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The Secret Stock Tax

February 5, 2001

When does a federal government "fee" become a tax? 

Probably when it starts grossing about six times more than it was designed to take in. Probably when the government is in no hurry to end a windfall that generates an extra billion or two of play money each year. Probably when the government says that to cut the fee would be a boon to the rich, so don’t even think about it. Probably when the average investor’s share of a fee comes to an extra $1,000 a year taken out of his or her pocket.

This is a story of the Section 31(a) fee, which was part of the New Deal regulatory reforms of 1933 and 1934. The fee, which is now assessed at 1/300 of one percent of the sale price of a security, was merely designed to fund the costs of federal regulation. But over the past few years it has become a cash cow for the federal government. Although it is not nearly the cash cow of, say egregious payroll taxes, it still uses the same devious methods. 

Tell taxpayers you are assessing a fee, or an "insurance premium," merely to pay for the costs of one program. Then ensure the rates or fees are so high that you generate far more money than you need. Once the imbalance starts, under no circumstances tell the taxpayers that they should receive some of their money back! Use the windfall to fund anything you want. Go on a spending rampage. Take your pals on a trip around the world. And have a good time. After all, it’s only taxpayer money! In the case of Section 31(a), it’s a familiar story.

The 1930s securities act authorizes assessing the securities industry for the "costs related to such supervision and regulation, including enforcement activities, policy and rulemaking activities, administration legal services and international regulatory services."

When the act became effective, it was only designed to apply to an exchange market. For many years, taxes generated tended to be almost the same as the SEC budget. But in 1996, with the passage of the National Securities Markets Improvement Act (NSMIA), the fast growing Nasdaq market, which was not a traditional auction market as envisioned in the original legislation, was included in the taxable base of Section 31(a). 

In the 1990s trading volumes and tax receipts exploded. It has been a windfall for the federal government. Yet NSMIA had only been designed as a fee---not a general tax---to recoup the costs of regulation. With Nasdaq volumes rising at a dramatic pace each year in the late 1990s, the funds flowing into government coffers to fund the SEC far exceeded anything the government had ever received. 

The Section 31(a) is a fee whose detractors charge has become a de facto tax. Last year, Section 31(a) receipts, along with other fees paid to the SEC to cover the costs of regulation, came to about $2.27 billion, according to the Securities Industry Association (SIA). But the SEC budget last year was some $377 million. That gave the government a bonus of $1.8 billion more than it was needed to fund the regulatory operations of the securities industry.

Christi Harlan, a Senate Banking Committee staffer and a former Wall Street Journal reporter, says the overtaxing problem actually began in 1993 and 1994, but didn’t become as pronounced until 1996.

This over funding, says Arthur Pacheco, a lobbyist for the New York-based Securities Traders Association, ends up in the general treasury, where it can "pay for pork barrel stuff." Senator James Bunning, a Republican from Kentucky, calls the Section 31(a) fees a "backdoor tax on capital formation [which] is an unfair burden to investors and brokers." 

The Clinton administration, which often played the class warfare card, opposed a revision of these fees that have become de facto taxes. Nevertheless, Section 31(a) fees are not a simple case of the rich against the poor.

"This is not a partisan issue. And it is in the best interests of all Americans to have this issue addressed," says Pacheco. Susan Woodward, an economist retained by the STA to study the issue, concludes "the fee is not shared by producers and consumers, but borne entirely by consumers." She estimates the fee costs the average investor about $1,000 a year.

Legislation that would have cut the Section 31(a) tax died in the last two sessions of Congress. But there is a slight problem with the class warfare argument used so effectively by pols whenever the subject of tax cuts comes up. 

Today, the "fat cat" investors include a lot of average people who are hurt by Section 31(a) fees just as tens of million of average Americans pay too much in payroll taxes. About 50% of American households now own equities directly or indirectly. They are hurt too. 

How bad is the overtaxing? Even the bureaucracy the fee was designed to fund is a little embarrassed about the windfall tax. SEC officials didn’t return telephone calls. However, last year, at a subcommittee hearing, then SEC Chairman Arthur Levitt said that the SEC, "shares the subcommittee’s concern that fee collections are currently well in excess of initial projections." 

Even some of the liberal big government members of Congress have turned on this favored "revenue raising device." Senator Charles Schumer (D-New York) has co-sponsored a bill (SB 143) along with Senator Phil Gramm (R-Texas) that would give Congress the authority to change the rate to ensure that tax receipts don’t exceed the SEC budget. However, it appears Senator Schumer has some doubts about what he is doing. 

"I might like to see what the SEC could do with a budget of $2.3 billion, but I don’t think Chairman Gramm would." (Having been Schumer’s constituent for over a decade I can confidently say, the "might" should be removed from the last sentence)."Today," Schumer said, "the fee collections are used to fund the SEC and the rest becomes part of the overall federal budget. That means investors are helping pay for activities ranging from tanks to highways to cancer research. These are all worthy expenditures, but it’s not why Congress created Section 31 fees and it’s simply unfair to investors." 

(Translation: "We can’t get away with this chicanery much longer. Let’s just enjoy all the money we have spent and find some other places where we can skin some more suckers. And, if by good luck, this bill dies again in this session, I won’t be upset").

SB 143 isn’t utopia. The bill, as a sop to the bureaucracy, actually contains pay raises for SEC staff so their salaries reach parity with those of the Federal Reserve Board. It probably won’t be a radical tax cut because members of Congress will retain the ability to adjust the Section 31 (a) rate instead of just cutting the rate and telling the bureaucracy to learn to live with less. 

However, it will likely mean the government will take in less money from the overtaxed investor who struggles to get ahead and save for everything from retirement to higher education for his children. 

Section 31(a) relief will still amount of a tax no matter when our Potomac Janissaries want to call it. But it will likely be a slightly smaller tax. Optimists might say the leviathan might become a bit smaller. One has to start somewhere. 


Gregory Bresiger, a New York-based financial writer, has appeared often on Mises.org. See his archive and send him mail.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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