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NY Times Reporter Casts Doubt on Financial Transactions Taxes

3 min readBy: Scott Greenberg

So far, taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy has not been a central focus of the Democratic presidential primary: none of the campaigns have released comprehensive tax reform proposals and few candidates have devoted much attention to the issue. However, one tax policy proposal has been endorsed by several candidates in the Democratic field: a financial transactions tax.

In the last few months, Hillary Clinton, Bernie Sanders, and Martin O’Malley have come out in support of a tax on financial transactions: sales and purchases of stock or other securities. Because millions of financial transactions happen every day, proponents claim that such a tax would be able to raise a significant amount of revenue with a low rate.

As a rationale for a financial transactions tax, all three candidates have cited a desire to discourage high-frequency trading: the use of computer algorithms to execute stock trades very quickly. High-frequency traders are often able to make fractions of a cent per transaction by anticipating the direction stock prices will take. Opponents of high-frequency trading claim that these practices chip away at the returns of ordinary investors and destabilize markets. And proponents of financial transactions taxes claim that the entire practice of high-frequency trading could be eliminated with a small tax on each transaction.

However, an article in today’s New York Times argues against this rationale. In a column titled “Solution Without a Problem? A Tax on High-Frequency Trading,” Nathaniel Popper writes:

The odd thing about all this concern is that most of the investors who are actually facing off against the high-frequency traders – often on behalf of retirement savers – don’t see this as anything like the most costly problem they are facing…

The most commonly cited statistics suggest that high-frequency traders are making, at most, a few billion dollars a year in the stock markets. That take has been shrinking steadily in recent years…

Academics and regulators, meanwhile, have pointed to several other, less automated financial markets, where middlemen are taking significantly more money from ordinary investors on each trade. The cost of buying and selling municipal bonds, for instance, a popular investment for ordinary savers, is at least five times the cost of trading a stock, and usually much more than that.

Popper makes two points here about high-frequency trading. First, high-frequency trading does not appear to significantly diminish the returns of ordinary stock investors. Second, the stock market already works relatively well compared to other financial markets: it is more efficient, with more price transparency and fewer barriers to trading.

Although Popper does not make this claim explicitly, the conclusion is clear: the stock market works relatively well as a vehicle for savings and for the allocation of investment; a financial transactions tax might mess with that success.

Indeed, we have previously argued that financial transactions are a poor tax base, and that a financial transactions tax would lead to less market liquidity, result in “pyramiding” by taxing the same activity several times, and lock investors into their assets. While financial transactions taxes have met with mixed results internationally, instituting one in the U.S. seems like a risk not worth taking for a market that works pretty well.