th Cong. (2012)(Introduced Sep 14, 2012)