February 12, 2016
Morning Edition had a good piece this morning on Senator Bernie Sanders’ proposal for a financial transactions tax (FTT). There are a couple of additional points worth making.
First, while the piece noted a wide range of estimates of the amount that could be raised through such a tax, we do have some real world experience. As was noted, the United Kingdom has had a transactions tax on stock trades since the 17th century. This tax raises an amount equal to roughly 0.2 percent of GDP, which would be $36 billion annually in the current U.S. economy or roughly $400 billion over a 10-year budget horizon. This tax applies only to stocks, which allows traders to avoid it through options and other derivative instruments.
By contrast, Japan had a more broadly based financial transaction, which it eliminated in the 1990s. At its peak in 1990, the tax raised more than 1.0 percent of GDP, which would be $180 billion in today’s economy or roughly $2 trillion over a 10-year budget horizon. These experiences should provide some basis for projecting how much a broadly based tax in the United States could raise.
The other issue, which was touched on in the piece, is who bears the cost of the tax. The piece suggested that the tax would be passed on to pension funds and individuals with retirement accounts. There is an important point here that may not have been clear. While it is likely that the tax will be passed on in the cost of individual trades, pension funds and individuals with retirement accounts care about the total cost of trading, not the cost of individual trades.
This matters, because everyone agrees that there will be a large reduction in trading volume in response to the tax. If the percentage reduction in trading volume is larger than the percentage increase in trade costs due to the tax, people would actually be paying less money for their trading after the tax was imposed than before the tax. For example, if the tax raised trading costs by 25 percent, but trading volume falls by 30 percent, then people will be spending less in total on trading each year.
In that case, the financial industry bears the full burden of the tax in the form of reduced revenue from savers. This effectively is the assumption in the Tax Policy Center’s analysis of the impact of the tax, where they assumed that trading volume would fall by 1.5 times the increase in trading costs due to the tax.
In this case, there is only a cost to anyone outside the industry if the reduced trading volume somehow leads to a less well-functioning economy. In other words, the question is if we believe that reducing trading volume to its levels of 20 or 25 years ago would lead to a worse allocation of capital and more bad investment decisions by firms.
That seems implausible, but this is what those who argue a FTT would hurt the economy have to claim. If in fact, most trades are a zero sum game (one person profits by the trade, the other one loses) then the economy will not suffer from a reduction in trading volume. In that case, only the financial industry will be hurt by an FTT. The tax will effectively reallocate resources to more productive sectors of the economy.