Financial service industry needs to pull its weight in budget crisis

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A lot of taxes have been proposed lately – sales taxes, property taxes, income taxes – as the state’s budget stalemate grinds on and the city’s financial crisis metastasizes.

But the powers that be have taken one tax off the table, a financial transaction tax. It would target the very wealthy – the only ones in recent decades benefiting from economic growth.

A small tax on trades on Chicago’s futures exchanges could raise billions of dollars, and traditional traders wouldn’t even notice it, proponents say in a new report.

“Is a farmer or a pension fund manager going to walk away from a $50,000 contract because of a fee that’s the price of a cup of coffee?” asks Ron Baiman of the Chicago Political Economy Group, which has advocated for a financial transaction tax for several years.

The group that would feel the pain would be high-frequency traders, who use computer algorithms to do hundreds of trades in a fraction of a second, inserting themselves between buyer and seller in order to extract a tiny profit, sometimes using fake orders to drive prices up or down to their advantage. They often make less than $1 on a deal, but they make up for it with massive volume.

Some use the term “high-frequency trading” as a synonym for computerized trading, but CPEG is talking about a significant subset of traders, which they characterize as “rogue gamblers who are engaged in rigged and illegal trading strategies to enrich themselves at the expense of non-HFT traders.”

“On balance HFT firms take rather than provide liquidity” (which is the ability of an investor to buy or sell in a market at a desired price) and their activity “is fundamentally detrimental to the broader economy,” according to the CPEG report.

As a paper from business professors at the University of Chicago puts it, high-frequency trading produces “arbitrage rents” that “harm liquidity provision.”

And, Baiman says, if a financial transaction tax ended up suppressing high-frequency trading, regular traders could well come out ahead. The small fee would be more than offset by eliminating the losses they now experience to high-frequency traders, which amount to many billions of dollars.

But the exchanges seem to be committed to protecting the high-speed guys – and the exchanges’ own profits from the transaction and high-speed data access fees the traders pay­ – at the expense of their traditional customers.

CPEG has proposed a fee of $1 on agricultural futures contracts (which average about $73,000 in value) and $2 on other contracts (which average $335,000) at the Chicago Mercantile Exchange, Chicago Board of Trade and Chicago Board of Options Exchange. CME Group owns the Merc and CBOT.

That’s about a 0.00038 percent levy on the $937 trillion traded every year on the exchanges, and it would be paid by traders, not the exchanges. Compare that to the 6.25 percent sales tax the state charges for other kinds of purchases.

Levying this minimal fee on the millions of contracts executed in Chicago exchanges every year would raise $10 billion to $12 billion for the state, the group says. (They’ve also proposed that a portion be set aside for the city’s budget.)

That’s nearly twice as much as the state’s sales tax brings in. “This is an emergency situation for the state and city,” Baiman said. “And this is the answer.”

Mayor Emanuel, a former CME board member, has rejected the idea, and the Chicago Sun-Times has called it a “fairy tale,” saying it could drive trading out of Chicago exchanges, and perhaps even drive Chicago exchanges themselves to leave town.

For those who are worried that a $2 fee is going to drive trading elsewhere, the Electronic Liquidity Exchange provides a test case that suggests otherwise.

Would the exchanges move? Not likely. It would cost CME too much financially and politically since the only purpose for the move would be to protect high-speed traders and the exchanges’ profits from high-speed transactions that hurt traditional investors.

High-speed trading has come under increasing scrutiny in the past year, from the FBI and the U.S. Attorney’s office in Chicago.

Some traditional investors are concerned too, judging by a lawsuit filed last year charging CME with fraud.

CME’s federal regulator, the Commodity Futures Trading Commission, has said CME lacks sufficient enforcement staff. Earlier this year a major trading firm went to court, complaining that CME had failed to take action in 7,000 instances of price manipulation by high-speed traders that had cost the firm a half-million dollars.

A financial transaction tax could accomplish what regulators can’t, Baiman said. “These exchanges are really rotten, they’re not cleaning up their act, they have no incentive to do so as long as they’re making all this money,” he said. “The FTT is a way for the public to come in and say, you’ve got to have an honest exchange.”

But if that’s too large a goal for our political leaders (many of whom have gotten large contributions from the state’s leading high-frequency trader), he offers a compromise. The tax could be tiered based on holding time. For example, traders holding a contract for less than one minute could be charged 10 cents, with the rate rising as the holding period increases. That would still raise well over $6 billion at a minimum, he estimates. And the exchanges would still have their megaprofits.

Our public budgets are imploding because our revenue system doesn’t keep up with inflation. That’s because we disproportionately tax folks at the lower end, whose earnings have fallen behind.

The financial services industry is the most profitable sector of the state’s economy.  It’s not pulling its weight. It’s got to share the sacrifice.

And it ought to stop hiding behind high-sounding rhetoric while it’s raking in profits from unscrupulous activity.

Photo illustration: Taxes lettering/Shutterstock image

  • Richard Duran

    First of all, neither you nor CPEG know what they are talking about. The comments about HFT and a “subset of rogue traders is absurd. So too is the liquidity argument. A “group of professors” at the U of C can be countered by numerous professors at the same school and countless others. The notional value of a futures contract to measure the impact of a transaction tax is also pointless and clueless.

    As an analogy: assume Lake County decided to do away with sales tax on retail purchases of all kinds. Every person able would shop there. The same holds true for futures trades. London, Singapore, Dubai, Zurich and others do not charge transaction taxes. Since 95% of all trades are electronic! the migration to other exchanges would happen in a matter of days.

  • Curtis Black

    More here (including details on migration of electronic trades) – http://bit.ly/1k5Vrmr

  • Curtis Black

    Also – more details on HFT and fraud – http://bit.ly/1k5Vrmr