In a widely-circulated NY Times column (Jan 13, 2009), Bob Herbert proposes a 0.25% transaction tax on every stock trade. If this idea, which has been garnering support among politicians, passes into law, it will mark another devastating — perhaps fatal — blow to our public markets.
To appreciate what’s at stake, consider that public markets give companies easy access to a wide pool of investors from whom to raise capital. Simultaneously, they offer investors the ability to choose among thousands of opportunities to invest their savings. Public markets thus allow investors to efficiently allocate their capital to the most productive enterprises, fostering increased productivity and economic activity. Indeed it’s no exaggeration to say that America’s vibrant public markets played a significant role in her economic ascendance.
Yet public markets have been subject to mounting taxes and regulations for decades, reaching new heights with Bush’s passage of the sweeping Sarbanes Oxley bill (Sarbox). Instead of relying on existing laws, e.g. those against fraud used to prosecute Enron, Sarbanes Oxley sought to police public companies regardless of wrong-doing, operating on the unjust idea that corporations are guilty until proven innocent. Notably, Sarbanes Oxley made corporate leaders responsible for any errors or fraud committed within their companies, whether or not they knew of them; mandated onerous new annual audits; and turned corporate malfeasance into criminal offenses with penalties surpassing those for assault and other life-threatening crimes.
The results were predictable. Citing increased costs, a demotivating level of mistrust, and the desire to concentrate on customers rather than paperwork, many public firms went private, and many foreign firms listed elsewhere. Smaller firms, who could least bear the regulatory costs, delisted in droves; and the number of companies opting to go public dropped precipitously, from 250+ per year prior to Sarbanes Oxley, to only 6 last year.
So Sarbanes Oxley clearly puts public companies at a competitive disadvantage to their private counterparts. Yet public markets offer one benefit to mitigate these drawbacks: ample liquidity. Shareholders can increase or decrease their holdings whenever their circumstances warrant, and companies can easily raise additional capital.
Liquidity is a measure of the number of buyers and sellers of a stock. But even in public markets, liquidity isn’t automatic. Rather, it’s created by speculators, market-makers, hedge funds and other active traders who buy and sell stocks on a very frequent basis, trying to capture small price discrepancies with their trades. Typically their profits on any given trade are minimal, say less than 0.1% on average per transaction, but by doing hundreds of them each day, these traders can make money on the sheer volume of their activity.
The proposed transaction tax would eliminate the majority of short term trading, causing market liquidity to vanish — and with it, the one remaining advantage of being public. As such, it threatens to finish the destruction Sarbanes Oxley started, ultimately eviscerating the public markets.
Ironically, those whom regulators and legislators claim to be protecting, viz. small investors, are among those most aggrieved by this destruction. For public markets — where it’s possible to buy a single share of a company — are among the few financial venues in which those with limited capital can participate and grow.
Thus the assault on public markets — by preventing enterprising small businessmen from growing via IPO, and by eliminating a critical venue for astute small investors to build their wealth — has the effect of entrenching the status quo. No longer is it possible for the talented newcomer, whether businessman or investor, to climb the economic ladder.
But it doesn’t have to be this way. Historically an important moral appeal of laissez-faire capitalism was that it allowed social and economic mobility according to effort and ability. If we return to it, those virtues will once again prevail. Rejecting the proposed transaction tax — and the whole assault on our public markets — may be a fitting place to begin.