A financial transaction tax (FTT) is levied on each unique instance of the buying and selling of financial assets such as stocks, bonds, or derivatives. Under a financial transaction tax, a percentage of the asset’s value is paid in taxes when it is traded. FTTs usually apply only to select financial instruments and often have varying tax rates depending on the asset type.
How Does a Financial Transaction Tax (FTT) Work?
If an investor sells an asset worth $1,000, they would be charged $1 on the transaction under a 0.1 percent financial transaction tax (FTT).
An FTT can be levied by state and/or federal governments. Several U.S. states have had, and later repealed, FTTs, and a handful of countries in Europe levy them as well.
An FTT is a progressive tax because wealthy individuals tend to hold and trade a disproportionate share of financial assets, and because employees at the financial institutions that would be affected by an FTT tend to have higher incomes. That said, the policy would impact investors of all income levels both directly and indirectly.
Are Financial Transaction Taxes Effective?
Relative to other taxes, financial transaction taxes (FTTs) generally have low administrative and compliance costs. For example, the cost to administer the UK’s stamp duty is approximately 0.1 percent of the revenue collected.
However, the tax is not without downsides. An FTT would raise both explicit and implicit transaction costs, decreasing trading volume and lowering asset prices. In turn, the decrease in trading volume would reduce the revenue raised by the tax. As a result, many existing FTTs have missed revenue targets.
FTTs increase the cost of capital, as well as the cost of consumer goods, meaning that all taxpayers would be subject to the tax indirectly.
Additionally, the FTT could be counterproductive in meeting its goal of discouraging risky financial activity. Due to the higher transaction costs, investors and institutions would be disincentivized to rebalance their portfolios and avoid risk.
An FTT would violate three of the four principles of sound tax policy—neutrality, stability, and transparency. It is nonneutral in that it specifically targets the financial sector. FTTs are often unstable sources of revenue, as evidenced by multiple FTTs in other parts of the world and a wide range of revenue projections that come with imposing an FTT in the United States. The FTT is not a transparent tax, as the tax would affect producers, hedgers, pensioners, consumers, and investors in a series of indirect ways.
Stay updated on the latest educational resources.
Level-up your tax knowledge with free educational resources—primers, glossary terms, videos, and more—delivered monthly.
Subscribe