There’s a new financial transaction tax proposal in town. Here’s why that’s good news.

March 1st, 2019 at 7:41 am

The 2017 Trump tax cut committed at least two fiscal sins. By delivering most of its cuts to those at the top of the wealth scale, it worsened our already high-levels of pretax inequalities. And in so doing, it robs the Treasury of much needed revenues; based on our aging population, we’re going to need more, not less, revenues for the next few years.

Now, along comes an idea that pushes back against both of these problems (and one other one!): a small tax on financial transactions (FTT). Sen. Schatz (D-HI) and Cong. DeFazio (D-OR) are planning to introduce a tax of one-tenth-of-one-percent, or 10 basis points (100 basis points, or bps, equals 1 percentage point), on securities trades, including stocks, bonds, and derivatives, one that would raise $777 billion over 10 years (0.3 percent of cumulative GDP a decade), according to CBO (by the way, 10 bps on a $1,000 trade comes to a dollar).

Numerous articles have gotten into the arguments for and against an FTT. I’ve got one from a few years back that covers similar ground. My colleague Dean Baker has long argued on behalf of FTTs as has Sarah Anderson of IPS. Importantly, FTTs exist in various countries, including the UK and France, with Germany considering the tax (also, Brazil, India, South Korea, and Argentina). The UK is a particularly germane example, where an FTT has long co-existed with London’s vibrant, global financial market (though we’ll see if Brexit changes that).

In fact, we have an FTT here too! The SEC funds its operating budget through a tiny FTT of 0.23 basis points on securities transactions and $0.0042 per transaction for futures trades.

The pro-FTT argument focuses on the reversing the two fiscal sins noted above, along with raising the cost of high-frequency trading. In a Vox interview, Sen. Schatz was particularly motivated by this latter aspect of the tax: “High-frequency trading is a real risk to the system, and it screws regular people; that’s the main reason to do this. If in the process of solving that problem we happen to generate revenue for public services, that’s an important benefit, but that’s not the main reason to pass this into law.”

Because the value of the stock holdings is highly skewed toward the wealthy, the FTT is highly progressive: The TPC estimates that 40 percent of the cost of the tax falls on the top 1 percent (which makes sense as they hold about 40 percent of the value of the stock market and 40 percent of national wealth).

Finally, on the pro-side, there’s a certain justice in taxing the pumped-up transactions of a financial sector that not only played a key role in inflating the housing bubble that led to the Great Recession, but thanks to government bailouts, recovered from it well before the median household. In this expansion, corporate profits and the securities markets that rise and fall on such profitability have mostly boomed while workers’ wages have only recently caught a bit of a buzz.

So, as my grandma used to say, “What’s not to like?”

Opponents raise numerous concerns, some of which should be taken more seriously than others. The high-speed traders correctly note that even a small FTT would upend their business model. Unlike most such squawking of those effected by tax proposals, in this case I suspect they’re right. While a dollar on a $1,000 trade doesn’t sound like much, when your industry is running 4 billion trades a day, 10 bps can be a prohibitive increase in the cost of transactions.

But again, on this point, opponents and advocates agree. We just have different goals. Someone could make an argument that high-frequency trading improves capital allocation, but it would be a steep, uphill argument.

The more serious objection is that the FTT catches more than just the “flash boys” in its net, raising transaction costs for plain vanilla traders. This is, by definition, true, and because of this effect, FTTs tend to reduce trading volumes. But too often, opponents stop there, as if this is some sort of coup de grace for the tax.

That’s only the case, however, if current trading volumes are somehow optimal, or if diminished volumes create markets that are too thin to reveal price signals to buyers and sellers. But in markets where half the daily trades are high frequency, reduced volume does not necessarily translate into reduced liquidity or dampened price signaling. There’s such a thing, it turns out, as too much volume (you’ve heard heavy metal, right?).

In fact, work by economists Thomas Philipon and Rajiv Sethi have documented ways in which something unusual has occurred. As transaction costs have fallen—quite dramatically, given the rise of electronic trading and its diminished marginal transaction costs—financial markets have not become more efficient. One reason is that falling transaction costs have been offset by higher “intermediation costs,” meaning the incomes of the brokers and dealers in the industry (Sethi provides compelling examples of “superfluous financial intermediation”).

It is therefore plausible, as Sen. Schatz believes, that an FTT will reduce “rent seeking” in the finance sector (economese for excess profits beyond those they’d get under normal, competitive conditions), unproductive financial “innovation,” and speculative bubbles.

But it is also possible that both assets and trading volumes will be more negatively affected than I and other advocates of the tax believe to be the case. Design issues can help here. Sweden’s FTT worked badly as it was set at a high rate but with a relatively narrow base, so avoidance was rampant. The Schatz/DeFazio bill avoids this pitfall with a low rate and a broad base. It’s notable in this regard that the CBOs revenue estimate of a plan upon which the new proposal is modeled includes the budget office’s guesstimates of these dynamic responses (e.g., reduced volumes), and it still raises serious revenues.

