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5 Reasons the World Is Catching on to the Financial Transaction Tax

Financial transaction tax

SOURCE: AP/ Yves Logghe

Campaigners and European trade unions dress as Robin Hood while calling on European Union leaders to go ahead with a financial transaction tax to mobilize money to help poor people hit by the economic crisis, in front of the European Council building in Brussels on May 23, 2012.

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It has been more than 70 years since John Maynard Keynes wrote about the value of a financial transaction tax in “mitigating the predominance of speculation over enterprise in the United States.” A financial transaction tax works by levying a miniscule fee on the estimated $2.9 trillion of daily financial activity through the trading of stocks, bonds, and derivatives in U.S. financial markets, based on our analysis. The tiny tax makes some of the most speculative unproductive trading unprofitable, thus steadying markets and promoting real investment while raising much-needed revenues. Though many countries around the world already have a financial transaction tax in place, the United States does not yet levy such a fee on trading.

While the idea of a modest financial transaction tax—or FTT, as it is often known—has been around for a long time, with budget balances and economic growth strained in the aftermath of the Great Recession policymakers around the world are taking a new look at the tax.

Below are five reasons why the world is catching on to the financial transaction tax as a smart policy tool.

A financial transaction tax would bring in much-needed revenue

The U.S. government is currently operating at its lowest level of revenues in more than 60 years. A 2010 report from the International Monetary Fund identifies the financial sector of the economy—particularly in the United States—as substantially undertaxed.

Even a tiny financial transaction tax would raise tens of billions of dollars in much-needed revenue. A tax applied at a very low rate—for example, a 0.117 percent tax on stocks and stock-options trading, a 0.002 percent tax for bonds, and a 0.005 percent tax for futures, swaps, and other derivatives trading—would raise an estimated $50 billion a year, according to our calculations. To put that amount into perspective, $50 billion in essence pays for all of America’s veterans health services, which ran to $50.6 billion in 2012. Historical evidence and economic theory show that financial transaction taxes have the potential to raise substantial revenues without impeding the function of capital markets. By keeping constant the relative transaction costs of trading in different markets, a financial transaction tax can raise revenues without distorting market behavior.

Business and civic leaders support a financial transaction tax

The idea of a financial transaction tax isn’t new, but the chorus singing its praises is growing every day—from leading economists such as Nobel Prize winners Joseph Stiglitz and Paul Krugman to entrepreneurs such as Bill Gates and Marc Cuban, to financial leaders the likes of John Bogle, founder of the mutual-fund giant Vanguard Group. The financial transaction tax also has the support of unions for nurses and other health care professionals and service-sector workers.

Those in the financial sector have an obvious stake in any new tax on their business. But even many within the industry are making the case for a financial transaction tax. John Fullerton, former managing director at JPMorgan and current president at the Capital Institute, has said, “A modest financial transaction tax of less than 1 percent would serve as a remarkably efficient tool to achieve needed reform.” Bogle wrote about a transaction tax in his book, Clash of the Cultures: “Taxes can be brought back into play, replacing some of the frictional costs of investing that served to moderate the speculation that prevailed in an earlier era.”

Countless other financial professionals will concede, in the anonymity of polite company, that a modest and well-crafted tax on financial transactions would have negligible impact on the dynamism of capital markets, and might even help eliminate some of the more unsavory financial practices that stack the deck in favor of big investors and encourage unhealthy risk taking that can put the whole economy, as well as taxpayers, on the hook for the costs.

A financial transaction tax helps stabilize volatile financial markets

An astounding share of transactions on financial markets today consists of high-frequency trades made on the millisecond by computers programmed with sophisticated algorithms. The computers make large-volume trades based on tiny changes in prices—fractions of a penny—and, in so doing, reap tremendous trading profits. While economic theory might suggest that this would lead to slightly more efficient financial markets, the Bank of England’s Andrew Haldane has shown that “high-frequency trading appears to have amplified” the markets’ erratic undulations.

High-frequency trading is sometimes associated with the phenomenon of “flash crashes,” where market prices fall precipitously due to a perfect storm of preprogrammed computer trading. The largest flash crash to date came on May 6, 2010, when the Dow Jones Industrial Average dropped by almost 10 percent from the opening level, and literally billions of dollars in market value disappeared from the stock market in a matter of minutes. Prices rebounded over the next week, though investors were rattled and withdrew $137 billion from the market in the subsequent months. Since then, there have been many more mini flash crashes with no sign of abatement.

Flash crashes are just one example of how financial market power and high-frequency trading combine to create unfair and destabilizing effects in financial markets. Even a conservative financial transaction tax would make these types of trades unprofitable by levying a fee for every transaction, thus eliminating this risky behavior from our markets.

A financial transaction tax incentivizes investment for real growth

The financial transaction tax by design increases transaction costs of financial trading, thereby encouraging investors to hold financial assets in their investment portfolios for longer periods of time instead of trading often. Investors who expect to hold stocks longer tend to pay more attention to the enterprise and fundamental value of the stock rather than aiming to leverage capital and computational power to exploit market loopholes for big short-term profits. A longer-term outlook for investors and more stable financial markets mean more investment, more jobs, and higher productivity in the real economy—all of which drives growth.

By changing the incentives that investors face in U.S. financial markets, a tax on financial trading will shift behavior toward investment for the long term, which is better for financing businesses and for stable sustained economic growth.

Many countries already have a financial transaction tax

The standard stalling tactic for bringing a financial transaction tax to the United States is saying that we should wait until other countries do it first. But financial transaction taxes already operate in at least 23 countries around the world—including in international financial centers such as the United Kingdom, Switzerland, Hong Kong, and Japan—and that number is about to grow.

On January 22, 2013, 11 of the European Union’s 27 member countries, including France, Germany, and Italy, indicated their intention to initiate a financial transaction tax. As the policy nears implementation, other EU countries are certain to get on board. Of the world’s major financial centers, only the United States has no tax on financial trading.[1]

As more European countries implement such a tax, the United States could easily jump on board and do the same, becoming part of a global financial transaction tax system. Globalizing the tax not only would greatly reinforce its effectiveness and benefits, but would also avoid concerns about market migration and efforts to evade regulation in financial havens. Now would be a smart time for politicians in Congress to also rethink the benefits that a tax on financial transactions could bring to our economy.

Adam S. Hersh is an Economist at the Center for American Progress. Jennifer Erickson is the Director of Competitiveness and Economic Growth at the Center.

[1] Technically, the United States’s Section 31 that levies fees on U.S. stock transactions is a micro-FTT of .00224 percent. This tax funds operations of the Securities and Exchange Commission. “Securities and Exchange Commission: Selected Releases and Information Concerning Changes in the Section 31 Fee Rate,” available at http://www.sec.gov/divisions/marketreg/sec31info.htm (last accessed February 2013).

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