Like Socialism, Financial Transaction Tax Doomed to Fail
In The Wealth of Nations, Adam Smith coins the four maxims of taxation: fairness, certainty, convenience, and efficiency. Smith’s maxims are used as a litmus test amongst public finance economists when determining if a tax is “good” or “bad.” In the case of a financial transaction tax (FTT), such a notion is neither fair, certain, convenient, nor efficient—and therefore, bad public policy.
Simply defined, a FTT is a tax imposed on the buyer or seller of a security. With populist anti-bank sentiments at a high in the wake of the 2008 and 2009 financial crisis, the FTT gained momentum globally as advocates argued it would decrease market volatility while increasing government revenue. While varied in substance, several developed nations have embraced a FTT in the past decade. Earlier this month, the UK’s Labour Party even doubled down on their support of the FTT.
However, the FTT has not delivered any of its desired goals. Take Italy and France, for example, which both raised less than a quarter of expected revenues after implementing an FTT in 2012. Such a tax, according to Americans for Tax Reform’s Alex Hendrie, would also “increase market volatility as there would be fewer buyers and sellers and therefore more price jumps.” Beyond that, it’s not banks who bear the cost, but taxpayers and consumers.
While the U.S. has fortunately forgone adopting a FTT, policymakers have certainly tried. The first was Rep. Peter DeFazio (D-OR), who introduced H.R. 7125, the Let Wall Street Pay for Wall Street’s Illiquid Assets Act in 2008, as an alternative to H.R.1424, the Troubled Asset Relief Program. While both proposals were riddled with legislative malpractice, lawmakers chose to go with the latter.
Even after ten years and numerous cases of trial and error, politicians continue to beat the drum. In March, the aforementioned Rep. DeFazio introduced legislation with Sen. Brian Schatz (D-HI) that would levy a FTT of 0.1 percent on the sale of any stock, bond, or derivative. Shortly after, Sen. Bernie Sanders (I-VT) and Rep. Barbara Lee (D-CA) introduced similar legislation that would instead levy a FTT of 0.5 percent.
Authors of the bills hope that such proposals will “address economic inequality” and “curb Wall Street greed.” While numerous big-government groups expressed their support for the FTT, it didn’t sit too well with some moderate Democrats who lambasted such proposals.
Despite the limelight in recent years, the substance of the FTT is really nothing new. In 1694 King William III and Queen Mary II imposed a stamp duty —transaction tax—on vellum, a paper made of calfskin, and since 1986 it’s applied to the transfer of securities and other investment vehicles. From 1914 to 1965 the U.S. had an FTT on stock issuances which, according to the Investment Company Institute, was set at “initially 2 basis points (0.02 percent) in 1914, increased to a range of between 4 and 6 basis points from 1932 through 1958, and reverted to 4 basis points from 1959 until the tax was repealed in 1965.” The FTT was repealed since “the tax was viewed by Congress as complicating securities transactions.”
The FTT garnered academic credence in the 1930s as John Maynard Keynes pushed for expanded government involvement in the economy. Believing that the invisible hand was not enough to guide investors and consumers, Keynes wrote:
The introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States.
Throughout the latter part of the 20th century, those of a Keynesian pedigree would go on and advocate for similar policies—see Tobin (1978) and Stiglitz (1989).
In 1984, Sweden fell victim to the allure of a Keynesian FTT and introduced a 0.5% tax on the purchase or sale of any equity. This quickly proved to be a massive failure as “in the first week of the fixed-income tax bond trading volumes fell by 85%; the amount eventually raised from the tax averaged only about 3% of what was predicted. By 1990 over 50% of Swedish equity trading had moved to London.” When the tax was abolished in 1990 investors returned and in the past few decades Sweden has become one of the top countries for start-ups.
Despite the well-documented cases of failure both globally and domestically, lawmakers remain adamant that a FTT is the be-all and end-all of public finance. While the financial crisis and subsequent recession certainly weakened trust in financial institutions, channeling animosity against big banks through a financial transaction tax does nothing to better markets and only hurts already struggling consumers.