The proposed U.S. transaction tax leads investors on a path that in other markets has created distortions in trading, liquidity and costs, while achieving none of the hoped-for objectives in mitigating volatility, high-frequency speculation and systemic risk.
The Wall Street Trading and Speculator Tax, S.B. 410 and H.B. 880, was introduced Feb 28 by, respectively, Sen. Tom Harkin and Rep. Peter DeFazio. In addition, S.B. 277 was introduced Feb. 11 by Sen. Sheldon Whitehouse. In all three versions, a 0.03% tax would be imposed beginning next year,targeting trading in equities, fixed income and derivatives and including futures, forwards, options and swaps, as well as derivatives in currencies and commodities.
The low rate of such a tax, coupled with the high volume of trading, makes it attractive because proponents believe few investors will notice the sting of paying such a tiny amount. The administration and many members of Congress, hungry for revenue, have been searching to tap new sources, and a transaction tax appears to fill that need,
Mr. DeFazio, D-Ore., said in a statement that the legislation “reins in the excessive speculative activity that has destabilized our financial system.” Mr. Whitehouse, D-R.I., said in the same statement that the legislation will discourage “the kind of reckless high-volume trading that contributed to the financial crash in 2008.”
But clearly the primary reason for proposing the tax is raising federal revenue. “We need the new revenue that would be generated by this tax in order to reduce def-icits and maintain critical investments in education, infrastructure and job creation,” Mr. Harkin, D-Iowa, said in the statement.
An estimate of the financial impact of the legislation wasn't available. However, the Joint Committee on Taxation estimated in 2011 that a similar bill would raise $352 billion over 10 years.
The Senate bills are pending in the Finance Committee and the House bill in the Ways and Means Committee.
The tax is a bad idea. It likely won't raise anywhere near the expected revenue, and its broad, scattershot approach isn't tightly aimed at curbing so-called abuses or at addressing systemic risk posed by high-speed or other types of trading..
If high-frequency or high-speed trading is an abuse or disrupts markets, then the legislators need to address it directly, by identifying the concerns, specifying remedies and introducing a bill, or by calling on the Securities and Exchange Commission to propose rules to ban or regulate the practice's abusive elements.
In the aftermath of the financial market crisis, some policymakers embraced transaction taxes to curb volatility and raise revenue to pay for restoring the financial system, but none of the proposals moved forward.
However, the 2013 agreement to adopt a transaction tax by 11 European countries, including Germany, France and Italy, contributed to Messrs. Harkin and DeFazio and the other co-sponsors embracing the idea, and there is now more widespread support for such legislation.
The members of Congress should take into account the lesson of Sweden, which once embraced such a tax. Now its finance minister is a leading voice in opposition to it because of its all-around failure to meet its objectives, and the subsequent harm it caused.
Sweden implemented a transaction tax in 1984 at a 0.5% rate, doubled it in 1986 and then in subsequent years lowered it and finally abolished it in 1991, following disappointing revenue and disruption of its financial markets.
A European financial transaction tax is unlikely to raise the sums of money projected because it would encourage firms to move overseas, Anders Borg, Sweden's finance minister, told the BBC.
Mr. Borg said in the 2011 interview the tax caused much of the trading and many trading companies to migrate to other markets, and never approached realizing the revenue goals.
The existing transaction taxes raise relatively small amounts of revenue relative to GDP and government spending. In Switzerland the tax raises 0.37% of GDP. In Taiwan it raises 0.8% of GDP. In the United Kingdom, the Stamp Duty Reserve Tax on financial transactions raises just 0.3% of GDP. Even if a U.S. tax raised 0.5% of GDP, it would hardly make a dent in government spending, now running about 25% of GDP.A report of the International Regulatory Strategy Group, a U.K. organization of professionals in financial services, noted in response to the proposal of a new transaction tax in the United Kingdom that it would create market distortions, while not mitigating trading that poses systemic risk.
Transaction tax proponents in the U.S. contend short-term trading and speculation add to market instability. But speculation, such as arbitrage and short-selling, helps stabilize prices, keeping them from getting too extreme.
A 2003 study by two International Monetary Fund economists found that financial transactions contribute to increased volatility in the market and lower volume, not the purported result the tax proponents seek. Another IMF paper published in 2011 found that a securities transactions tax “reduces trading volume ....(and) may increase the price impact of trades, which will tend to heighten price volatility.”
There are other effects. Kenneth Rogoff, the Thomas D. Cabot professor of public policy and an economics professor at Harvard University, maintains transaction taxes raise the cost of capital, ultimately reducing capital investment and output, and cutting government revenue.
The DeFazio, Harkin and Whitehouse proposals could cause market distortions and complications because they exempt certain investors from the tax. Their bills might provide some exemption for retirement plans and some other qualified investors, but this could create a complex administrative burden. For example, commingled funds would have to split transactions between qualified and unqualified investors. Investment advisory firms would likely pass on such administrative and compliance costs, raising costs to pension funds even if they were exempt from such a tax.
As Mr. Harkin said in his statement: “There is no question that Wall Street can easily bear this modest tax. This Wall Street tax is a simple matter of fairness and fiscal sanity.”
But Wall Street ultimately will not bear the tax. The clients will.
Investors fight to eliminate every basis point of trading costs, because trading costs diminish investment performance. They will certainly fight this tax, or seek to avoid it. In doing so they might well take unnecessary and unintended risks.
A transaction tax is no way to stop trading abuses or improve fiscal finances. But it can have detrimental consequences on markets and investors.
