To curb Wall Street excess, the US should tax financial transactions as the UK does

by Dean Baker

Just like that perfect sweater, a financial transactions tax [1] (FTT) would look just great on those Wall Street bankers and financiers. A modest tax, which would be too small for normal investors to even notice, could easily raise more than $100bn a year [2]. That's real money even in the land of AIG and Citigroup bailouts.

The Wall Street boys and the politicians they support just hate it when people talk about a FTT [3]. They start huffing and puffing and get out their best indignant voices to quickly dismiss such naïve notions by those not initiated in the ways of finance. These arrogant dismissals are usually sufficient to scare reporters away from writing about the idea and to keep most interest groups and politicians from seriously pressing it.

But for those not easily intimidated by blowhard bankers and their hired flacks (which include many economists), a FTT makes a huge amount of sense. The basic point is quite simple.

A tax of 0.25% on the sale or purchase of a share of stock will make little difference to a person who intends to hold the share for five to 10 years as a long-term investment. This tax would cost someone buying $10,000 of IBM stock $25 when they purchase their shares. If the price doubles in 10 years, then they will have to pay $50 when they sell. These fees would be dwarfed by their capital gains taxes.

Similarly, if a farmer had to pay a tax of 0.02% on purchasing futures to hedge her wheat crop, the cost for hedging a $400,000 crop would be $80. This expense would have little impact on her decision to hedge her crop or on her income from farming. In fact, since the price of trading shares of stock, futures and other financial assets has fallen sharply in the last three decades, a modest transactions tax would just raise the cost of trading back to where it was 15 to 20 years ago.

A small increase in trading costs would be a very manageable burden for those who are using financial markets to support productive economic activity. However, it would impose serious costs on those who see the financial markets as a casino [4] in which they place their bets by the day, hour or minute. Speculators who hope to jump into the market at 2pm and pocket their gains by 3pm would be subject to much greater risk if they had to pay even a modest financial transaction tax.

Similarly, the financial engineers who specialise in constructing complex financial instruments may find a FTT to be a nuisance. A FTT could cause their derivative instruments to be taxed at several points. For example, the trade of an option on a stock would be taxed, as would the purchase of the stock itself if the option was exercised. More complex derivatives could be subject to the tax many times over, substantially reducing the potential profits from complexity.

The Wall Streeters and their flacks will insist that a FTT is unenforceable and will simply result in trading moving overseas. There is a small problem with this argument called the United Kingdom. The UK has had a tax on stock trades [5] (trades of derivatives and other financial instruments are untaxed) for decades. The revenue raised each year would be equivalent to $30bn in the US economy [6]. Obviously, the tax is enforceable.

In fact, we can go beyond the UK and add other measures to make enforcement more fun. For example, we can give workers an incentive to turn in their cheating bosses by awarding them 10% of any revenue and penalties that the government collects. There are surely many clerical workers in the financial industry who would welcome the opportunity to become millionaires by turning in their bosses.

Of course the prospect of the financial industry moving overseas should not be troubling any case. Why should we be any more bothered by buying our financial services from foreigners than by buying our steel from foreigners? If the industry moved overseas, then it could corrupt some other country's politics.

The basic point is simple. A FTT can allow us to raise more than $100bn annually to finance healthcare or any other budget item that we consider important. It does so in a way that is very progressive and will weaken the financial industry both economically and politically. In fact, even Larry Summers [7], the head of President Barack Obama's national economic council, even argued that a FTT was a good idea [8].

As Obama reminded us in reference the AIG bonuses, we can't govern out of anger [9]. However, we can govern with a clear sense of both justice and sound economics. A financial transactions tax fits the bill.