When bank robber Willie Sutton was asked, “Why do you rob banks?” he reportedly responded, “Because that’s where the money is.” Progressives should keep this insight in mind when talking and thinking about how to pay for the needs facing the United States—from job creation to road repair to expansion of human services to investments in green technology. This insight points us toward the financial sector because it is both the one that has grown most rapidly in the past three decades and that contributes the least to our overall welfare.
Since the mid 1970s, financial services have grown at a rate well above that of the economy as a whole. U.S consumers spent less on new automobiles in 2007 than they did on brokerage charges and investment counseling; in 1979, they spent ten times as much on the former. At the macroeconomic level, the profits of financial corporations jumped from close to 22 percent of total corporate profits in the mid 1970s (and earlier) to more than 40 percent by 2005–2006. Financial sector employees have done quite well, as can be seen most recently by the billion-dollar-plus average incomes paid to twenty-five individual hedge fund managers. Their earnings would have paid for 658,000 new teachers. These figures don’t show the big shift, though, which is that thirty years ago, income in financial sectors was 110 percent of the overall average U.S. income. Today, it is almost double the U.S. average.
We know where the money is. How do we get it? There are, of course, several ways of tapping this pool of dollars for broader social purposes, including raising income taxes on high incomes, reinstating and strengthening the estate tax, or levying a special surcharge on financial sector profits. However, the approach I favor focuses on taxing the primary activity that drives much of the individual incomes and corporate profit levels in finance. A financial transaction tax (FTT)—a tax on the trading of financial assets—has multiple appeals. First, it could generate significant revenue. Second, and equally important, it is a progressive tax that would affect primarily wealthy individuals and large corporate institutions, with benefits potentially flowing to many. Further, while an FTT is not a substitute for effective regulation of finance, it would act to dampen some financial activity, helping to reshape a political economy in which finance has become overly dominant. Finally, the political logic of an FTT—the dynamic of Wall Street vs. Main Street—should give it wide appeal.
How Much Money Could an FTT Raise?
Three broad classes of financial assets would be subject to an FTT: stocks, currencies, and debt instruments (for example, bonds, treasury notes, and bills). There are two important points to keep in mind about the structure of markets for financial assets: these assets may be traded either on or off organized exchanges (the latter are usually referred to as over-the-counter markets), and they are traded in a variety of forms. The latter include markets for the asset itself, often referred to as the “cash market” (for example, the New York or NASDAQ stock exchanges for stocks) and markets that trade instruments whose prices are derived from these cash markets. These latter include markets for trading futures and options (which may also be on or off exchanges). An effective FTT should cover all venues and all instruments without advantaging one venue or instrument over another. If it doesn’t, trading will shift from a taxed venue to an untaxed one.
LET’S LOOK AT HOW such a tax would work in the trading of stocks. This is probably the instrument most familiar to many readers and one that has been taxed in other countries.
In what follows, I draw from various annual reports of the World Federation of Exchanges and from the Securities Industry Fact Book for different years. In 1984, the total value of stock trading on the New York Stock Exchange (NYSE) and the NASDAQ Stock Market first approached the $1 trillion level. In 2008, the traded value on these two markets, which together account for more than 90 percent of stock trading in the United States, totaled slightly over $70 trillion, a more than seventy-fold increase in twenty-four years. Even in the more subdued environment of 2009, the value of stock trading on these two markets exceeded $46 trillion.
This seventy-fold increase in stock traded value wasn’t because of an increased value of the stocks available for trading. At year-end 1984, the total capitalization of the U.S. equity market was $1.8 trillion; at year-end 2008 it was $11.6 trillion. Even taking into account the 2008 market collapse and using year-end 2009 data, total U.S. market capitalization was $15.1 trillion. Thus, the value of stocks available for trading grew by 544 percent between 1984 and 2008. But the value traded (the sum of all trades in a year) jumped over 7000 percent. This means that, on average, shares in the U.S. stock market changed hands less than once every two years in 1984; in 2008, shares changed hands about every three months (in 2009, the average share changed hands every four months).
This growth in trading rather than value resembles a game of musical chairs in which the speed of the music increases as the game progresses. It is very difficult to ascertain any benefits that have accrued to the U.S. economy or to the average equity investor as a result of it. It is clear, however, that those who do the trading and those individuals and firms who skate on the bubbles of investment, skimming off a few pennies with each trade, have done quite well.
So, how much revenue could a modest FTT raise from the trading of stocks and stock derivatives? An FTT of 0.25 percent—a levy of $1 on every $400 of stock traded—would have raised $350 billion in 2008, assuming that both buyers and sellers are charged the FTT. Of course, 2008 was a very active year for stock trading; applying the same FTT to 2009 would have raised $233 billion.
