Financial Transaction Taxes (FTT) make for great political soundbites. Tax the banks! Raise revenues! There are a bunch of ways to get that job done but FTTs aren’t it. Here’s why FTTs are not fit for purpose while damaging the constituencies that politicians want to support.
The more recent call for a FTT came from the Michael Bloomberg campaign for the US democratic nomination. His plan proposes “a tax of 0.1% on all financial transactions, including stocks, bonds and payments on derivative contracts. The tax would be phased in gradually, starting at 0.02%, to monitor and minimize any unintended consequences.”
The surface logic of FTTs always make sense: if you want to make money, go where the money is. In this case, that’s the business of trading and trading commissions. Theoretically, the impact of a tax would affect only the rich and would reduce high frequency speculative trading. The Bloomberg campaign says that “By one estimate, if the U.S. imposed a financial transaction tax of 0.10%, about two thirds of the burden would fall on the top 10% by income. Bloomberg is far from the only politician in the US or globally who thinks FTTs are a good idea. Other US presidential candidates have called for it as well as US House representatives, and 10 EU countries including France, Germany and Italy continue to push for a joint FTT across the union.
The bad news is that FTTs fail to deliver on several fronts, notably:
- FTTs aren’t a tax on banks, often the target of progressively minded politicians. Rather, they are a pass-through tax to investors. Banks simply mark up the cost of a trade with the tax and charge their client. This makes trading more expensive, which in turn decreases the amount of trades that happen and lower shareholder returns and potential willingness to trade to begin with. SIFMA’s president and CEO Kenneth E. Bentsen, Jr., emphatically summed up this point in a comment on FTTs last week: “A Financial Transaction Tax, or FTT, would tax middle class savers, including pension funds, 401ks and IRAs. At a time when market development, efficiency and competition are driving the cost of investing toward zero, it makes little sense to increase the cost through what is essentially a sales tax. Further, the threat such a tax poses to the efficiency of the U.S. capital markets is real. It begs the question, what’s the point?” We have to agree.
- Imposing a tax on high frequency traders will put some strategies out of business but will embolden others – this is a game of whack a mole. We have seen countless times that trading firms take advantage of whatever their particular market environment offers. If a new FTT is part of the equation, you can be certain that traders will find a way to capitalize on new arbitrage conditions. If you want to discourage very short term trading, impose a larger tax on very short term trading, not all trading.
- FTTs often fail to generate the revenues that excite politicians in the first place. In the last five years we have seen FTTs in France, Italy and Hungary fail to live up to expectations, at times generating no more than 50% of projected revenues. A big FTT experiment in Sweden almost 30 years ago led to a total collapse in the government bond markets.
Even the research paper that Bloomberg uses in support of an FTT is uncertain whether this is a good idea. The 2015 “Financial Transaction Taxes in Theory and Practice” from the Tax Policy Institute concluded that “An FTT at the rates being proposed and adopted elsewhere would discourage all trading, not just speculation and rent seeking. It appears as likely to increase market volatility as to curb it. It would create new distortions among asset classes and across industries. As a tax on gross rather than net activity, and as an input tax that is not creditable and thus cascades, the FTT clearly can most optimistically be considered a second-best solution.”
If you want to tax banks and trading firms, there are easier ways to do it, including taxation based on the size of the balance sheet, duration of trading activity or reserves held at the Fed. An FTT will fall on the underlying people and institutions who transact in financial markets. There will be some high frequency traders, but also millions of small retirement savers. It will also force a rethink of trading strategies by major institutions, which will lead to a decline in market liquidity on a daily basis, which in turn leads to increase costs for issuing firms (and governments). FTTs sound really good on paper, but the broader impacts to financial markets and investors is are not worth the press. There are better ways to achieve similar goals.