New York and New Jersey Consider Financial Transaction Taxes

July 23, 2020

Seeking new sources of funding, New York and New Jersey—two states at the heart of global financial markets—are considering financial transaction taxes. New Jersey’s A4402 would impose a 0.25 cent tax on every financial transaction processed in the state. In New York, some lawmakers have proposed a rate as high as 5 cents per share (1.25 cents for stocks worth less than $5). If either state succeeded, it would represent the only financial transaction tax (FTT) in the United States, although New York had its own FTT from 1905 to 1981. There is no federal-level FTT in the U.S., though fees are imposed to fund the regulatory activities of the Securities and Exchange Commission (SEC).

The quarter-cent tax would be imposed on each transaction that is processed in New Jersey, with a transaction defined as any purchase or sale of a security—including a share of stock, a futures contract, a derivative, or any similarly traded financial instrument or contract. The tax would be imposed per instrument, not per trade, meaning that a purchase of 1,000 shares would generate $2.50 in taxes. This rate may seem small, but it would quickly pyramid as the same instrument is traded—and therefore taxed—multiple times.

The bill proposes a flat-rate transaction tax, while most countries with FTTs levy a percentage-based tax. This distorts investment decisions in that it slightly favors contracts with higher values. Because the tax is imposed per transaction, the effective rate would be much higher on stocks that trade at lower prices—largely, though not invariably, associated with small and midcap stocks. The effective rate on the sale of a Berkshire Hathaway Class A share ($288,257 at market close on July 22) would be 0.0000009 percent, while the rate on the sale of a share in Sirius FM ($5.94 at close) would be over 48,500 times higher at 0.04 percent. The same ratios would hold in New York, where proposals are more nascent but also much more aggressive. Trades of shares of Sirius would be taxed at 0.8 percent.

At a price point of, say, $40 a share (some large companies trade for orders of magnitude higher), New Jersey’s tax on Wall Street transactions—for which the state’s only connection is housing the data processing facilities—would be three times the so-called Section 31 fee designed to support all SEC regulatory activity. New York’s tax on the transaction itself would run almost 50 times higher than the federal tax.

A state FTT would raise both explicit and implicit transaction costs, bringing down the volume of trades and lowering the price of assets by dipping into investor profits. It would especially reduce high-frequency trading. These kinds of trades see very small profit margins, and thus are more affected by taxes. While the primary tax burden would fall on the wealthy—as is probably intended—all investors would see lower portfolio values because of the decrease in asset prices. Restricting high frequency trading, moreover, can reduce liquidity, locking in investors as share prices are falling.

Any trading decrease would then reduce the revenue raised by the tax. There is currently no fiscal note indicating how much revenue this tax would raise if implemented. However, it is difficult to predict the magnitude of the trade reduction, which has caused many existing FTTs to miss their revenue targets.

Implementation of this tax raises an additional issue: it is much easier to avoid a state FTT than a national FTT. New Jersey’s tax base is defined as transactions that take place using “electronic infrastructure” located in the state. This would capture many of the major exchanges in New York City, as they use New Jersey-based data centers. These exchanges would either move their data centers or absorb the tax and pass it on to traders. For many securities, it would be relatively easy to move trades to the Chicago Stock Exchange and thus avoid the tax altogether, which would further pressure New York’s financial industry to relocate its processing centers.

In an industry where latency matters, options for relocating New York Stock Exchange (NYSE) data processing are not unlimited—but at the same time, they are not wholly constrained to New Jersey, either. It is easier to switch data processors than to remove an entire stock exchange to a new region.

But even that larger move is not impossible. New York’s financial transaction tax is technically still on the books, but a 100 percent rebate has been in place since 1981, in response to threats that the NYSE would relocate to avoid the tax. The role of the trading room floor has changed, and there is far less now to preclude a relocation—or a shift in transactions to another exchange—to avoid a tax like the one some New York lawmakers are considering.

New Jersey’s A4402 includes a clause aimed at avoiding double taxation. However, this refers to transactions that involve multiple entities (the first person to process the trade is responsible for the tax), not protecting the same equity or contract from being taxed every time it is traded. In New York, the proposals are still notional, though one approach would be to reverse some or all of the rebate on the existing tax.

A financial transaction tax is extremely challenging to audit and enforce at the state level, highly susceptible to avoidance given the inherently mobile nature of electronic transaction processing and even the relocation of entire exchanges, and inequitable in its application. Although the prospects of microtaxes on such vast swaths of financial activity may sound appealing, the proposals come with considerable risk in an increasingly mobile economy. Wall Street is reportedly responsible for 17 percent of state tax revenue in New York. That is a lot of activity to risk on such an experiment.

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