Financial Transaction Tax

Philippe Douste-Blazy, the Chairman of Unitaid and the former French foreign minister writes in an op-ed in the New York Times about how the world could come up with the funds to meet the United Nations Millennium Development Goals

The one untapped source that could easily provide the amount of money needed is the foreign currency market, which handles almost $800 trillion in trades annually, all of which is untaxed. A tiny levy of 0.005 percent on transactions involving the world’s most traded currencies — the dollar, the euro, the pound and the yen — would raise more than $33 billion annually for development, while not hurting the market or affecting the average international traveler.

Earlier this year, Bob Herbert, also writing in the New York times said

The economist Dean Baker is a strong advocate of a financial transactions tax. This would impose a small fee — ranging up to, say, 0.25 percent — on the sale or transfer of stocks, bonds and other financial assets, including the seemingly endless variety of exotic financial instruments that have been in the news so much lately.

I am actually surprised that there has not been a much more active discussion about a financial transaction tax. Politically it should be a very convenient tool. As the Senate Finance Committee wrestles with how to raise revenue to pay for health care reform they are considering measures like capping the Flexible Spending Account. While I think that FSA is a poorly designed, regressive tax deduction (I wrote about it earlier this month) it will definitely hurt some middle class tax payers. Keeping in mind the current economic situation and President Obama’s campaign promise not to raise taxes on people earning less than $250,000, it is hard to see how any such measure will succeed.

On the other hand, a financial transaction tax has minimal if any impact on tax payers. If there is an impact, in the form of reduced trading, it will be on the broker-dealers, who are not exactly popular at this time. So, in fact a financial transaction tax could be politically expedient.

What of the argument that a transaction tax will reduce liquidity and thus harm the global financial system and ultimately the tax payer? To that I have two arguments to offer.

There are countries that already have a transaction tax. India has had a securities transaction tax on equities and equity derivatives since 2004. On most equities it is currently 0.125%. India’s stock markets have not appeared to have suffered at all during this period. On the contrary they are healthy, growing and competitive.

If you take the total of brokerage commission and the transaction tax to be the ‘friction’ to financial transactions, the friction on financial transactions has been steadily (even rapidly) coming down as regulation, innovation and technology have squeezed the margins from when they were quoted in percentage points to today’s basis points. An additional transaction tax will increase the friction, no doubt, but at worst the friction will take you back a few years. At which time, the markets were functioning well enough.

What the transaction tax actually is, is worth careful consideration. 0.25% may be too high. Perhaps it should be pegged to the brokerage commission where that is transparent. Perhaps it should just be a very low tax but on all kinds of asset classes. But that discussion is possible only if a transaction tax is on the table.

The argument that minimizing friction and maximizing liquidity in financial markets is an objective that trumps all other objectives runs thin, in my opinion. Which makes it all the more surprising that law makers aren’t considering it as an option to raise revenue.

1 Comment

  1. Kevin says:

    Interesting idea i.e. pegging to brokerage commission.
    Thanks for sharing this.


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