September 26th, a Saturday, is an ominous day for New Jersey lawmakers hoping to generate billions of dollars in annual revenue from a financial transaction tax targeting New York-based stock exchanges that currently rely on electronic infrastructure located across the river in New Jersey. On that day, all the U.S.-based exchanges will simulate a day’s worth of trading using their backup sites in the Midwest.
Geographically dispersed backup sites have always been prudent, but this time the test is about much more than a potential interruption of service in New Jersey; it’s also a dry run for relocating the data processing permanently should New Jersey go through with its new financial transactions tax. The New York Stock Exchange (NYSE) is going a step further: when the markets open the following Monday, it will run one of its five subsidiary exchanges from Illinois for the entire week, a demonstration of its ability—and willingness—to relocate its electronic processing to avoid discriminatory taxation from New Jersey.
Such relocation is not without its costs and may encounter a few initial snags, but the notion that it would be prohibitively difficult to move data processing out of New Jersey is dramatically overblown. Those who need low latency for high frequency trades can have their own processing follow the exchanges in digital relocation—which doesn’t require relocating personnel—and these would, in fact, be the traders most incentivized to avoid the impact of a financial transaction tax, which is imposed on every trade of a stock or other financial instrument (above certain thresholds).
New Jersey is a convenient location for the New York-based NYSE and Nasdaq data centers. The Chicago-based Cboe Global Markets, which acquired the New Jersey-based National Stock Exchange, also maintains some processing in New Jersey. There are advantages to a New Jersey location—but all three exchanges are signaling that these advantages are not so important as to prevent them from shifting their transactions to data centers elsewhere. This is no idle threat: it’s very much within their power and would likely be worth it.
New Jersey’s proposal, a 0.25 cent tax on every financial transaction processed in the state, has won favor with both Gov. Phil Murphy (D) and Senate President Steve Sweeney (D), who have often disagreed on tax policy proposals. Governor Murphy has, however, warned against including projected revenues from the tax in the budget over concerns that the exchanges might sue over the tax’s implementation.
They very well could. The proposed tax is not an excise tax on the use of in-state data processing; it is a tax on each share traded, even though none of the parties to that transaction are necessarily in the state. Easier than suing, however, might just be leaving.
About a decade ago, the CME Group, which houses both the Chicago Mercantile Exchange and the Chicago Board of Trade, secured concessions from Illinois that largely exempted them from tax increases when the company made clear that—name and history notwithstanding—it was not strictly tied to Chicago. Here, the process is far easier. The exchanges would not have to leave Wall Street; they would simply have the electronic processing take place somewhere other than their current location in New Jersey.
If implemented, New Jersey’s financial transaction tax would be a flat-rate tax imposed per instrument, not per trade, meaning that a purchase of 1,000 shares would generate $2.50 in taxes. As we have noted previously, this rate may seem small, but it would quickly pyramid as the same instrument is traded—and therefore taxed—multiple times.
Because the tax is imposed per transaction, the effective rate would be much higher on stocks that trade at lower prices—largely, though not invariably, associated with small and midcap stocks. The effective rate on the sale of a Berkshire Hathaway Class A share ($328,430 when markets opened on September 14th) would be 0.00000076 percent, while the rate on the sale of a share in Sirius FM ($5.51 at the opening bell) would be nearly 60,000 times higher at 0.045 percent.
At a price point of, say, $40 a share (some large companies trade for orders of magnitude higher), New Jersey’s tax on Wall Street transactions would be three times the so-called Section 31 fee designed to support all SEC regulatory activity. A state FTT would raise both explicit and implicit transaction costs, bringing down the volume of trades and lowering the price of assets by dipping into investor profits. It would especially reduce high-frequency trading. These kinds of trades see very small profit margins, and thus are more affected by taxes. While the primary tax burden would fall on the wealthy—as is probably intended—all investors would see lower portfolio values because of the decrease in asset prices. Restricting high frequency trading, moreover, can reduce liquidity, locking in investors as share prices fall.
In July, we observed that relocating the electronic processing of these transactions was a realistic response to the threat of a multi-billion-dollar distortionary tax imposed on transactions that simply flow through a state’s digital infrastructure. As leading exchanges prepare to conduct a test of their server capacity elsewhere, New Jersey lawmakers may be forced to rethink the viability of their proposal.
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