Financial Markets

Will a Financial Transaction Tax Put Markets at Risk?

Friday, August 21, 2020

By Jeffrey Kutler


Legislative proposals for financial transaction taxes have been surfacing with increasing regularity for at least a decade. The FTT idea – to impose small levies on trades of stocks and other instruments – has just as regularly been fought off by financial institutions and markets.

But the coronavirus pandemic has brought about new urgency on both sides. Despite a political climate that has been hostile to new taxes, FTT advocates have argued that the fractional surcharges are a relatively painless way to finance anything from anti-poverty programs to infrastructure projects to government budget-balancing – and the last has grown particularly critical as the economic contraction takes a heavy toll on conventional tax revenues.

Legislators in New York and New Jersey, where sizable market-transaction volumes are processed, have floated FTT proposals that are being taken seriously because of those states' dire budget outlook – and the “progressive” proclivities of left-leaning, Democratic voting majorities.

In Europe, FTT supporter Germany has failed in the past to get a majority of European Union countries behind it. However, the ambitious program that Germany has outlined for its six-month presidency of the Council of the EU, which began July 1, calls attention to “the major transformation processes of our time such as climate change, digitalization and the changing world of work,” and asserts: “We are also committed to the introduction of a financial transaction tax at European level.”

Standing Up for Investors

The more feasible or realistic those hopes, the more mobilized the anti-FTT forces are likely to become. They tend to be financial establishment voices that, ironically, strike a populist or pro-individual-investor tone against a concept rooted in the progressive-taxation principle that the wealthy – and presumably active traders – should pay more.

“FTT proponents highlight its progressivity (the rich pay more), its voluntary nature (don't want to pay? don't trade), and its ability to discourage unproductive high-frequency trading,” as Brookings Institution fellow and policy director Aaron Klein has summarized.

Critics argue the tax harms savers and investors, reduces economic growth, and fails to raise promised revenue by driving activities to lower-taxed areas overseas,” Klein said. “Recent stock market volatility due to the coronavirus has roughly doubled the amount of stock trading on a daily basis” – and some bottom lines have swelled. Intercontinental Exchange, owner of the New York Stock Exchange and other trading and clearing venues around the world, boosted its second-quarter revenue 8% year-over-year, to $1.4 billion, and operating income 10%, to $744 million.

Volatility Effect

Top investment banks’ trading revenues soared as “the coronavirus pandemic triggered extreme volatility spikes in the capital markets,” S&P Global Market Intelligence said. Goldman Sachs, Morgan Stanley and JPMorgan Chase & Co. posted second-quarter, year-over-year increases of 93.11%, 73.21% and 67.34%, respectively.

There was not yet a pandemic alarm last December when U.S. Treasury Secretary Steven Mnuchin was dismissive of FTT proposals from Democratic presidential primary candidates Bernie Sanders and Elizabeth Warren. Mnuchin said at a House Financial Services Committee hearing, “I am very concerned that that would destroy our capital markets, and . . . American holders of mutual funds would bear the majority of the cost.”

Steven Mnuchin headshot
Treasury Secretary Steven Mnuchin: concerned that a transaction tax “would destroy our capital markets.”

By the time the Democrats had nominated Joe Biden for president and Kamala Harris for vice president, they and most of the party’s other contenders had expressed support for FTTs.

The Securities Industry and Financial Markets Association has a “strongly opposed” web page at the ready. It includes a link to a February 18, 2020 statement by SIFMA president and CEO Kenneth E. Bentsen Jr. that an FTT “would tax middle-class savers, including pension funds, 401{k}s and IRAs. At a time when market development, efficiency and competition are driving the cost of investing toward zero, it makes little sense to increase the cost through what is essentially a sales tax. Further, the threat such a tax poses to the efficiency of the U.S. capital markets is real. It begs the question, what's the point?”

The tax “ends up being borne by the very people it's purported to help,” said one of 58 market professionals responding to a survey by Greenwich Associates. A July report by Greenwich senior analyst Shane Swanson said that nearly 70% of the respondents expected FTT to result in a decline in their firms' trading, 72% thought it would harm the retail end of the market, and 84% believed that a negative impact on active managers would accelerate the move toward passive management.

