Renewed Talk of Financial Transactions Taxes: Say it Ain't So

December 06, 2011

The Joint Economic Committee held its Joint Hearing on Tax Reform and the Tax Treatment of Financial Products earlier today.  The hearing came soon after the Section of Taxation of the American Bar Association (ABA) sent a letter to the Senate Committee on Finance and the House Committee on Ways and Means entitled "Options for Tax Reform Relating to Financial Transactions." 

Though the lengthy paper contained within the ABA's letter does not attempt to economically examine financial transactions taxes (FTT's), it brings back discussion on a subject which was last seriously advocated for on Capitol Hill by Nancy Pelosi.  The hearing also came on the heels of an EU proposal to tax financial transactions and will undoubtedly stir up some dormant talking points for U.S. legislators. 

However, even at a time when fiscal consolidation is desperately needed, such taxes should never be seriously considered as a panacea for four simple reasons:

·         High transaction volumes provide liquidity necessary for price discovery.

·         Much of short-term transactions are done to hedge and mitigate risk.

·         An increase in transaction costs will increase short-term volatility.

·         People can easily circumvent an FTT and the tax will be cumbersome to structure.

Even proponents of FTT's must, at the very least, concede that the academic literature on the subject is totally ambiguous.  A survey of 11 articles published between 1989 and 2010 shows that the literature is completely divided, with four articles arguing against FTT's and three arguing in favor of them.  The legitimacy of any policy taxing financial transactions would assuredly be undermined by this division. 

Even revenue estimates range from $17 billion to $360 billion (in 2010 dollars).  Though the low figure does not account for the large increase in trading volume since 1989, doing so still yields a very large gap in estimates.  This fact should discourage legislators from justifying the implementation of such policy by claiming that FTT's will be a certain and stable revenue source.

Patrick Honohan and Sean Yoder put it best in their 2010 World Bank paper on the subject (Financial Transactions Tax: Panacea, Threat, or Damp Squib).  "Certainly not a panacea, and more likely a damp squib in terms both of revenue and efficiency gains (and perhaps more likely to result in efficiency losses), financial transactions taxes could be a threat to fiscal stability."  A threat to fiscal stability—the absolute last thing American solvency needs.

Follow David S. Logan on Twitter @Loganomix

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