Alternative Taxation (bit of a funny read)

Discussion in 'Economics' started by Chagi, Sep 24, 2005.

  1. Chagi


    I'm doing a bit of research right now, trying to dig up how taxation of futures trading works in Canada, and I bumped into an amusing write-up that I thought I would share.

    For those that aren't familiar with Canadian politics, the "Green Party" is relatively newer on the scene, haven't yet won a significant number of seats federally, so not really a political "force" as of yet.

    I should also mention for background purposes that in Canada we receive a 50% capital gains tax credit unless someone trades stocks as a full-time business. So if I realize a $1000 gain from buying then selling a stock, only $500 of it is taxed.

    Speculation and Taxation

    Issue: Speculation, inflation, taxation

    Speculative activity in financial markets has been often associated with negative social impacts. The nature of speculation is that no new wealth is created, but yet it absorbs substantial social and economc resources. The value speculators provide in a market economy is that they absorb risk and provide liquidity in the marketplace (for a chance at making gobs of money) but how much speculation is too much? Speculative activies contribute to economic bubbles and stock market crashes, currency traders have economically destabilized whole regions as in the 1997 Asian Financial Crisis. In the event of these destabilizations it is inevitably the poor who suffer most. Labor Economist Jim Stanford argued in his book Paper Boom that tax regulations that favor financial speculation over "real" investments in factories and equipment have undermined Canada's (and the world's) economy.

    see wikipedia:speculation

    AIMS reviews "Paper Boom"
    TWN reviews "Paper Boom"

    Speculation also fuels inflation? (this is unlikely in the long run)

    Alternative # 1 - adopt a sliding scale over time for a capital gains tax

    REPLACE the existing 50% capital gains exemption with a
    sliding scale based on how long the capital asset had been owned. So for any purely speculative trade of stock, real estate, currency or whatever that was held for only a month before reselling, the exemption would be
    0%, i.e. the entire gain would be taxed as income. For a true investment where the asset is held for 25 years or more, the exemption would be 100% - none of the gain taxed.

    Argument - Doug's initial comments
    Here is an idea to modify the capital gains tax in order to bring all speculators to heel.

    Speculators, including currency traders, make gobs of money without doing any productive labour. (LOL) Currency speculators, in particular, can destabilize currency relationships and are the parasites of international money markets.

    I think most people would agree that speculation is bad, whether it is currency, the stock market, real estate or even fine art. They drive prices up without adding any real value. One can argue that they lose when prices come down but in reality, the losers are the poor suckers that get drawn into these markets without really knowing what they're getting into. For every dollar that a speculator makes, somebody else loses a dollar. The people who make a living out of speculation have the timing down to a fine art and many of the big players have the financial clout to make the markets dance to their tune.

    Speculation also fuels inflation (other factors cause inflation but rapid inflation in a free market economy is driven by speculators). When markets contract, once again it is fuelled by speculators dumping their overpriced portfolios at below cost.

    Canada encourages speculation by including only 50% of the capital gain as income. (The other 50% is tax free.) The argument for this is that it encourages investment, whether in the stock market, small businesses or farms - all very worthwhile reasons.

    But there is a difference between speculation and investment, and in any particular situation none of us would have any problem telling one from the other. However writing an all-inclusive definition is more difficult.

    While not perfect, the easiest distinction is the time that an asset is held. We can be pretty certain that buying and selling stocks within a few hours is certainly not investment nor is reselling a house before the initial purchase has even closed. These blatantly speculative transactions should be taxed at 100% in order to take all the profit out of it. (Note that I'm proposing that such short term profits are added to actual tax payable rather than to taxable income.)

    I would propose that this formula would apply to any asset ownership of less than a month. Beyond a month there would be a sliding scale starting with 100% of the gain added to income down to 0% for an asset that's been held for 25 years or so.

    Obviously if there are no profits in short-term trading, it would disappear. True long-term investment would be encouraged by a better-than-current tax treatment and farmers and small businesses get the tax treatment they need as well.

    There might need to be some exemptions to this (short term trading in some commodity markets does serve a useful function - there are probably other examples as well) but on the whole I like to keep things simple. The fewer exemptions and regulations, the fewer bureaucrats you have to pay. Wouldn't it be nice to have a tax system that legitimate business people were not afraid of?

    A sidelight to this is that it should help alleviate economic disparities to some degree. At the top end, a lot of the income of the very wealthy comes from speculation, and at the middle level we would be protecting poor suckers from themselves - the ones that get drawn into 'hot' markets just before they fall, leaving them holding the bag. (Instead of gambling on stocks they can invest in lottery tickets in which case we know that 50% is going into public coffers.) (*rolls eyes*)
    And it would eliminate one of the main drivers of inflation.