Given the uncertainty, here’s what I think should guide our thinking regarding an FTT. First, there is no perfect tax. In every case, you can come up with stories, some of which will be true (most of which will be hugely exaggerated) about some person or sector who is going to get hurt. In this case, the tax is small and there’s a plausible argument that its sectoral impact could be benign or useful. Second, we need the revenues. Third, we need the progressivity.

In other words, if the Trump tax cuts committed fiscal and distributional sins, the FTT looks potentially corrective and meritorious. I’d say it’s time we give it a Schat(z).

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11 comments in reply to "There’s a new financial transaction tax proposal in town. Here’s why that’s good news."

  1. Gerald Scorse says:

    “I say we give it a Schat(z)!” Tough to beat that for word play; nice start for March. 🙂


  2. Chuck Sheketoff says:

    Good post. I’d only quibble with your comment that there’s no perfect tax. There’s the Monty Python tax: https://www.ocpp.org/2009/04/10/blog20090409heres-hoping-monty-python-tax/ – a tax on foreign nationals living outside the country.


    • Jared Bernstein says:

      I stand corrected!


    • Kevin says:

      Chuck, my man!

      This was a great find, although none of the videos will download for me.

      But, in fact, in the U.S. Tax Code, life imitates satire – but backwards.

      In the U.S. Tax Code, we exempt “non-resident aliens.” When your bank pays you interest, you get an IRS Form 1099 in the mail and have to pay taxes on the interest. But not if you are a “non-resident alien.” The income they earn on U.S. financial assets is tax exempt and we help them avoid taxes at home.

      And the most bizarre part? We do this to help us finance and run trade deficits! That’s right, we give tax breaks to help us run those trade deficits that Donald Trump (rightly) hates.

      That’s right! Our trade deficits are a feature, not a bug, of our tax code: Totally through the looking glass!

      If you think that I am making this up, read this excellent research by the Tax Justice Network:

      http://www.financialsecrecyindex.com/PDF/USA.pdf

      So, if the U.S. Gum’mint wants to collect billions of bucks in additional taxes, the IRS would have to treat “non-resident aliens” just like the IRS treats you Chuck.

      Is there a catch? Darn tooting! You would have to buy more American-made stuff since it would be harder to finance trade deficits!


  3. Jill Shaffer Hammond says:

    So the way to explain this to the man on the street, or more especially, the woman in the supermarket:

    We* pay sales taxes on almost everything (ok, maybe not food) and it’s generally accepted/suffered through. Those rates are several percentage points like 5%, 7.5%, 9%, whatever. Doncha think all those Wall Street types ought to pay a sales tax too, every time they buy/sell some stock? Doncha think 0.1% is REAL cheap? Especially since those guys can crash the economy?

    Time for them to pony up, too.

    Sure hope this is a tax whose time has come.

    *OK, so those of us in NH don’t pay a general sales tax. But we do pay a Room & Meals Tax (9% when you go out to dinner), a Real Estate Transfer Tax, a Telecommunications Tax, a Gas Tax… Just call it by the transaction your taxing and you don’t have to call it a sales tax.


  4. kevin says:

    The idea that high-speed trading adds liquidity is sort of bizarre and inverted. Lots (lots and lots and lots) of pre-existing liquidity is a prerequisite for high-speed trading.

    So if high-speed trading disappeared and we went back to the way that things were before high-speed trading, only high-speed traders would notice their own absence. And if you are buying and holding for your own 401K account, you won’t notice the difference.

    But if you are managing to make millions of dollars by “adding liquidity,” please flush afterwards!


  5. Gerald Scorse says:

    For a direct FTT link to sales taxes, see the paragraph toward the end of this op-ed in the New York Daily News: https://www.nydailynews.com/opinion/ny-oped-the-tiny-tax-on-the-wealthy-that-could-raise-hundreds-of-billions-of-dollars-20190225-story.html


  6. kernel says:

    YES. It’s about FTTing time for US to tax high-speed transactions in particular.

    I don’t have the math to prove it, but I’ll bet that using equations from fluid dynamics to analyze finance would show that increasing the friction a bit would stabilize the system. I’m hoping that’s in the links (Phillipon & Sethi) that I haven’t been able to open yet.

    And Two Bonus Points to JB for good lines – the pun at the end, and the Heavy Metal metaphor for Volume!


  7. Otto Meyer zu Schwabedissen says:

    Very insightful post! The most convincing argument against the FTT to me is it being detrimental to efficient capital allocation but I will have a look at the paper you linked in the post.
    I also wonder about the share of GDP that might be lost if high-frequency trading is wiped out thorugh regulation and whether this technique is commonly used among established financial institutions as well. Anyone have data on that?


  8. EWM says:

    If I did business in the same manner as government does, and forced strangers to give me money, would you consider me a criminal?


  9. Bob says:

    The FTT has always made sense, but much more now that transaction costs are so low. The FTT would reduce trading profits (very slightly) and would therefore reduce income that would otherwise be taxable. In plain English, it would be deductible. An ordinary rational investor would presumably trade a little less because the cost of executing each trade would be a bit higher, and that could be a good thing. The tax would have to be extended to derivatives or else trading would just move there to avoid it. And there should be no ‘exempt’ wholesale transactions, otherwise, only retail investors would pay it. It will have to apply to all trading on all exchanges by all participants.


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