Jacobin, June 27, 2017
In the last couple years, the financial transactions tax (FTT) has moved from a fringe idea to a policy proposal treated seriously by even the mainstream of the Democratic Party. The decision by Senator Bernie Sanders to make it a central part of his presidential campaign certainly helped, but a number of members of Congress, including Keith Ellison and Peter DeFazio, have also pushed FTT proposals for many years.
The FTT is also gaining momentum overseas. There’s a push to enact an FTT in the eurozone. And in England, an expanded FTT — the London stock exchange has long levied a 0.5 percent tax on stock trades — was included in the Labour Party’s platform in the recent election.
But while the idea of taxing financial transactions is growing more popular, even many of its proponents don’t realize its full benefits. An FTT is usually seen as a way to raise large amounts of revenue (in the US, it could possibly generate as much as $190 billion a year, or 1 percent of GDP). Or it is viewed as a means to limit speculative trading in the financial sector, potentially making markets less volatile.
The best argument for an FTT, however, is that it can sharply reduce some of the highest incomes in the economy by curtailing the trading that makes those incomes possible. As a result, it can play a large role in reversing the upward redistribution of income that we’ve seen over the last four decades.
The key point that many miss about a financial transactions tax is that it would be borne not by investors but by the financial industry.
The logic of this point is straightforward. Any tax would likely be passed on almost in full to investors in the cost of an individual trade. This means that if a tax were equal to 50 percent of the current cost of trading stocks, bonds, or other financial instruments, then the cost of a trade to an investor would rise by close to 50 percent.
For example, suppose the current cost for selling $10,000 of stock is $30, or 0.3 percent of the sale price. If we imposed a 0.15 percent tax on the sale, then we would expect the cost of the sale to investors to increase to roughly $45 ($30 plus the $15 tax), if the tax was passed on completely to investors.
But there is a large amount of research showing that trading volume would decline roughly in proportion to the increase in trading costs. This means that if the cost of a trade rose by 50 percent, as it would in this scenario, then we would expect trading volume to fall by roughly 50 percent. In other words, a typical investor would end up trading roughly half as much as he had before the tax was imposed.
The drop in trading volume would matter to investors if they actually benefitted from trading, but taken as a whole, they don’t. If someone sells shares of stock at a high price, they win from the deal. But someone else bought the shares at a high price and ended up as a loser. On average, the winners and losers balance out, which means trading is, on net, a wash for investors. If we have less trading, because of an FTT or any reason, investors aren’t hurt by it.
Detractors might argue that lower levels of trading would hinder market liquidity. If investors didn’t think they could sell shares of stock reasonably quickly, they would be more reluctant to buy them. And if they were more reluctant to buy them, companies would have a harder time raising capital in financial markets, which would slow investment and growth.
While this could be a problem if we had a small and underdeveloped capital market, that is not the case in the United States today, nor has it been for many decades. Even if we cut trading volume in half, we would still have as much trading as we did in the mid-1990s, when the US capital markets were already very large.
... And Industry
Instead of coming out of the pockets of investors, the revenue from an FTT would come out of the pockets of the financial industry.
An FTT that raised $100 billion a year, for instance, would shrink the financial sector’s size by roughly $100 billion. This downsizing would sharply reduce the number of very high-paying jobs in the sector. The narrow financial sector (securities and commodities trading) would be trimmed by a third, presumably reducing the number of very high-paying positions by at least that much.
Since the financial sector includes many, perhaps most, of the highest paid workers in the country, an FTT would be a big blow to those at the top. Just how big? The Social Security Administration (SSA) reports that the 202 highest-paid people in the country enjoyed average salaries of more than $90 million each in 2015. (This likely understates their actual pay since much of their wage income is hidden as capital gains income in the form of “carried interest.”)
While the SSA data does not include industry breakdowns, it is likely that many or even most of these 202 super-high earners work in the financial sector. Even for a CEO, $90 million is an extraordinary sum. The financial industry likely also employed many of the next eight hundred top earners, who received an average of roughly $30 million in 2015.
In addition to reducing inequality directly — by eliminating many high-paying positions — an FTT would also have a substantial indirect effect. If we got rid of a large percentage of very high-paying positions in the financial sector, it would reduce the number of super-lucrative slots in the economy as a whole. We could expect this to put downward pressure on compensation at the top more generally as more people looked for high-paying jobs in software, biotech, or other sectors.
The dynamic would be somewhat analogous to what’s happened in manufacturing: the loss of good-paying jobs due to trade pushed down the pay of non-college-educated workers more generally. The difference is that in the case of finance, we’re talking about a very small group of extraordinarily well-remunerated workers, not the bulk of the US workforce.
Think of an FTT as a job-killing robot for rich people.
Of course, the attack on the financial sector can and should go beyond imposing an FTT.
Much of the profit in private equity stems from tax gaming and abusing bankruptcy law. If we eliminated the opportunities for gaming (most importantly, the tax deduction for corporate interest payments), the high earners in private equity would take a big hit.
There are other areas in which the financial sector is purely predatory, such as the excessive fees charged on retirement accounts or the management fees charged to public pension funds.
If these avenues for getting rich were closed off, the opportunities for very high-paying jobs would be substantially reduced. While this would not directly fix a broken corporate governance structure that allows for outlandish CEO pay or address the arcane licensing rules and immigration restrictions that allow many medical specialists to earn more than $500,000 a year, whacking the financial sector would be a very good start in reversing rising inequality.
And as a bonus, we could use the money raised to pay for free college or other good things — rather than letting it continue to line the pockets of investment bankers.