    One result would be that speculation would move offshore and I'm not equipped to guess the impacts of that. But speculation is a worldwide problem and if Canada did it, other countries might follow suit.

    A second impact would be that the brokerage industry would be decimated. (I once tried to find out if anybody had ever tracked stock market buys to see how long, on average, assets were being held but nobody had any answers - I would guess that at least 90% of the brokerage business is speculative.) Stock markets could get back to their original intent of bringing potential investors in contact with businesses needing capital.
  2. Chagi


    Roy's Comments
    currency trading has been targeted primarily because currency trading is "speculative", "volatile" and therefore poses "market shocks" to our economy. therefore, the following arguements are presented to counter these points.
    Foreign currency market (also know as the forex market) is by far the largest (volume) and most liquid financial market in the world. comparing to the products that can be traded against stocks (thousands in NYSE alone), futures and options (hundreds in CBOT alone), one would see that forex (tens) has the fewest products. for those 2 reasons, forex products have the biggest volume (sample size) and thus their variation is the lowest of them all. Indeed, the average daily move of any major currency is less than 1%. whereas even blue chip companies in canada vary more than 2% daily. For instance, on 19th oct 2004, the price differentials of Manual Life is >5%, Great West Life ~ 3%, Sunlife is 3.7%, Bank of Nova Scotia is another 3%. On top of all this, Canadian stocks are considered quiet since there isn't much commericial activities in the country.
    In addition, since currency is 24 hour trading. and i do not mean eletronic trading. eletronic trading after hours create more volatility. So, if volatility is of concern, banning e-trading may be a good idea. Because the stock market and other exchange-traded markets only have a percentage of the volume of the currency market, these investors run a greater risk of having wide dealing spreads or large price fluctuations while trading.
    Since there is so much volume, there is a huge liquidity. This provides investors to opt out if things go bad. In fact stocks are required to have > 25kUSD for day trading, else the number of daily transactions are limited. You think that is to limit volatity? That is to limit the ability of the small guys to get out the market if bad things happen.
    Since the spreads is a lot thinner in forex than in stocks, that also limits volatity. the smallest variation from a currency product is at the 4th decimal, whereas stocks usually vary by the penny (2nd).
    Under certain price conditions, the number and types of transactions that a futures trader can make are limited. The futures market restricts a trader from initiating new positions and only liquidating existing ones, if the price of a specific currency rises or falls beyond a specific predetermined daily level. This is an artificial way to control daily price volatility. This mechanism is meant to control daily price volatility, but since the futures currency market follows the spot currency market anyway, the next day the futures price can gap up or gap down to readjust to the spot price. In the foreign currency spot market these artificial restrictions are nonexistent, so the trader can trade freely without limitations, applying his trading strategy with stop losses to protect himself from unexpected price fluctuations caused by high volatility.
    There are no restrictions to sell currencies short, unlike stocks which have to be sold short on an Uptick rule. This means that with currency trading you can make money just as easily in rising and falling markets. This advantages is especially attractive to currency day traders who want might want to sell a currency short quickly, without any possibility of the trade being delayed by artificial means.
    All of these advantages make currency trading less speculative to stock and futures trading in many ways.

    Having time depedent tax structure will punish people who need to opt out when bad things happen. and bad things happen without telling you that it is about to happen. it will dry up volume since the product is already discouraged from being traded. this will make the price more volatile since the sample size is now smaller. the product will also become riskier since the product has few transaction to demontrate its market price and has less liquidity. so, having such a structure does not only defeats its own purpose, but also creates the problem it intends to fix but did not exist.

    Doug's response
    An interesting analysis - it is apparent that there is already a lot of regulation in speculative trading but I'm not sure what impact it has. It may protect small players from their own foolishness but it doesn't seem to slow down any of the bigger players.

    'Speculation' serves 2 functions - 1) absorption of risk and 2) liquidity.

    1- Risk: When economists talk about absorption of risk they are talking about the inherent risk of the asset (e.g. that the business's sales will go up or down, or the CEO has a heart attack, or whatever.) Traders who buy and sell in short time frames are not accepting any of that inherent risk. In fact when they bail out 'when bad things happen', they are clearly speculators - they are dumping the risk onto others. The only risk they are willing to assume is the risk that other traders will force the value of their stock down - the very same risk that a gambler takes - that he may lose the money he puts in. True corporate risk is increasingly being absorbed by investors operating outside the stock markets such as venture capitalists and large institutional traders to whom the markets are largely irrelevant.