It’s not that simple, of course. Because there are derivative markets as well as markets for the underlying asset—in this case, stocks—traders can produce returns equivalent to those from investing in the S&P 500 index stocks by using either futures or options. Therefore an FTT must encompass these products as well.
In 2008 the value of trading in S&P 500 futures and options on the futures was $61.8 trillion and the value traded in S&P 500 index options was $25 trillion, for a total of $86.2 trillion.
The two kinds of trades occur at different rates, though, so an FTT needs to be designed to be fair to both kinds of trades. For instance, excluding the exceptionally high turnover in 2008, the average share of stock changed hands every six months during the 2004–2009 period. But unlike stocks, futures and options have a limited life span—the contracts expire at predetermined dates. Almost 90 percent of the trading in index futures and index options is concentrated in the nearest (“front”) month of the March/June/Sept./Dec. cycle, requiring trades every three months.
If the FTT were the same for each trade, participants would move to markets with fewer trades per year, that is twice a year rather than four times. An FTT that would not advantage either cash or derivative trading should be set so that the FTT levy on the four futures round turns (eight trades) would equal the FTT levy on the two cash portfolio round turns (four trades). Thus, equalizing the impact of an FTT across cash and derivative equity markets suggests a tax of 0.125 percent/side for the index derivatives or $1 for every $800 of notional (or underlying) value traded.
An FTT set at this level would have generated $154.6 billion from index futures and options on index futures trading in 2008 ($147.2 billion in 2007). There would have been an additional $62.5 billion from the levy on index option trading in 2008 ($67.2 billion in 2007).
Thus, taken all together, an FTT covering stock and stock derivative trading would have generated at least $567 billion in 2008 and $475.8 billion in 2007. This calculation is conservative, because there are several small stock markets that are not included in this calculation as well as trading of futures and options on other indices such as the Dow Jones Industrial Average. The table above provides the summary data.
EXTENDING THE ABOVE calculations to the remaining two asset classes, currency and debt, more than doubles the totals shown above. But how politically probable is such a tax?
The idea of taxing transactions in trading of financial assets is not new. John Maynard Keynes advocated a tax on trading of stocks, particularly with respect to the U.S. equity market, to mitigate an activity he considered akin to that occurring in casinos. James Tobin raised the idea in 1972 and again in the 1990s. Ironically, in 1989, Larry and Victoria Summers wrote a very good article advocating such a tax. Paul Krugman and Joseph Stiglitz have also advocated an FTT, as has Lord Adair Turner, the senior UK market regulator, who argued that an FTT would reduce the “socially useless” activity that much financial asset trading represents.
One of the most appealing aspects of an FTT is that it is strongly progressive. The answer to the question “Who would pay the tax?” is, of course, anyone who trades financial assets. The more such individuals or businesses engage in trading of financial assets, the more tax they would pay. These would be people who could afford it.
Although almost half of all households in the United States own some stocks, the majority own stocks indirectly, that is through a mutual fund or a pension plan. Slightly over 20 percent of U.S. households own stock directly, and it is only among the top 10 percent of households by income that the average value per household exceeds $20,000. Therefore a tax on trading activity will fall heavily on this affluent 10 percent of all households. Of course, even in this case, households that follow a buy-and-hold strategy will pay very little tax.
Households that own stock indirectly would pay the tax indirectly to the extent that the portfolio managers who invest their savings engage in trading activity. These households can also exercise considerable control over the extent to which they pay the FTT by choosing funds that trade infrequently. There is little or no evidence that increased trading by active managers outperforms index funds (although it does generate increased revenue to the active managers), so that any shift by households into such funds will certainly not depress and may actually improve their long-run returns.
The unprecedented increase in equity trading over the past thirty years reflects both (1) an increase in broker-dealer trading for their own account and (2) the rapid growth in proprietary trading activity by investment bank trading desks, hedge funds, and other financial institutions.
These elements of the financial sector would pay the bulk of the FTT. To the extent these firms are simply skimming a few cents per share, any loss of activity would be of no concern to other market participants because it would reduce trading that may be of very questionable legality, such as the flash trading that has been in the news lately, an activity without which stock markets survived and thrived for centuries. Proprietary trading that seeks returns in excess of the 0.5 percent FTT should be only slightly affected. In addition, the nonfinancial corporations that have borrowed to sharply increase their participation in financial markets over the past two decades would also pay a significant amount of FTT.
Finally, day traders would pay the tax. Those whose profits are eliminated by the small FTT would cease to trade; others would experience slightly reduced returns. A decline in the number of day traders poses no threat to the viability of stock markets nor would a decline in the number of day traders be detrimental to the U.S. economy.
