Taxing Wall Street Speculation
This piece is the third in a six-part series on taxation, and a joint project by The American Prospect and its publishing partner, Demos.
As the White House mounts a major campaign to sell the “Buffett Tax” this week, there is another, better tax on the 1 percent that Washington should be considering: A financial-transaction tax—better known as a financial speculation tax (FST).
A financial-speculation tax has been discussed, from time to time intensely, ever since the financial crisis of 2008 riveted attention on the markets that drove the economy to the edge of a Great Depression-quality abyss. One motivation was to make the perpetrators pay, as the public focused on bonuses at levels befitting Croesus and callous disregard for the responsibility borne by the banks for the great recession. But the financial-transaction tax is also good policy. Under the concept, financial transactions—purchases and sales of equity shares and bonds and the execution of derivatives—are taxed based, at least in part, on the size of the transactions. As a revenue source, it has great potential: An FST could easily raise more than $150 billion a year, according to some estimates, depending on the details of the tax and trading volumes in a post-tax environment.
The FST could rein in some of the worst excesses of financial markets that too often operate like casinos. By increasing the costs of placing trades, the tax would moderate trading activity generally, but it would most strongly deter short-term trades rather than longer-term investments. Importantly, for example, an FST could reduce the profitability of high-frequency trading, whereby computerized trading system enter and exit trading markets many times during the day—a practice that regulators worry gives an unfair advantage to some firms and increases market volatility.
Adopting an FST does not involve a leap of faith. From 1914 to 1966, the U.S. imposed a small tax on all stock trades, and Congress more than doubled the tax in 1932 to raise revenues during the Great Depression. The Securities Exchange Commission still exacts a fee equal to .00257 percent of each equity transaction traded on an exchange that funds the agency off-budget. In the U.K., the government imposes a “stamp tax” equal to 0.5 percent of each equity transaction. About 29 other countries also impose some form of an FST. In these jurisdictions, markets have survived and even thrived, even though trading in other jurisdictions without an FST is available. Most notably, financial markets in the U.K. have grown considerably since the early 1990s even with an FST in place.
The FST should be an attractive alternative for politicians, since it raises serious revenue from an unpopular sector at a time of urgent fiscal needs. Yet proposals for an FST that grew out of the financial crisis have not yet been implemented. Nowhere has an FST been more seriously considered than in Europe, where the idea has backing from the German and French governments. But European finance ministers recently failed to reach agreement on enacting the tax in the face of a U.K. refusal to go along unless there is a global tax, meaning the U.S. would have to enact an FST as well as the EU.
The irony of the U.K. position is maddening since the country already has a tax on equity trades and a stock market that is one of the world’s largest. Various leaders have suggested that the FST be imposed in the Eurozone only, but there is opposition based on fears that business will migrate to the U.K. The best case is that the FST will be considered in the European Parliament, where there is greater sympathy than among the finance ministers, but only after the French presidential election in June.
In the United States, legislation was introduced in 2009 by Senator Harkin and Representative De Fazio to impose an FST on equities, bonds, and derivatives. While it was not successful, the concept is likely to be a consideration in future tax discussions. Most recently, the Congressional Progressive Caucus proposed an FST focused on derivatives and foreign exchange trading that it estimated would raise tens of billions of dollars a year.
A number of issues are important to the discussion. First, is the tax collectible? Exchange-traded stocks, bonds, and futures can easily be taxed. The greater concern is with bilateral transactions. In this instance, derivative and bonds will be subject to comprehensive information transfers to central repositories. Since each transaction will be “touched” at this moment, the tax can attach there. This would make evasion more difficult.
The other way to assure reliable collection is to make the consequence of non-payment unacceptable. It makes sense to structure the FST as a “stamp tax,” like the U.K. equity tax, so that the transaction that it attaches to is not recordable or enforceable unless the tax is paid. Under this system, it must be clear to all parties to a transaction that the tax has been paid. Exchange-traded transactions will not suffer since attachment will be easily demonstrated. Bilateral transactions will require assurance that the responsible party has actually paid the tax so they will be burdened by an additional complexity. This is a beneficial outcome, since exchange trading should be encouraged over shadow-market, bilateral trades.
The second great question is how should the tax be measured? For equity markets, the starting point is the U.K. tax. That tax is 0.5 percent of every amount of the price of every trade. But bonds are assets that differ in duration to maturity, so value depends on duration as well as principal amount. And derivatives are bilateral contracts that have no intrinsic market value at inception but rather accrue value over time as referenced prices change. Clearly, measurement is a difficult question. Professor Robert Pollin of and Dean Baker, among others, have studied the thorny issue of structuring an FST in great detail.
For the tax to work properly, it must be at a level that does not stifle the activity taxed so as to diminish its value as a revenue source. Professor Pollin and James Heintz considered a number of factors, including the elasticity of trading activity in relation to the potential tax at several rate levels. Elasticity is, in large part, related to the size of the tax in relation to the other transaction costs associated with the trade. If the tax is a larger percentage of the total transaction costs, the trading activity will be more elastic. Professor Pollin examined numerous configurations and came up with a plan that makes sense from a revenue generation perspective (See details here).
The Obama administration and key Democrats in Congress have yet to support a financial-speculation tax, even as pressure grows to raise new revenues and reduce deficits in ways that don’t burden middle-class Americans. The Obama administration has voiced doubts about the enforceability of an FST as well fears that the costs would be passed along to ordinary investors and the overall effect would be to raise the costs of capital and hurt growth. These objections are groundless. Enforcement has not proved to be a major problem in the U.K. as just discussed. And ordinary investors may actually benefit from an FST as fund managers have fewer incentives to engage in excessive trading that increases fees for investors. As Ian Salisbury has pointed out, “Excessive trading can be a drag on fund performance because funds' brokerage commissions and other costs are deducted from investors' returns. Trading can also pump up capital-gains taxes that investors pay.” Moreover, the markets may well become more efficient in achieving their primary social function—raising capital for enterprises, as Professor Thomas Philippon has argued. Volume is very different from liquidity, though the administration conflates the two. Elimination of predatory trading practices that inflate volume to boost profits for traders, best exemplified by high-frequency trading, would be a benefit rather than a cost.
Overall, the biggest obstacle to an FST is the outsize clout for the securities and investment industry in Washington, which has made more than $350 million in campaign contributions to politicians of both parties since 2007 and spent $400 million on lobbying during this same period.
Yet elected leaders intimidated by the financial industry’s clout need to consider the political pain associated with other avenues for raising revenue—e.g., reducing popular tax breaks for homeowners, cutting popular programs like Medicare, or raising tax rates on middle-class households. There are no painless ways to raise significant new revenues for the federal government. The benefit of an FST is that it is sound policy, would raise major amounts of money, and would penalize a very small group of people who are engaged in negative behavior.
One last benefit of an FST is that taxing Wall Street is popular with the public. Americans haven’t forgotten who caused today’s economic mess. Making the financial sector bear a greater burden for fixing America’s economy and fiscal situation is sure to be a winning idea with voters.
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