    2 - Liquidity: - If I want to sell something in the open market, adequate liquidity is achieved if there are enough buyers available to establish a 'market' and I can sell within a reasonable time frame. Liquidity does not require that I can sell within 10 milliseconds. (Indeed in the fine art market it can take months to sell a piece by auction and there is still considered to be good liquidity.) How many traders does it take to establish liquidity? Probably not very many - certainly only a tiny fraction of the number of traders in the market currently.

    Alternative # 2 - Only a five year threshold

    Any asset that is sold after being held for
    a minimum of 5 years will recieve 10% tax
    credit if treated as capital gains, or 20% tax credit if treated as income.
    Further in the case of real estate, if it was improved in ways not always valued
    by the market like reforestation, habitat restoration, energy efficiency or other similar measure, then the amounts spend on this are treated as deductible from
    income or capital gain.
    Or for stocks, any sale of an ethical fund, or stock meeting a certain ethical
    criteria could have an additional tax incetive.

    Argument - Chris' comments
    If your ongoing buisiness is making speculative gains on property, then revenue
    canada treats this as regular income, not
    capital gains. for example someone regularly buys real estate and resels it in
    short term, they will have to treat this as
    regular income. So the favourable capital gains treatment does not affect this,
    and different kind of incentive is needed.

    Doug's Comment: Does anyone have any statistics or even hunches as to how often Revenue Canada does this?

    Roy's Comment: Revenue Canada does it very year. If it pleases you, you may consider participating at the following item that affects a much bigger population of Canada and eases income equality much more effectivelyproperty, investment and taxation

    So for most individuals their capital gains that would be treated favourably
    would be investments in real property ie(rental,
    cottage), stock or mutual fund investment (so long as it is not sheltered in an

    You need to also note that there is no tax on the capital gains tax at all on
    peoples main residence.

    So if we ignore for the time being international currency markets, then the
    problem should be looked at controlling speculation on real estate and stocks.

    What is speculation? Basically it is gambling. Guessing that you can buy
    something, on the gamble that market conditions
    will change in some way to significantly add value to the asset.
    Basically it is intelligent investment. Guessing that you can anticipate better
    than the market as a whole, you can buy an
    asset guessing that you have read the market trend ahead of the rest.

    Doug's Comment: The moment you mention market trends and timing you leave the world of investment and enter the world of speculation. A true investor is interested in the inherent value of the asset.

    Roy's Answer
    I do not know if I have mentioned to you this before:
    every investment IS speculation.

    even when you are putting money in your saving account AND you do not intend to make it an investment, you are making a speculation about the value of that money.

    If you want to counter this argument by saying that there is that 60k bank insurance, it is still a speculation. you are speculating the future value of the money grows slower than the bank interest rate.

    even when you are putting money in your wallet as cash, you are still making a speculation. whenever the money is not in consumption, a speculation decision has been made. the people who do not speculate are the ones who completely spend all their money in durable goods and non-appreciative assets (i.e. cars). a primary residence purchase is a speculation if you intend to pass it along for someone else's consumption (your children or spouse or donation to charity).
  3. Chagi


    Chris' Respons What is the inherent value? This is difficult to asses. Often what people value things at now does not represent the full value, because people are not fully aware of the value. For instance the cost of cod before the collapse of the east coast fishery would have been higher if everybody realized that the stock was about to be depleted to near extinction.
    Equally if inner city neighbourhoods in many areas were for long periods undervalued because of peoples obsession with the subburbs, and government subsidies for building them, does that mean that someone who bought a home in an innercity neighbourhood in the 1970's was speculating, or investing in something they saw value in. And then 20 years later everyone realized what they had been missing. I think that is why I start to agree with others that suggest this line of policy is a no go. Because it is difficult to reasonably define what is true speculation, and what types of speculation cause damage.
    However, I do feel that short term speculation does re-enforce a short term world view. Which goes against the principals of a sustainable economy.

    I would argue that in of itself speculation is not bad, and part of intelligent
    investment is to try and see the value in something
    before everyone else catches on.

    However, speculation often encourages short term thinking for quick gains. If we want to encourage people to take a long term perspective on the environment, and society, then tax policy should be tailored to discourage short term speculative behaviour.

    So what kind of incentive could we put for people to hold assets for longer
    periods. And ideally tie this in with other policy
    goals like land stewardship, affordable/sustainable housing, ethical investment criteria.