Sen. Kirsten Gillibrand (D-NY) recently endorsed a proposal to implement a financial transactions tax of .03 percent on every Wall Street transaction.
This proposal is not new: Sen. Bernie Sanders (I-VT) proposed one in his tax plan when he ran for president in 2016, and many other progressive lawmakers have championed this idea. Its defenders cite that the rate (.03 percent) is low, while the base (financial transactions) is relatively broad, which theoretically indicates that it would raise significant revenue while not hurting the economy too much. Furthermore, advocates say the 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. would be very progressive.
However, despite the good intentions behind it, the financial transactions tax would cause or worsen many economic problems if implemented. While the tax would follow one principle of sound tax policy, a low rate and broad base, in this case, the tax would function 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. , creating 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. , violating a sound tax policy principle.
The tax also violates another principle. Income should only be taxed once. Financial transactions taxes tax the act of trading itself, on top of existing capital gains, personal income, and corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es. For that reason, Gillibrand’s proposal would distort economic decision-making and raise the cost of investment.
According to a Congressional Budget Office (CBO) report from 2011 on a proposal to impose a .03 percent tax on financial transactions, such a tax would “raise the cost of financing new investment… [and] reduce output and employment.” Furthermore, the financial transactions tax may also hurt smaller investors the most, as transaction costs tend to be much bigger for small, individual investors than for large, institutional ones.
A financial transactions tax would distort asset markets, as types of securities traded more frequently would be taxed much more than assets traded less frequently. This distortion would lead to investors holding certain assets longer than they should in order to avoid the tax. The tax also decreases liquidity and increases transaction costs.
While supporters of the tax assert that making short-term investing less attractive will rein in speculation and limit volatility, the evidence for this claim is mixed at best. While the financial transactions tax might discourage speculation, it will also discourage transactions between well-informed investors; furthermore, much of the research on the issue of volatility suggests that higher transaction costs correlate with more volatility, not less.
Financial transactions taxes are also not surefire revenue generators. In the 1980s, Sweden imposed a financial transactions tax, and, thanks to the relative mobility of capital markets, 60 percent of trades moved to different markets. Not only did this behavior mean that the financial transactions tax raised little revenue, it also drove down revenue for the capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. , ultimately lowering total government receipts.
The tax might also worsen government finances in other ways. The CBO report on financial transactions taxes notes that the tax will increase the cost of financing state and local governments. More importantly, the tax would hurt state pension plans by both reducing their asset values and raising transaction costs. At a time when many states’ pension plans are in dire financial straits, the new tax could worsen an already-serious problem.
While the financial transactions tax might sound like smart, low-rate, broad-base tax policy, the nature of capital markets would mean that such a tax would not only lower incentives to invest, but also disproportionately negatively affect smaller investors. Furthermore, there’s little convincing evidence that the tax would achieve the goal of reducing economic volatility, or consistently raise revenue. If Sen. Gillibrand is looking to support new government programs, she should consider a less distortionary and economically harmful tax to finance them.
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