“Although the U.S. markets are the envy of the world, an FTT could damage that machinery, resulting in spreads widening, liquidity dropping, stock prices falling, and the possibility of volatility increasing,” Swanson commented.

The consumer group Public Citizen counters that the costs of a modest FTT “would be little to nothing for middle-income families and would be easily manageable for average families in the top income bracket . . . Because only about half the families in the United States have retirement accounts and very few of the families lacking retirement accounts likely own non-retirement securities, about half the families in the country would likely experience no costs at all from a financial transaction tax.”

Expanding on the Tobin Tax

FTT proposals are variations on the Tobin tax, suggested in 1972 by the late Nobel laureate in economics James Tobin, on the theory that higher transaction costs, widely distributed, would take the edge off of volatility in the currency markets.

Kenneth Bentsen headshot
SIFMA chief executive Kenneth Bentsen: “The threat to the efficiency of the U.S. capital markets is real.”

Today's battle lines took shape after the 2008-'09 financial crisis, as advocates contended that a fractional tax on financial trading would help to curb market excesses and asset bubbles. The potential billions in resulting revenues – the broader the tax base, it is said, the better – could be applied toward domestic, global or societal priorities.

The philanthropist and Microsoft Corp. founder Bill Gates galvanized such discussions with a report presented in 2011 to the G20 summit in Cannes, France.

“Across different instruments, the tax could be sized to reduce potential economic distortions, so that the tax on equities would be slightly higher than the tax on long-dated bonds, short-dated bonds, swaps, and futures,” Gates explained. “Some modeling suggests that even a small tax of 10 basis points on equities and two basis points on bonds would yield about $48 billion on a G20-wide basis, or $9 billion if it were confined to larger European economies.”

Gates urged that not all of the proceeds be treated as general revenue: “It is critical that a portion of the money raised be reserved for investments in development.”

Billionaires and Other Backers

By February 2016, the Washington, D.C.-based Center for Economic and Policy Research (CEPR), which later that year presented a 36-page case for the FTT titled Reining in Wall Street to Benefit All Americans, had compiled a list of prominent supporters. It included billionaires Gates, Warren Buffett, Mark Cuban and George Soros; economists Paul Krugman, Robert Reich, Joseph Stiglitz and Lawrence Summers; former regulators Paul Volcker of the U.S. Federal Reserve, Sheila Bair of the U.S. Federal Deposit Insurance Corp. and Adair Turner of the U.K. Financial Services Authority; House Minority Leader (now Speaker) Nancy Pelosi; German Chancellor Angela Merkel; and Archbishop Desmond Tutu.

Concluding that “a financial transactions tax could likely raise over $105 billion annually (0.6% of GDP), based on 2015 trading volume,” CEPR co-founder and senior economist Dean Baker noted that then-Senator Tom Harkin, Democrat of Iowa, and Representative Peter DeFazio, Democrat of Oregon, had “put forward a bill that would tax most financial transactions at a 0.03% rate.”

A DeFazio bill introduced in 2019, the Wall Street Tax Act, “would tax the sale of stocks, bonds, and derivatives at 0.1% [10 basis points, or $1 per $1,000], and would raise an estimated $777 billion over a decade,” the congressman said. (Michael Bloomberg, during his run for the 2020 Democratic presidential nomination, proposed a 0.1% levy on all financial transactions.)

A Senate co-sponsor of the tax act, Kirsten Gillibrand, Democrat of New York, said, “Congress needs to do everything it can to prevent another financial crisis, and this bill would update the rules for Wall Street, help prevent systemic risk in our financial system, and raise revenue so we can invest in our economy.”

“Creating a new financial transaction tax is an appealing way to generate substantial tax revenue in a highly progressive fashion, with the positive side effects of discouraging market churning and front-running high-frequency traders,” Brookings' Aaron Klein wrote under the headline Investors Shouldn't Fret.

A Little Dampening”

“The tax targets active investors who are concentrated in the wealthiest segments of the population,” Brookings says, citing 2016 data, when the top 10% of Americans by wealth owned 93% of stock market value. However, the think tank notes, “the middle class may feel the indirect effects of the tax“ through investment or retirement plans, and mutual funds incurring the tax could pass the cost along. 

