Taxing Transactions a Few Too Many Times

Yesterday, Representative Peter DeFazio (D-OR) and Senator Brian Schatz (D-HI) introduced the Wall Street Tax Act, which would create a financial transactions 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. of 0.1 percent on stocks, bonds, and derivatives. The bill, which would “generate billions in revenue, while addressing economic inequality and reducing high risk and volatility in the market,” includes several cosponsors, including Representative Alexandria Ocasio-Cortez (D-NY) and 2020 presidential candidate Senator Kirsten Gillibrand (D-NY). Policymakers should be wary about adopting a financial transactions tax.

Like a gross receipts taxA gross receipts tax, also known as a turnover tax, is applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. , a financial transactions tax results in tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. . The same economic activity is taxed multiple times.

For example, an individual might sell a stock worth $100 to diversify her portfolio and then purchase stock in a new company with that same $100. The $100 is being taxed twice: first, when the individual sells the stock, and then again when the money is used to buy the new security. Imagine this happening thousands of times a day. The tax pyramiding quickly adds up. That is why this tax would generate nearly $770 billion over a decade.

Financial transactions taxes illustrate an important concept in tax policy. While economists, like me, argue that we want taxes that have low rates and broad bases, we should distrust taxes that have too low of a rate and too broad of a base. That generally means that the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. is much too large and improperly structured.

Supporters, however, argue that the Wall Street Tax Act is needed, because it would reduce volatility in financial markets. It’s not clear that it would reduce volatility. In 2012, the Bank of Canada studied the issue and concluded that “little evidence is found to suggest that an FTT [financial transactions tax] would reduce speculative trading or volatility. In fact, several studies conclude that an FTT increases volatility and bid-ask spreads and decreases trading volume.”

The report also noted that there are “a number of challenges associated with the design and effectiveness of an FTT that could limit the revenues that FTTs are intended to raise. For these reasons, countries considering the imposition of FTTs should be aware of their negative consequences and the challenges involved in implementation.”

Sweden’s imposition of a financial transactions tax in the 1980s illustrates the challenges perfectly. The country experienced a 60 percent decrease in trading volume as it moved to other markets, as well as a decrease in revenue.

As policymakers debate new sources of revenue for the federal government, the financial transactions tax should not make the short list.

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