Last month Senator Brian Schatz (D., Hawaii) introduced a bill in Congress to pass a financial-transactions tax (FTT) at the federal level. An FTT would effectively act as a 0.1 percent levy per trade on all financial transactions (e.g., stock and bond trades). Further to the right, Oren Cass — the founder and executive director of the think tank American Compass — has argued that policymakers “should consider . . . imposing a financial-transactions tax on asset exchanges in the secondary market.” In an interview with Bloomberg, Cass suggested that some congressional Republicans had indicated privately that they would be receptive to such a tax.
If so, that’s disappointing. Considering the FTT purely as a revenue-raising mechanism (although, to be fair, many of its advocates see it as a punitive measure to limit what they see as “unproductive” economic behavior), it is likely to raise less money than hoped. Instead, FTTs often encourage exchanges to move and institutions to reroute their trades, while middle-class retail investors end up facing a large degree of the tax incidence in the form of higher transaction costs. Some New York State and New Jersey lawmakers have also been advocating an FTT, prompting the president of the New York Stock Exchange (NYSE) to threaten that the Big Board could leave New York and relocate its servers from New Jersey to a more welcoming destination if the Garden State went through with plans to introduce an FTT there.
The truth of the matter is FTTs (or “Tobin Taxes,” as named after Yale economist James Tobin, who recommended a federal FTT in 1972 amid the collapse of the Bretton Woods system), have a long international history and a very poor track record.
A recent report by the Committee on Capital Markets Regulation provides an excellent summary of the academic literature on FTTs. Every study in the survey finds that such taxes in France, Sweden, and Italy reduced liquidity and lowered trading volume in equity markets (France and Sweden have since abolished their FTTs). In most cases, studies also found heightened market volatility as a result of FTTs. Similarly, economists Anna Pomeranets and Daniel Weaver find that the New York State Securities Transaction Tax (STT), an FTT that was in place between 1932 and 1981, had the same effect on liquidity and volatility, results which, taken as a whole, are hard to square with the broader objectives of some of those supporting an FTT (who specifically want to reduce the levels of trading activity).
The consequences of FTTs aren’t purely financial, either. These taxes can have meaningful effects on the real economy. In a 2014 paper, USC economics professor Yonhxiang Wang found that when the People’s Republic of China reduced its FTT in the 1990s, market valuations rose as a consequence, along with higher levels of real investment, innovation and equity financing. The results highlight the harms to businesses and households from policies that distort capital markets as the prospects of the real economy are very much intertwined with the prospects of the financial economy.
Over time, many countries have given up on FTTs much as they have given up on wealth taxes for, primarily, pragmatic reasons in that these taxes have incentivized capital and trading activity to move elsewhere, reducing the prospects for revenue generation. Sweden abolished its FTT in 1991 (as trading moved to London) and Japan ended its FTT in 1999. While the U.K. retains an FTT to this day, the majority of trades are exempt from the tax.
There are some caveats to some of these findings. FTTs can be less harmful in nascent markets with few institutional investors. In a recent Journal of Financial Economics article, the authors found that FTTs significantly increase market volatility only in advanced economic financial markets (such as the U.S.) that have a significant number of institutional investors. The latter should be further warning to Senator Schatz and others who want to introduce an FTT here in the U.S.
Another paper in the Journal of Economic Behavior & Organization describes an experiment with treatment groups (experiencing an FTT) and control groups (with no FTT), finding that a simulated FTT “reduces trading volume, shifts market share to untaxed markets, and leads to negligible tax revenues if tax havens exist.”
The CBO estimates the proposed 0.1 percent FTT would raise only $77 billion per year on average (a drop in the bucket in the U.S. economy with a GDP of $20 trillion), a small amount of revenue relative to the amount of economic distortion it would create.
As economist Art Laffer famously said, “All taxes are bad. Some are worse than others.” FTTs are certainly among the worst from an efficiency standpoint.