Amid the grim debates on the U.S. fiscal crisis and the impending “fiscal cliff,”—all problems, lest we forget, that should rightfully be traced to the 2008-09 global financial crash caused by casino capitalism—it is important to remember that there are real alternatives to surrendering to the austerity chorus. One major one is to generate formidable amounts of government revenue while simultaneously discouraging Wall Street hyper-speculation through imposing a tax on financial market transactions. This is has been variously termed a financial transaction tax (FTT), and more vividly, “Make Wall Street Pay tax,” “anti-speculation tax,” and “Robin Hood tax.”
Over the past 18 months, a movement to establish such a tax in the United States has been energized by my friends (and collaborators on this blog project) at the National Nurses Union, under the theme “Heal America, Tax Wall Street.” The Occupy Wall Street movement also strongly supported the idea, as one of the few specific policy measures they endorsed. In November 2011, Senator Tom Harkin and Rep. Peter DeFazio introduced a bill in the U.S. Congress for an FTT, although, as we discuss below, the tax rate they are proposing is far more modest than it needs to be. Last September, Rep. Keith Ellison introduced a much more ambitious FTT bill in Congress, the “Inclusive Prosperity Act. (Full disclosure here: I provided background analysis and participated in drafting the Ellison bill. More details on that below).
There is also strong support for an FTT throughout Europe, as, among other things, one crucial new way for the European Union to raise pubic revenues and oppose the austerity agenda now engulfing the region. In Europe, this proposal is not only being supported by traditional progressive communities, but also by the Archbishop of Canterbury in the UK, the Pope, and even, in some versions, German Chancellor Angela Merkel, among many others.
In its essentials, the idea of a financial market transaction tax is simple. It would mean that financial market traders would pay a small fee to the government every time they purchased any financial market instrument, including all stocks, bonds, and derivatives—the derivatives being options, futures, and swap trades. This would be the equivalent of sales taxes that Americans have long paid every time they buy an automobile, shirt, baseball glove, airline ticket or pack of chewing gum, eat at a restaurant or have their hair cut.
The financial transaction tax can be used to address two distinct but equally important concerns. First, the tax discourages financial market speculation because it raises the costs—and thus reduces the profit opportunities—for speculators. But assuming the tax rate is not set high enough to shut down financial market trading altogether, the tax can also be a large new source of government revenues. The tax rates could also be adjusted higher or lower, depending on whether the primary aim was either to shrink speculative market trading, to raise revenues, or to try to hit a sweet spot that achieves both aims to some meaningful degree.
Experiences with FTTs
It is important to recognize that the proposals now being advanced in both the U.S. and Europe by no means represent exotic flights into uncharted policymaking territories. In fact, financial transaction taxes have been a commonly used and generally effective policy tool through the world. Under financial market conditions closely comparable to those in the U.S., stock trading in the United Kingdom is subject to a 0.5 percent tax. This UK tax raises about $6.5 billion per year in revenues. Roughly 40 other countries are either operating now with some version of such a tax or have done so in the recent past.
Even the United States has long operated with a small transaction tax, revenues from which, to this day, finance the operations of the Securities and Exchange Commission. Moreover, in the aftermath of the 1987 Wall Street crash, such a tax or similar measures were endorsed by then House Speaker Jim Wright, a Democrat, as well as the Republican Treasury Secretary Nicholas Brady and the Direct of the Office of Management and Budget Richard Darman serving under President George H.W. Bush.
How a U.S. FTT Could Work
For stocks, the buyer could be charged, for example, 0.5 percent of the sale price, which is the amount both suggested by Former House Speaker Jim Wright when he proposed a bill in 1987, as well as being the current rate in the UK stock market (the buyer and seller could also split the total fee). For a $1,000 stock trade, the financial transaction tax obligation would therefore be $5. This is also the rate that Rep. Ellison is proposing for stock transactions under his Inclusive Prosperity Act proposal.
The tax could then be scaled for bonds, options, futures and other derivative instruments based on the 0.5 percent rate on stocks. As one possible approach here, to reflect the fact that bonds, unlike stocks, have a limited amount of time until they mature, the tax rate could be 0.01 percent for every year to maturity of the bond. Thus, the rate would be 0.1 percent on a bond that matures in 10 years and 0.5 percent—the same as with stocks—on a bond maturing in 50 years. The Ellison proposal takes a simpler approach, which is to set a flat 0.1 percent rate on all bond trades. This means that the tax on trading either a U.S. Treasury bond, a State of Massachusetts bond, or a General Motors bond worth $1000, the tax rate would be $1.
Ellison’s bill also proposes a much lower flat rate of 0.005 percent on trading of all derivatives—i.e. options, futures, and swap contracts. Therefore trading a contract to deliver $1000 worth of oil in one year—one standard version of a futures derivative contract—would entail paying a financial transaction tax of one-half of one cent only.
An FTT at the rates proposed by Rep. Ellison would have virtually no impact on anyone who bought an asset and did not promptly resell it for a quick profit. For example, if someone bought shares of stock at $500 and sold them 10 years later at $1000, this trading tax would be $5 per share (0.5 percent of $1000), on a $500 capital gain (i.e. bought at $500, sold at $1,000).
