Over the years, many prominent economists have advocated taxing financial transactions. During the Great Depression that followed the 1929 stock market crash, John Maynard Keynes advocated such a tax to curb financial speculation and help ensure that investments went to productive endeavors rather than short-term gains. Nobel laureate James Tobin proposed a financial transactions tax for foreign currency trades. He saw this as a way to “throw sand in the wheels” of finance and to keep finance (in this case, large changes in exchange rates) from damaging the real economy. More recently, Paul Krugman and Joseph Stiglitz have both come out strongly in favor of a financial transactions tax.
As the name implies, the financial transactions tax is a tax on the purchase and/or sale of financial assets. It can be imposed on just a few assets—shares of stock or financial derivatives, such as the mortgage-backed securities that led to the Great Recession. Alternatively, it can be imposed on a broad array of transactions that involve financial assets.
More countries are adopting or expanding the financial transactions tax than are cutting the tax or abandoning it. The reason for this is quite simple—unlike the wealth tax, the financial transactions tax has encountered few problems when it has been implemented.
While no one likes taxes, or having to pay them, not all taxes are equally bad. Economists have identified a few key characteristics of a good tax. It should be cheap to administer and collect revenues, it should be fair, and it should distort the economy as little as possible. The financial transactions tax meets all these requirements.
A financial transactions tax would involve no new bureaucracy or reporting requirements. Financial transactions reporting already takes place in the United States and most other developed nations. The clearing and settlements systems that do this are centralized and automated in those markets where assets are traded. This makes it easy to collect the tax. Since almost all trading takes place through the existing electronic technology, there are records of every transaction and an easy way to assess a tax on each transaction. This means that, unlike other taxes, a financial transactions tax would be very difficult for the rich to avoid.
We even have a great deal of historical experience taxing financial transactions, and the results have generally been favorable. Traded stocks have been taxed in the United Kingdom since the 17th century, and more than 40 countries today tax the financial transactions taking place in their financial markets. Even the United States currently imposes a very small tax on each financial transaction. The revenues raised from this are used to fund the Securities and Exchange Commission, which regulates U.S. securities markets and exchanges. It would be very easy to raise the tax rate to generate even more revenue.
The tax has worked so well because it is effectively a fee for verifying an ownership transfer. If the asset transfer were not made official by the government, and if taxes were not paid on it, the transfer would usually not be legally enforceable. Institutional investors, who hold and trade the vast majority of assets around the world, don’t want to take large risks when it comes to the legal status of ownership. They would rather pay the small fee imposed by the government than incur large costs in a possible court case. The fact that some of the fees wind up being paid by investors living abroad makes this a rather popular source of government revenue. In the U.K., 40 percent of financial transfer tax receipts are paid by residents of foreign nations.
Another plus is that the financial transactions tax is paid only by those who own and trade financial assets. For this reason, it has been called a “Robin Hood tax.” It falls mainly on the rich, since the rich own proportionately more financial assets than the middle class, and the poor own next to no financial assets. The revenue from such a tax can then fund programs that benefit the poor and the middle class (more on this later).
Most middle-class wealth is held in the form of home equity, which would not be subject to the financial transactions tax. Even the relatively small amount of financial assets owned by middle-class households are typically held in stock funds that do not trade regularly or are bought to be held for a long period of time. Money in an S&P 500 stock fund must be invested in the stocks that comprise the S&P 500. Only when there is a change in one of the 500 stocks that make up this index will funds be required to sell one stock, buy another stock, and be taxed on this trade. Changes in the S&P 500 take place rather infrequently—around 20 times a year during the past half-century. In half these cases, the change was necessitated by a merger or acquisition. A financial transactions tax should provide incentives to make such changes even less frequently.
Among the wealthy, most of the loss from a financial transactions tax will be borne by hedge fund managers, frequent traders, stock funds that frequently change their holdings, and flash traders. These are people who own financial assets to trade, and they trade these assets to make money quickly. Long-term investors, including pension funds and stock mutual funds, would pay very little in taxes, and there would be very little change in rates of return on money held in these accounts as due to the tax. As a result, the tax will reduce stock speculation and short-term trading as people focus more on long-run returns.
There is another fairness issue that puts the financial transactions tax in a good light. Some goods and services are subject to a sales tax when they are bought; others escape sales taxation entirely. In some cases, this is done by design. For example, we don’t tax food (or at least food bought in the grocery store) or health care because we regard these as necessities. In other cases, goods escape taxation for no reason at all. When I buy a new car or fly somewhere for vacation, I am taxed on my purchase. It is not clear why financial transactions should be treated any differently.
Whenever one good is taxed and another good is not taxed, the untaxed good will be relatively cheaper. This gives an unfair advantage to the suppliers of the untaxed good while hurting suppliers of the taxed good. Regarding financial transactions, the beneficiaries are the wealthy individuals who are not taxed, and who are then able to have their wealth grow untaxed, or undertaxed, year after year.
