Last week, Representative Peter DeFazio reintroduced his financial transactions tax (FTT) proposal. The bill would impose a tax 0.03 percent on trades of stock, bonds, options, and other derivative instruments. (That's 3 cents on $100 of trades.) This can be thought of as the equivalent of a sales tax imposed on financial transactions, which are now largely untaxed.
According to the Joint Tax Committee, this tax would raise roughly $400 billion over a 10-year budget horizon. This translates into 0.2 percent of GDP. That would cover about 60 percent of the annual food stamp budget.
The tax would also dampen speculative trading on Wall Street. Many trades that involve flipping assets in a matter of minutes or even seconds would become unprofitable with even this small tax. This could make financial markets more stable.
But the really neat aspect of this tax is that it all comes out of the hide of Wall Street, rather than ordinary investors. Considerable research shows that trading volume declines roughly in proportion to the increase in trading costs.
This means that if the DeFazio proposal would raise trading costs by one-third, then trading volume would fall by roughly one-third. Investors will pay one third more on each trade, but they will carry out one-third fewer trades. This means their total cost of trading with the tax will be no larger than it was without the tax. (The Tax Policy Center of the Urban Institute and the Brooking Institution actually assumed that trading volume fall by 25 percent more than the percentage increase in trading costs, meaning that total trading costs would fall as a result of the tax.)
With most items, we would consider it a bad thing if we consumed less due to a tax. For example, if we got less health care or education because we taxed these items, it would be a serious loss. But this is not the case with trading financial assets.
Trading is on net a wash for the economy. If I sell my stock at a high price, then I won on the trade. On the other hand, someone paid a high price for the stock and will thereby end up a loser. On average, the winners and losers even out, so if we can just spend less money on trading, we are better off.
The big exception is the folks in the financial industry who make money on the trades. They are losers in this story.
There is an argument that we need liquid markets to make it easier for companies to get money for investment. No one would ever buy shares of GE stock if they weren't pretty confident they would be able to sell them if they needed. But current trading volumes are way beyond what is needed to maintain a liquid market. If volumes were cut in half we would still be looking at trading volumes equal to what we had in the late 1990s. By any measure, the U.S. already had very deep capital markets in 1998.
The way we should think about a FTT is that it will radically reduce the opportunities for people to make millions, or even tens or hundreds of millions, annually by flipping stock and other assets. These people might have to instead work developing software or go into biotech or other areas for their paychecks. This is a great way to make the economy more efficient by reducing pay at the top.
That's a real win-win.