February 25, 2021
If you were worried that you had a drinking problem, you probably would not ask your neighborhood bartender for advice (Let’s assume the bartender owns the bar, so they pocket the cash from the drinks.) The bartender may be a very nice person, and may actually be your friend, but they obviously have a material interest in keeping you coming back to the bar.
It is the same story for pension funds when it comes to their various pension advisers. The pension funds’ boards (the people who actually are in charge of running the fund) are often on good terms with the people who manage their money. In many cases, they have used the same group of advisers for years or even decades.
Nonetheless, the fund’s investment advisers are in the same relationship to the pension fund as the bartender is to the person worried about their drinking problem. The advisers are making money off the fund.
This simple point is important to keep in mind in considering the reactions of pension fund advisers to proposals for financial transactions tax. The goal of a financial transactions tax is to raise revenue for the government while reducing the volume of excess trading.
The idea is that a modest tax (0.1 percent is the rate proposed in a recent bill introduced by Representative Peter DeFazio) will have little impact on the ability of financial markets to effectively allocate capital, but it would substantially reduce the resources devoted to high-frequency and other short-term trading.
According to the Congressional Budget Office, this tax could raise more than $700 billion over a decade, or $70 billion a year. This is roughly equal to the size of the food stamp budget, an amount equal to 1.5 percent of total spending.
This money would come almost entirely out of the pockets of the financial industry. Research shows that when trading costs go up, trading volume declines by roughly the same percent. If the DeFazio tax raises the average cost of a trade by 40 percent, we should expect that trading volume will also decline by roughly 40 percent.
This means that, from the standpoint of a pension fund, they can expect to be paying 40 percent more on each trade, but since they are doing 40 percent less trading, they will spend no more on their trading with the tax than they did before the tax. In other words, for the pension fund, the tax is a wash.
But aren’t they hurt because they are doing less trading? The evidence is that they are not. Every trade has a winner and a loser, and most people end up in each camp roughly half the time. This means that pension funds do not typically benefit from the amount of trading they are currently doing. (Yes, every investment adviser tells us they are a star and always beat the market. They aren’t.)
So why do investment advisers tell pension funds that a financial transactions tax is bad news for the pension? They say this for the same reason the bartender tells their customer they don’t have a drinking problem.
They want the business.