In sum, on stock trading, an FTT would be a sharply progressive tax with most of the population paying none of the tax and a small proportion of wealthy individuals and large financial corporations—and some non-financial corporations—paying the vast bulk of the tax. Of course, what is true for stocks is even more the case for trading in currencies and debt instruments, since trading in both of these markets is almost entirely by large financial and non-financial firms.
How Have FTTs Worked in Other Countries?
No country has instituted an FTT across all three financial asset markets. However, there are or, in some cases, have been transaction taxes in some stock markets. The United Kingdom and Sweden offer insights we can use. The UK has had a stamp duty tax on shares for several decades while Sweden imposed and later removed a tax on stock trading.
The UK tax has had none of the negative effects that opponents of an FTT often cite. The UK stock market has not seen increased volatility or a decline in liquidity, nor has trading in UK stocks moved offshore. In fact, although the British economy is only the sixth largest in the world, the London Stock Exchange is the second largest, having passed the Japanese stock market during the period in which the tax has been in effect.
Sweden first imposed a 0.5 percent tax on trading of stocks in 1984 and doubled the fee in 1986. After the increase in the tax, much of the trading in Swedish stocks moved to London, and the government responded to intense lobbying from Swedish finance by eliminating the tax. The Swedish case is frequently cited by opponents of an FTT to argue that imposing such a tax will simply move trading offshore. However, this has not happened in the UK case, so the obvious question is how the two situations differ and what can be learned from this difference.
First, Sweden is a relatively small economy and stock market in the same time zone as the much larger, and potentially competitive, London market. Second, the tax was in effect for two years before it was raised and trading moved to London. This suggests that the tax did not, in and of itself, cause trading to move but rather the level may have passed some economic threshold for market participants. Most important, however, the UK stamp duty is levied at the clearinghouse level, that is when the buyer and seller are matched and the trade is confirmed. In contrast, the Swedish tax was levied at the broker-dealer level, making it relatively easy to move the geographical location for trade entry to London, which did not tax these trades.
Impact on the U.S. Political Economy
The arguments against an FTT fall generally into two categories. First, critics claim that a tax on trading would reduce liquidity and increase volatility, an economic loss to all participants in the market. Second, an FTT may be evaded by moving trading to a different location.
The claim that an FTT would make markets less efficient rests on the notion that more trading is always better. There is very little evidence to support this, and some studies show that trading itself may actually increase volatility. Even with the imposition of an FTT at the levels outlined in this article, the costs of trading would be lower than in the 1970s and 1980s, when U.S. equity markets as well as markets for other financial assets were found by financial economists to be efficient although trading levels were much less than half of today’s.
The argument that trading may move is undercut by the UK experience. It is, obviously, important to levy the tax at the appropriate point in the trade process and that appears to be the clearing level. Market participants are very unlikely to move trading outside of these clearing entities since the trades would then take on increased risk of default by one or the other party. Of course, to a large extent the question of enforcing an FTT is a question of political commitment to do so; taxing financial asset transactions is no more difficult than tracking down intellectual property violations; this is one of the purposes of treaties.
Beyond the revenue that can be raised by an FTT, are there other potential benefits of the tax? I believe there would be. First, the likelihood that some socially useless trading would cease is in and of itself a good thing. Second, the possibility that the rewards from careers in finance would be somewhat lessened implies that more of our bright young people might decide to enter medical, educational, engineering, or other careers. Finally, any decline in the revenues and profits accruing to the financial sector would help return the United States to a more balanced political economy. Let us note that even a 50 percent decline in trading would leave us with a volume more than double that of the late 1990s. An FTT is not a substitute for adequate financial regulation, but it may help us move in that direction.
The possible economic impact of an FTT is interesting, but most important is the political significance. An FTT could be cast in terms of Wall Street vs. Main Street or it could be articulated as a matter of economic justice. In either case, the financial sector would be called upon to return some of the assistance that was rendered to it during the meltdown of 2008. This formulation would have immense political appeal and, I believe, help the United States break out of the politics-as-usual gridlock into which we have drifted after the initial enthusiasm of the Obama election and the sense that the times were right for change.
In urging an FTT, progressives should tie the revenues to programs and policies that distribute benefits widely and would be seen to be such. For example, a significant portion of FTT revenues could be earmarked for a jobs program designed not simply to recover the over eight million jobs lost since December 2007 but to expand access to good jobs across the U.S. labor force. Revenues from an FTT tied to a jobs program could also be the basis for an industrial policy that restructured the U.S. economy along the lines of sustained and sustainable growth that increases equality rather than inequality. The possibilities are visionary in scope. What we need now is the political will to move forward.
Bill Barclay worked for twenty-two years in financial services. He is a member of the Chicago DSA chapter and a founding member of the Chicago Political Economy Group (cpegonline.org)