The Urban-Brookings Tax Policy Center predicts that the top 1% of American households would pay 40% of the tax, the bottom 60% just over 11% of the revenue.

Who bears the burden of a financial transaction tax?

“Opponents make the point that the tax will dampen the velocity of trades,” said longtime FTT advocate Jared Bernstein in March 2019. A senior fellow of the Center on Budget and Policy Priorities (CBPP) who was economic adviser to Vice President Joe Biden, Bernstein continued, “But given the tiny magnitude of the tax, the large decline in transaction costs over recent decades and the outsize role that speculative finance has played in recent economic bubbles and busts, perhaps a little dampening is warranted.”

“Since there has been an enormous explosion in trading volume over the last four decades, even a reduction in trading volume of 50% would only get us back to 1990s levels,” CEPR's Dean Baker wrote in an October 2019 blog. “And, we certainly had very robust financial markets in the 1990s. The purpose of the financial sector is to allocate capital to its best uses. It would be hard to convince those of us who lived through the housing bubble and the subsequent financial crisis that the increase in trading volume has allowed the financial industry to do a better job allocating capital than in prior decades.”

At the State Level

As Congress, wrestling with economic stimulus and relief measures, was slow to answer calls for direct aid to states and municipalities, New Jersey and New York legislatures had FTTs on the table.

Aaron Klein headshot
FTT can “generate substantial tax revenue . . . with the positive side effects of discouraging market churning and front-running,” says Brookings’ Aaron Klein.

“New Jersey's A4402 would impose a 0.25 cent tax on every financial transaction processed in the state,” said a July 23 report by the Washington-based Tax Foundation. “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 in the United States, although New York had its own FTT from 1905 to 1981.”

New York, however, does have a stock transfer sales tax on the books, but it gets rebated to brokerages. According to renowned consumer advocate Ralph Nader, that amounts to a $40 million daily benefit for “an upper-economic class already further enriched by Trump's 2017 tax bonanza,” and that could be retained to reduce the state's widening deficit.

“Bear in mind, a fraction of 1% of this tiny sales tax is paid by the investors buying stocks, bonds, and engaging in massive volumes of derivative speculation,” Nader wrote in June. “Since the great bulk of trading is conducted by upper-income people and large companies, this sales tax, unlike the regressive 8% sales tax ordinary New Yorkers pay when they buy from stores, is progressive in its impact.”

“Economists from both academia and the private sector have urged New York to collect the Stock Transfer Tax [STT],” says New York State Assemblyman Phil Steck, Democrat of Schenectady, who sponsored a bill to require it. “The consequences of not collecting the tax pale in comparison to the economic benefits of doing so.”

“Wall Street leaders like [former Treasury Secretary and Citigroup director] Robert Rubin support the Stock Transfer Tax,” Steck adds. “Saying it should be implemented at the federal level, which is politically unrealistic under current conditions, is not a justification for not reinstating it in New York.”

Revenue from the FTT that Steck's bill calls for, ranging from 1.25 cents to 5 cents per share of stock, would go into New York's general fund for three fiscal years, and then into infrastructure development, with New York City's Metropolitan Transportation Authority getting 25%.

Across the Hudson River, in similarly cash-strapped New Jersey, Nasdaq and New York Stock Exchange data centers process a “staggering volume of financial transactions daily whether the Dow is soaring or plummeting,” Democratic congressional candidate David Applefield (who died a day after losing in the July 7 primary election) and former Senate Budget Committee counsel Andrew Ellis wrote in a opinion article. They supported “a pittance of a financial transaction fee,” or “micro-cent solution.”

A 0.25 cents-per-share FTT could yield as much as $10 billion annually, a 0.5-cent fee twice as much, the New Jerseyans stated. One possible use for the proceeds: “Promote new procedures and programs for law enforcement officers who place a premium on forging constructive alliances with local communities of color, the communities hardest hit by inequality and the coronavirus.”

Fearing Exodus

New York Governor Andrew Cuomo has reportedly signaled his opposition to raising taxes on the financial industry, lest this major contributor to the Empire State economy and tax base take its business elsewhere.