On the other hand, a 0.5 percent tax would seriously reduce the profit prospects for short-term speculators, who now account for about 70 percent of all market activity. It is not uncommon for speculators to buy a stock or other financial asset, hold it for a day or even hours, then resell it for a small gain. If someone bought a share for $990 yesterday, then sold it for $1000 today, the transaction would net a $10 capital gain, a good return on a one-day investment. But the tax in this case would again be $5, wiping out half the earnings from the trade.
A financial transaction tax at a 0.5 percent rate on stocks and scaled appropriately for other instruments is not high enough, acting on its own, to adequately discourage speculation and channel credit to productive purposes. An FTT at this rate would be most effective as one measure among several others within a broader package of policies coming out of the 2010 Dodd-Frank financial regulatory law, assuming that Dodd-Frank is enforced seriously (which is a strong assumption to make; more on that in a later blog post).
Of course, one could use the tax to dramatically cut financial speculation. That would only entail raising the tax rate until the point where traders see little incentives to trade at all. But the aim of the tax should not be to shut off financial market trading altogether. For one thing, shutting down trading totally would mean that the tax revenues from trading would fall to zero. Also, to my knowledge, nobody has developed a coherent plan for operating the U.S. economy today in the total absence of financial market trading.
The FTT has the unique feature that even if it is set too low to dampen speculation, the revenues generated from the tax would provide major fiscal benefits at a time when new sources of government revenue are badly needed. Working with 2011 figures, James Heintz and I estimate that the FTT at rates proposed by Rep. Ellison would raise on the order of $600 billion per year if trading did not decline at all after the tax was imposed. By this estimate, even if trading declined by 50 percent as a result of the tax, the government would still raise around $300 billion per year. ( Read here if you want to follow how Prof. Heintz and I generated these estimates, in a memo requested by the Robin Hood Tax coalition).
Even assuming the full 50 percent reduction in trading resulting from the FTT at Rep. Ellison’s proposed rates, the level of revenue generated by the tax could cover nearly 25 percent of the entire U.S. federal deficit for 2012. These funds could also be used as a major new source of revenue for public investments in infrastructure and the green economy, and, as such, a major new engine of job creation. Crucially, the burden of the tax would fall most heavily on Wall Street speculators, who are almost entirely upper-income people.
Setting the Tax Rate High Enough to Matter
Of course, an FTT can neither generate large amounts of revenues nor discourage excessive speculative trading if the tax rate is set too low. The proposal now in the US Congress by Senator Harkin and Rep. DeFazio would set the tax rate on all financial market trades—stocks, bonds, and all forms of derivatives—at 0.03 percent of the value of a trade. That is, the tax on a $100 trade of would be three cents. This is 1/17th as large as the 0.5 percent tax that now operates on stock trading in the United Kingdom and is proposed for the U.S. by Rep. Ellison’s measure. Supporters of Harkin/DeFazio justify this low rate for the U.S. on the grounds that setting the rate higher—for example at 0.5 percent on stocks—could render financial market trading prohibitively expensive. Revenues generated by the 0.5 percent tax could then end up lower than at the 0.03 percent rate, since trading volume would fall excessively.
However, a recent technical paper by James Heintz and I examined a wide range of evidence on financial market trading patterns in the U.S. and elsewhere. We found that there is no scenario within a reasonable range of assumptions about market activities in which a 0.03 percent FTT on stocks will end up generating more tax revenues than a 0.5 percent tax on stocks. Rather, considering the full range of alternatives, we found that a 0.5 percent tax on stocks will produce between 3 and 17 times more revenue than a 0.03 percent tax. You can read that study here.
Beyond such specific issues, the major challenges for successfully implementing an FTT in the U.S. are not technical but political. Predictably, the Wall Street titans are vehemently opposed. Despite being themselves the main culprits causing the 2008-09 global financial meltdown, and despite having been rescued from the consequences of their excesses through a U.S. taxpayers-funded bailout, Wall Street continues to exercise tremendous political power, in both the Obama Administration and among Republicans. The FTT will therefore not possibly become law unless a large mobilization of political progressives follows the example of the National Nurses Union to fight hard in supporting it. Implementing the FTT would be one important tool for forcing these high-rollers to pay for cleaning up the mess they created. More broadly, the financial transaction can make major positive contributions towards forcing the financial markets away from the logic of the casino and, thereby, to reorder the market’s priorities in behalf of long-term productive investments and job creation. This is exactly the type of initiative we need to break out of the logic of fiscal austerity and the fiscal cliff now threatening to engulf President Obama’s second term.
If you would like to plunge into a full-scale academic study of the issue that Dean Baker, Marc Schaberg and I published on this topic nine years ago in the Eastern Economic Journal, you can find that here.
If you will allow me to indulge in an “I told you so,” moment, you can read a piece that Dean Baker, Marc Schaberg and I published in The Nation in 1994 (!), called “Wall Street vs. Main Street: Taxing the Big Casino.”
In July 2011, I participated in a full-scale 2-hour debate with Professor James Angel of Georgetown, a leading opponent of the FTT, which was shown on C-Span. If you have the time, you can watch that here.
A much more recent, and also much shorter, 13 minute, semi-debate between Prof. Angel and me, along with news material on Rep. Ellison’s bill, can be found here.