And I was stupid enough to vote for this communist: Market makers face dimmer futures, options under Obama tax proposal Comments June 2, 2009 BY STEVE HUNTLEY The Obama administration is aiming a tax increase at a signature Chicago institution -- the futures and options markets. President Obama's budget would repeal tax treatment for commodities and options dealers won by Dan Rostenkowski in 1981 when he headed the House Ways and Means Committee. The goal then was to help out the "market makers" who invigorate the futures and options exchanges that allow farmers, businesses and investors to hedge their risks on all manner of commodities, ranging from wheat crops to stocks. Repealing that tax treatment would be "messing with something that has worked for 25 years and worked well during the worst financial decline in 80 years," warns William J. Brodsky, chairman of the Chicago Board Options Exchange. The so-called 60-40 tax lets traders pay a 15 percent capital gains tax rate on the first 60 cents of a dollar and ordinary income taxes on the rest. It was designed to compensate traders who under revised market regulation became subject at year's end to taxes on paper profits that could evaporate Jan. 2. The blended tax yields a top marginal rate of 23 percent. Obama's tax proposals hit traders with a double whammy, since the administration wants to raise the top income tax rate to 39.6 percent -- a combined tax surge of nearly 17 percent. The tax hike targets proprietary trading firms, men and women who invest their own money in markets like the CBOE and the old Chicago Board of Trade and Chicago Mercantile Exchange now combined in the CME Group. Proprietary traders are 21st century versions of the "locals," traders wearing colored jackets and name tags whom you've seen in TV images gesturing and shouting in the noisy frenzy of trading pits. Arrival of electronic trading sent savvy traders migrating to computer screens in offices still located in Chicago's financial district. Individual traders formed partnerships to pool expertise in the various markets. They hired math and computer wizards to write software to analyze and trade futures at mind-boggling speeds. "A trader's edge comes from being a few microseconds faster than the next guy," says one insider. In seeking profit by making lots of trades daily, they operate on razor-thin margins, so taxes matter big time for them. While the purpose of the stock market is to raise capital for business, the futures and options markets are about managing risk. For example, a farmer at planting time will try to lock in a price for his crop at harvest time by buying a futures contract. The CBOE offers the same benefit for hedging the risk of buying stocks. The vital service traders provide is to give markets liquidity -- ensuring plenty of willing buyers and sellers exist to keep the exchanges active, thereby supporting farmers and stock holders hedging their risks. More liquidity means higher volume, which lowers trading costs. Proprietary traders account for a third of the CME's business volume -- hence the term "market makers." They're crucial to regulated markets like the CBOE and to the general economy in hard times. Says Brodsky, "If options markets don't provide liquidity, people may be less willing to own stocks because they can't hedge them efficiently." The tax treatment Rostenkowski got for the industry showed "government recognized that the risk management of futures trading attracts capital from around the world," says Jeffrey Carter, a futures trader for more than two decades. "It's a volatile business, and nine out of 10 traders don't make it." Now the Obama administration says there's no reason to treat commodity and options traders differently than anyone else. Futures trading is an arcane business, and I won't pretend to comprehend all the implications of this tax change. But clearly if you make an enterprise less profitable, people do less of it, especially in places where it's become less lucrative. We live in a globalized economy, and Chicago isn't the only place to invest. "I risk money to make money," says Carter. "But if I have to take a 17-percentage-point extra tax hit, I'm going to risk less, and I may look elsewhere to trade."