FTT proponents downplay such worries, contending that FTT economic costs are de minimis in absolute terms, and that large-scale relocations are the opposite.

Applefield and Ellis acknowledged that New Jersey processors “might threaten to bolt to a neighboring state, though relocating the giant transaction processing houses is no simple matter. One solution would be a regional, fee-sharing coalition with New York and Connecticut. That might mean less for New Jersey but would still help the states hit hardest by the coronavirus.”

They added, “Despite the likely objections of stock exchanges to transaction fees, stock trades are just another type of sale and are taxable where the sales occur — indeed, many brokers earn their keep by charging transaction fees.”

Location and Economics

Assemblyman Steck maintains that New York offers comparative advantages for finance in the way Seattle does for technology. Firms in New York ”continue to pay real estate prices that are at least 20% higher (if not more) than in New Jersey” because of proximity to the large financial community and its economies of scale, he says. “In comparison, [the stock transfer tax] would not be a significant component of cost for the industry. In short, the costs of moving so far exceed the cost imposed by the STT as to make moving economically foolhardy.”

“Every single significant exchange in the world has a financial transaction tax save one, which is Germany, and they've proposed it there,” Steck said to Bloomberg News. “Is the London Stock Exchange out of business? Have they moved to Dublin?”

The U.K. has a longstanding 0.5% stamp duty on share purchases. “No investor wants to save 0.5% of an investment to risk losing the other 99.5% of it,” Avinash Persaud, a former J.P. Morgan banker and Gresham College emeritus professor, has said. Persaud prefers to focus on the less frothy, more stable markets that he believes FTTs promote by “shining a torch on all of the other transaction costs that the industry charges consumers, often via the excessive churning of investment portfolios they manage.”

Hong Kong’s stamp duty bolstered the embattled market center’s finances this year. In the first seven months of 2020, chief executive Carrie Lam reported, that income jumped 40% year-over year amid high stock trading and IPO volumes, even as GDP was declining.

Where the Taxes Are

Financial transaction taxes are neither unprecedented nor uncommon, though they are far from universal. Some have flown under the radar, such as New York State's rebated securities sales tax and a fee that the Securities and Exchange Commission collects from self-regulatory organizations under Section 31 of the Securities Exchange Act of 1934.

In 2018, Bank of New York Mellon Corp. published A Global Perspective, identifying more than two dozen Asian and European jurisdictions, including the European Union, with established or proposed FTTs or the equivalent. BNY Mellon said in its preface “that no matter what the outcome is of any proposal from the European Commission, the matter of a financial transaction tax will continue to attract public and political attention.”

The more countries – or states within the U.S. – that adopt an FTT, the less avoidable it would become. Germany, with France and likely a few others initially backing it, will once again be trying to get all 27 EU members to go along.

Financial Transaction Taxes in Europe

As of January 2020, according to the Tax Foundation, “Belgium, Finland, France, Ireland, Italy, Poland, Switzerland, and the United Kingdom currently levy a type of FTT. The FTTs differ significantly across countries.

“For example, Switzerland levies a 0.15-0.30% stamp duty on the transfer of equities and bonds involving a Swiss securities dealer, while France implemented an FTT that taxes equity trades at 0.3% and high-frequency-trading at 0.01% . . . Ten EU countries, including France, Germany, Italy, and Spain, are still interested in the common tax and negotiations on the design of that tax are ongoing.”

Industry Resistance

Reliably taking positions against the FTT will be industry groups like SIFMA and the Investment Company Institute. The latter tweeted out a video in January about “how FTTs would harm millions of individuals on Main Street saving for retirement and other financial goals.”

Phil Steck headshot
“The consequences of not collecting the tax pale in comparison to the economic benefits of doing so,” says New York Assemblyman Phil Steck.

SIFMA, in a paper last year, pressed such arguments as “FTTs have been shown to harm individual investors,” outweighing any benefits; and that the resulting revenue (at 0.28% of GDP, excluding that of outlier Hong Kong, and “low ratios” across the G7 countries) “is not the panacea it is often touted to be.”

