Financial Transactions Taxes Act As Drag On Economic Activity

Published September 6, 2013

Since the 2007-2008 financial crisis, legislators in the United States and across the world have proposed new taxes on certain financial transactions, including securities trading and stock transactions. For proponents of these financial transaction taxes, commonly known as “Robin Hood” taxes, the goal is twofold: raise revenue for the national governments and slow down short-term speculative trading, which they believe causes unnecessary market volatility.

While the creation of a financial transactions tax has yet to gain significant momentum in the United States, several countries in Europe have already implemented such a tax or are strongly considering one. In August 2012, France imposed a new 0.2 percent transactions tax on certain stock purchases. Early in 2013, 11 member nations of the European Union created a new tax of 0.10 percent – or 10 basis points — to be imposed on stock and bond trades and one basis point on derivatives.

Two Tax Proposals

Two pieces of legislation that would create a financial transactions tax are currently being considered in Congress.

The first, which was reintroduced by Senator Tom Harkin (D-IA) and Representative Peter DeFazio (D-OR) in late February, is the “Wall Street Trading and Speculators Act.” Under the Act, a 0.03 percent, or 3 basis points tax would be imposed on stock and bond trades.

A second bill, proposed by Representative Keith Ellison (D-MN), takes these reforms even farther. Ellison’s “Inclusive Prosperity Act of 2013” would impose a tax of 0.50 percent — or 50 basis points — on stock trades to raise additional billions of dollars in new tax revenue.

Proponents of transactions taxes argue markets can absorb them with little disruption, with the burden being borne by speculators. Opponents respond that these new taxes would harm financial markets by decreasing trading volume. This, in turn, would result in less revenue than governments anticipate. 

They also note transactions taxes would lower the values of pensions, retirement savings accounts, and financial tools like annuities, charitable trusts and money market funds.

Lack of Evidence

Hilary Till, a Heartland Institute policy advisor and co-editor of the book, Intelligent Commodity Investing, said she doubts a transactions tax would achieve its stated goals.

“Regarding the ‘Inclusive Prosperity Act of 2013,’ which proposes to ‘impose a tax on certain trading transactions [in order] to strengthen our financial security, reduce market volatility, expand opportunity, and stop shrinking the middle class,'” said Till, “I would think the onus would be on the sponsors to prove that such a taxation policy could actually achieve all of these goals. I certainly am unaware of such evidence.”

Harvard economics professor Kenneth Rogoff argued in an article on the European tax reforms that ordinary workers, not banks, would bear the brunt of the transaction tax.

“Higher transactions taxes increase the cost of capital, ultimately lowering investment,” Rogoff wrote. “With a lower capital stock, output would trend downward, reducing government revenues and substantially offsetting the direct gain from the tax. In the long run, wages would fall, and ordinary workers would end up bearing a significant share of the cost.”

Jeffrey V. McKinley, CPA and co-founder of Senex Solutions, LLC, says a transactions tax likely would raise the costs of investing and slow the economy.

Less Liquidity

“Historical experiences with transactions taxes in other countries have led to declines in liquidity, and most fall far short of their estimated revenue generation,” he said. “In fact, a study showed that the recently proposed bills, if enacted, would lead to the total elimination of all volume in 6 US Futures contracts including the S&P 500.

“The ‘tiny’ tax that legislators speak of is actually a 12,000 percent increase in trading costs for most professional trading firms. This disruption to the marketplace would have a devastating effect on price discovery and risk transfer mechanisms in the economy, both in the US and worldwide,” McKinley said.

The tax also likely would raise the cost of capital for corporations and other entities that issue stocks and bonds while reducing returns for investors.

‘A Blunt Instrument’

“The rationale is to raise revenue and reduce trading activity that some legislators believe is harmful to the marketplace and economy,” McKinley said. “As [Vermont Senator] Bernie Sanders has stated: ‘This bill will reduce gambling on Wall Street [and] encourage the financial sector to invest in the job-creating productive economy.’ Those terms of ‘gambling’ and investing in ‘job-creating productive economy’ are extremely vague terms and concepts. This is reflective of the danger of something like a transactions tax. A broadly applied tax is a very blunt instrument to combat a supposed market abuse.” 

McKinley said speculation plays an important role in managing risk and creating liquidity in the marketplace. Instead of imposing a tax to disrupt this activity, he said, the government should focus on real spending reform.

“Politicians are looking in the wrong direction by pursuing new taxes,” said McKinley. “They need to focus on cutting spending. Since 1948, the government has increased spending per individual in inflation-adjusted dollars by 500 percent.  The size of government needs to shrink.”