Why the U.S. Could Use a Financial Transaction Tax

Feb 11, 2013Greg Noth

Taxing speculation would raise revenue and make markets safer for everyone.

In January, 11 European countries implemented a Financial Transaction Tax (FTT), which places a small tax on stocks, bonds, and other products traded in financial markets. They expect to raise billions of dollars in revenue, and there are signs the idea for a similar tax may be gaining traction in the United States. Senator Tom Harkin and Rep. Peter DeFazio are reviving their Wall Street Trading and Speculators Tax Act, which includes an FTT but died in committee in 2011.

The purpose of a Financial Transaction Tax is to raise revenue by requiring buyers and sellers to pay a very small fee for each trade they make. The FTT proposed by Harkin and DeFazio, for example, places a three-basis-point charge on most stock, bond, and derivative trades. (In comparison, the European FTT taxes stock and bond trades at 0.1 percent of their value.) A basis point is one-hundredth of one percent, meaning a tax of just 3 cents would be paid for every $100 traded, $3 for every $10,000 traded, and so on. It would apply to any trade in the U.S. and by any U.S. individual or company, so corporations’ offshore subsidiaries would not be able to get around it.

The bipartisan Joint Committee on Taxation projects a three-basis-point FTT could raise as much as $352 billion over the course of 10 years – an average of $43 billion a year. This is a significant amount of money. With it, many of the harsh across-the-board cuts put in place by the 2011 Budget Control Act (BCA) (also known as sequestration) could be alleviated. For example, the $38 billion scheduled to be cut from non-defense discretionary spending – for things like housing assistance and community development – could be avoided entirely.

The FTT is a very low-risk bet, and, as mentioned, the returns could be huge. Most Americans are not trading derivatives or credit-default swaps, and thus would have nothing to worry about. The International Monetary Fund (IMF) examined Europe’s FTT and said it was “quite progressive.” According to the European Tax Commissioner, banks and other financial institutions, such as hedge funds, carry out as much as 85 percent of taxable transactions. In practice, the FTT would function in a similar way to the capital gains tax, which affects a very small number of people, most of whom are already wealthy. It would not be like the sales tax, which is regressive and falls disproportionately on the poor.

A Financial Transaction Tax would create a less volatile and speculative stock market, something few Americans would have a problem with. Because trades would be taxed (albeit at a very low rate), investors and financial managers would have an incentive to think long-term when making investments. This would discourage high-frequency trading (HFT), which offers very little to normal investors and has exploded in recent years, making the market more volatile  and dangerous. If HFT did not decline, however, it would simply result in more revenue.

Opponents of the FTT say it would harm financial markets and companies looking to raise money. However, smart legislation can avoid that problem rather easily. For example, the Harkin-DeFazio FTT would exempt the initial issuance of stocks, bonds, and other debts. Loans from financial institutions, companies’ initial public offerings (IPOs), and a city’s sale of municipal bonds, for example, would all be exempt from the FTT the first time they are sold. If a financial institution decided to trade a company’s debt after issuing it a loan, however, the FTT would come into effect.

Those arguing against the FTT also say the costs incurred by the tax would be passed on to retail investors -- through increased ATM fees, for example. But this is entirely avoidable with the right legislative language. The law could simply ban the practice, but even without an explicit ban, it is unlikely banks would take that course. Since some banks’ activities would fall under the FTT more than others’, not every bank would have the same incentives to raise fees on customers. As a result, if only a select few banks did so while others did not, marketplace competition would drive consumers to institutions without FTT-related fees.

In the wake of the 2008 financial disaster, which banks and financial institutions played a large role in creating, it makes sense to have policies designed to incentivize responsible trading practices and reign in reckless behavior. A Financial Transaction Tax would result in a more stable and less volatile stock market. It would also raise billions of dollars that could help avoid the harsh cuts set to begin March 1 – and it would do it all without touching the vast majority of Americans’ wallets.

Greg Noth is an intern in the House of Representatives and has formerly worked with the Center for American Progress and Iowa Senate Democrats. He is a graduate of Knox College in Galesburg, IL.

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