“Taxes and other fees are passed onto the end user, individual investors, in the total cost of the trade,” both implicit and explicit costs, SIFMA said. “The FTT will be no different” – an incremental, explicit cost “passed down the chain to the individual investor.” The SEC's Section 31 transaction fee, though “very small,” works this way, and, with an FTT, “the government will have added two transaction taxes on each trade – significantly increasing trade costs for individual investors.”

Buttressing the industry associations' arguments is the Tax Foundation. The non-profit says it favors “smarter, simpler policy,” but the FTT doesn't pass muster.

Though conceding early this year that a broad-based tax “would be a substantial revenue source,” the foundation agreed with SIFMA that it would raise transaction costs, thereby decreasing trading volume – which would reduce the tax revenue – and lowering asset prices.

“Depending on the design of the tax, derivatives could potentially be substituted for their underlying securities to avoid the tax, reducing the revenue the tax raises,” the foundation said.

And it did not agree that risky financial activity would be reined in: “Due to the higher transaction costs, investors and institutions would be incentivized to avoid rebalancing their portfolios and leave risk unhedged. Furthermore, investors and institutions moving to derivatives to avoid the tax would face additional risks associated with trading those instruments.”

In an analysis of then-candidate Michael Bloomberg's FTT proposal, the Tax Foundation said, “Despite a seemingly minuscule [0.1%] rate, the FTT violates good tax policy on multiple grounds. Even though the proposal adheres to the tax principle of a low rate on a broad base, it functions similarly to a gross receipts tax in that it taxes the same activity multiple times, creating tax pyramiding. Bloomberg's plan would distort economic decision-making and raise the cost of new investment.”

The National Association of Plan Advisors, which objects to taxing retirement savings, noted that of the 2020 Democratic primary candidates' favored FTTs, vice presidential nominee Kamala Harris’ percentages were higher than most – 0.2% for stock trades, 0.1% for bond trades and 0.002% for derivatives – to finance “Medicare for all” health insurance.

Modified Perspectives

In its 2019 SIFMA Insights report, the association cited a Vanguard Group study quantifying micro impacts of a 0.1% FTT: “Individuals would be forced to work 2.5 years longer before retirement; individuals would experience a $5,989 20-year investment loss to their retirement savings, a 19% decline; and individuals would experience a $7,800 shortfall in a college savings account, meaning parents would need to save an extra $250 per annum per child.”

Avinash Persaud headshot
“No investor wants to save 0.5% of an investment to risk losing the other 99.5% of it,” says economist and former banker Avinash Persaud.

Vanguard's founder and CEO, the late John Bogle, was on the other side in a 2009 interview that was quoted years later by CEPR: “The financial institutions that control 75% of all stocks are tax free. Pension funds are tax free. Mutual funds are about half tax-deferred, but the other half is run by managers who pay no attention to taxes. So we've got these two giant industries basically operating without any frictional costs when they trade stocks back and forth . . . and that helps explain why we've had this orgy of speculation.”

Another nonconforming perspective, on how an FTT “could potentially help everyday investors,” came this July from John Rekenthaler of Morningstar's investment research department. He proposes a “revenue neutral” approach, including reducing federal income tax liability by 3.5%. At the same time, a 0.1% FTT, borne half-and-half by buyer and seller, would generate $778 billion in federal revenues over 10 years, according to Congressional Budget Office estimates.

“Admittedly,” Rekenthaler wrote, “the deal will be moot for most investors who make less than the median income, because they will neither pay much in federal income taxes nor have much of a portfolio with which to transact. For half the country, adding an FTT would be a footnote.”

Saying he has no quarrel with Wall Street or its level of trading volume, nor does he “wish to fill the Treasury's coffers,” Rekenthaler makes a rare attempt to find middle ground on a typically polarizing, pocketbook issue. To date, it has engaged policy experts and lobbyists in lively debate but has not stirred the general public's passions. Might that change as citizens and governments struggle through difficult economic conditions and accompanying political upheavals and power shifts?

CBPP's Jared Bernstein has been waiting for the right “political space” to bring a progressive FTT vision to fruition. But, for him, the case for the tax boils down, simply, to “we need more revenue.”


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