Taxing Transactions a Few Too Many Times

March 6, 2019

Yesterday, Representative Peter DeFazio (D-OR) and Senator Brian Schatz (D-HI) introduced the Wall Street Tax Act, which would create a financial transactions tax 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 tax, a financial transactions tax results in tax pyramiding. 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 base 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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