Forbes, February 25, 2010
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The reckless behavior of a severely bloated financial sector has given us the worst downturn in 70 years. Let's do something about it. Let's put a tax on hyperactive traders.
A financial transactions tax can be an effective tool for downsizing the sector and restoring it to its proper role in the economy so this sort of calamity does not happen again. The idea is to place a small tax on financial transactions to discourage speculation without hampering productive investment. Bills recently introduced in the House by Peter Defazio and in the Senate by Tom Harkin call for a 0.125% tax on each side of a stock purchase, with comparable rates on trades of other financial instruments such as options and credit default swaps.
Computerization has brought transaction costs down sharply over the last three decades. Therefore this tax would be pushing trading costs only back to where they were in the 1980s and early 1990s. Both bills have exemptions for trades carried through by pension funds and other tax-sheltered accounts, ensuring that the overwhelming majority of small investors and people saving for retirement will be virtually unaffected by the tax.
Such a tax could raise close to $100 billion a year, depending on the extent to which trading declines in response to higher transaction costs. This money could be used to rebuild infrastructure, reduce other taxes and/or reduce the deficit. The revenue would come largely at the expense of excessive trading in the financial sector. This would yield two benefits: The tax would raise revenue and reduce the volume of speculative trading, which serves no productive purpose. Does rapid-fire trading create jobs or build the nation's capital? I doubt it.
Ideally the tax would be put in place in coordination with other countries to minimize the possibility that trading would move offshore. As a practical matter, such coordination would probably not be difficult, since the finance ministers and heads of state of Germany, France and the United Kingdom have all indicated support for a transactions tax. The U.S. has been an outlier in its opposition to trading taxes.
It is important to realize that while coordination is desirable, it is not essential. There are already large differences in trading costs between countries, with the U.S. being one of the lowest-cost markets. Even with a transactions tax, transactions would still be cheaper to undertake in the U.S. than in many other markets. Furthermore, since investors care about a wide range of services, not just the transaction costs, it is implausible that everyone would move their trades to India to avoid a tax of 0.125%.
This is not just speculation. The U.K. has taxed stock trades for many decades. Its rate is 0.25% on each side of a trade, twice the level proposed in the bills before Congress. Relative to British GDP, this tax, which applies only to stock trades, raises an amount equivalent to $30 billion a year out of the U.S. economy. This experience shows that the tax is obviously both collectible and consistent with a vibrant capital market. Even with this 0.5% levy on a transaction, the London Stock Exchange is the largest in Europe.
Wall Street will put up a ferocious fight to prevent a speculation tax from being enacted, but the rest of the country, including the rest of the business sector, stands to be a big winner from this tax. Given that much of the country is still reeling from the Wall Street-induced economic collapse, while the financial sector is enjoying handsome profits and paying seven-figure bonuses, a financial transactions tax is fair payback.