Another consequence of taxing one good but not another is that consumers buy less of the taxed good; instead they buy the cheaper, untaxed goods. (This is why necessities are usually not taxed by governments.) Not taxing financial transactions leads to increases in short-term buying and selling and enhances the prevalence of finance in our economy. Such a policy might be justified if some great social gains were realized from having a larger financial sector. However, the recent history of the United States, including the rampaging wealth gap and the major economic and financial crisis following the fall of Lehman Brothers in 2008, shows that financialization has hurt the nation rather than providing any gains.
A financial transactions tax also is a good revenue source for the government. Even a small tax (around two-tenths of a percentage point for stocks and derivatives and around one- or two-hundredths of a percentage point for bonds and futures trading) would bring in somewhere between $150 billion and $400 billion a year, depending on how high the tax is actually set, which assets it applies to, and how much of a drop we get in financial transactions as a result of the tax.
This money can do a great deal of good. Even the lower revenue figure would close the entire U.S. infrastructure gap identified by the American Society of Civilian Engineers (see my article in the April 2018 Washington Spectator). Alternatively, it could fund a large number of programs advanced by Democratic presidential hopefuls that focus on helping children—including eight weeks of paid parental leave ($18 billion per year), universal pre-K ($3 billion), universal child care ($70 billion), and baby bonds or “opportunity grants” that seek to help low-income children go to college or make a down payment on a house ($42 billion). As with infrastructure spending, such spending would yield returns (from things like lower crime, reduced transfer payments and more productive tax-paying citizens) that exceed the rates of return found in most private sector investments.
A number of proposals for a financial transactions tax have already been introduced in Congress over the past decade; many of them have been cosponsored by Rep. Peter DeFazio (D-Ore.). And a few Democratic presidential hopefuls have come out for a financial transactions tax. New York City Mayor Bill de Blasio and Senator Bernie Sanders both support it. Andrew Yang sees the financial transactions tax as one source of revenue for his basic income plan.
There are, of course, numerous critics of financial transactions taxes. As would be expected, most are people with ties to the financial industry or day traders, who stand to lose the most from the tax. Nonetheless, their objections are worth examining and dispelling.
One frequent complaint is that a financial transactions tax would subject owners of financial assets to double taxation because capital gains on financial transactions are taxed already. This is a phony objection, one that gets raised against almost every tax. In fact, all income is taxed many times in America and throughout the world. We pay income taxes to federal, state, and local governments, and then we pay sales taxes and property taxes with the money we have left over. Nothing is taxed only once.
Another criticism of the financial transactions tax is that it would keep finance from doing its job of allocating money to the most productive investments. This is a very peculiar defense of finance. As we have seen many times, especially during the Great Recession and in the many cases of fraud in the early 21st century (including those involving firms such as Enron, Global Crossing, and WorldCom), financial markets are rife with fraud. The many examples of this problem make clear that self-policing is ineffectual and that financial markets have not done their job of directing investment to where it does the best for the nation, or even for the markets themselves.
Finance has grown rapidly over the past four decades. It expanded from 5 percent of the U.S. economy in 1980 to 7.5 percent of the U.S. economy today, down a bit from its 2006 peak of 8.3 percent right before the financial crisis and Great Recession. Just as finance has grown rapidly since the 1980s, the economic condition of the average American has worsened. Household incomes have stagnated, and household debt has soared. Inequality has also increased, because almost all the income gains in the nation over the past four decades have gone to the top 1 percent.
While correlation does not mean causation, there is a good case that the financial sector has gotten too big for its britches and that not taxing finance is part of the reason for this change. A financial transactions tax would tame speculation by throwing a little sand in the sector’s wheels, as laureate James Tobin suggested we do. It would also help to address the great U.S. inequality problem.
Finally, some claim that a financial transactions tax in the United States would result in finance moving from Wall Street to securities markets in other countries that do not tax financial transactions. This, too, is a claim without any empirical backing or merit. It also lacks awareness of the simple facts about financial transactions taxes. As noted above, a large number of countries already use this tax. Others are ready to start employing one. Further, the U.K. has had this tax for a long time, and it does not seem to have led to any such exodus or related negative effects there. It is true that finance is moving out of the U.K. right now—but because of Brexit, not because of the financial transactions tax.
A financial transactions tax is easy to implement and progressive in its incidence, and it would help the U.S. economy in many ways. In public opinion surveys throughout the world, once people understand this idea, they strongly favor a low-rate financial transactions tax. This includes two-thirds of those in the United States.
It is time to start taxing financial transactions. And it’s time for more Democrats to jump on the financial transactions tax bandwagon.
The author is professor of economics at Colorado State University, author of Fifty Major Economists, 3rd edition (Routledge, 2013), and president elect of the Association for Social Economics.