December 2015, Dean Baker and Nicole Woo
As financial transactions taxes (FTT) have moved to be part of the mainstream debate on tax policy, there has been increased attention to the incidence of such taxes. This is an important aspect to the debate, since the merits of the tax will depend to a substantial extent on who will end up bearing the burden. There are three key issues in making this assessment:
1) Which groups directly bear the burden in the sense of carrying through trades that will be subject to the tax;
2) The extent to which tax payments will be offset by a reduction in trading volume, which lowers transaction costs; and
3) The extent to which reduced trading will lead to a less efficient allocation of capital, and therefore reduce growth and output.
The issues associated with the first point are straightforward, even if the data may not be as clear as would be desirable. The allocation of the tax will be in proportion to the volume of trading by each income group, however, there are not reliable data for trading by income group. As a first approximation, it can be assumed that trading is proportional to the financial assets held by each income group. These data are available from the Federal Reserve Board’s Survey of Consumer Finances.
The second issue depends on the elasticity of trading volume with respect to the cost of trading. If trading is very responsive to changes in transactions costs, then reductions in trading volume can offset much or even all of the tax. Investors may have to pay the tax on trades they conduct, but they will save money on other transactions costs because they do less trading. There is research that provides evidence on trading elasticity, although it does leave a wide range of uncertainty.
The third issue is the most important one. If the high current volume of trading is somehow leading to a better allocation of capital, then reducing trading volume will lead to a less efficient allocation of capital. In this case, FTTs will lead to slower growth and less output. Here, the incidence of the tax depends on the apportionment of this lower level of output. Insofar as it means lower returns to capital, households will lose if they own capital. Insofar as it means lower returns to labor (i.e. lower wages) households will lose if they have workers relying on labor income.
This paper discusses these issues in further detail, assessing what the evidence shows on each issue.