Published on
The Wall Street Journal

Liberals Continue to Push for Financial Transaction Tax

Ronald D. Orol

WASHINGTON - As policymakers in the U.S. and Europe
contemplate mechanisms to ward off another economic near-collapse, one
idea is gaining traction among liberals at the same time as it is
infuriating conservatives: a financial transactions tax.

Democratic lawmakers and other advocates are pressing for the creation
of a sales tax applied to stocks, derivatives and other financial
instruments. The idea has been around for decades. In fact, there was
just such a tax in the United States from 1914 to 1966. The U.K. raises
more than $30 billion a year on a tax that applies only to stocks.

Backers of financial transaction tax -- including labor unions and
liberal groups -- argue that even with the major decline in stock and
derivatives transactions stemming from the tax -- some estimate as much
as a 50% decline in volume of trades -- such a fee could raise more
than $100 billion a year to fight the deficit, create jobs or other

Proponents of the tax also argue it would
dampen financial speculation and hyper-trading would diminish, which
they say contributed to the bubble that led, in part, to the crisis in

Opponents of the tax contend that it will increase the volatility of
stock prices, reduce liquidity and efficiency of the financial markets,
and at the same time raise the cost of transactions for long-term
"average Joe" investors directly -- or indirectly, through their
retirement savings funds.

Critics argue that the kind of trading the tax would eliminate --
mostly a form of high-frequency trading that by some estimates
represents 70% of all the trades on an average day -- did not cause the
financial crisis. Securities groups contend that the tax could
undermine the tentative economic recovery underway and stifle job

White House not sold on the idea

Rep. Peter DeFazio, D-Ore., introduced a financial transaction tax in
December, which would impose a 0.25% fee on stock transactions.
Derivatives swaps would be taxed at a rate of 0.02%, based on the bill,
which has 27 supporters in the House. Sen. Tom Harkin, D- Iowa, is
working on legislation in the Senate that would tax stock transactions
to generate revenues to help reduce the deficit.

"We need something to damp down speculation and raise revenues," DeFazio said.

Nevertheless, Treasury Secretary Timothy Geithner says the Obama
administration isn't on board with the efforts. Rather than back a
transaction tax, the White House proposes taxing financial institutions
with $50 billion or more in assets to cover the remaining cost of a
financial rescue package.

In addition to Geithner, former Federal Reserve Chairman Paul Volcker,
who is an advisor to Obama, has expressed reservations about it.

Nevertheless advocates are organizing events on Capitol Hill, seeking
to generate support for the measure. Dean Baker, co-director of the
Center for Economic and Policy Research in Washington, argues that a
transaction tax would result in a major decline in the volume of
trading, which he says would be a good thing because it could reduce
volatility, increase efficiency and dampen the kind of speculation
bubble and busts that led to the recent financial crisis.

"It may lead to situations that are less prone to the sort of
speculative run-ups that we have seen in markets in recent years,"
Baker told participants at an event organized by Public Citizen.

Baker argues that the financial industry is akin to the trucking
business in that it is an intermediary that brings goods -- in this
case investments -- from point A to point B. However, he points out
that, unlike the trucking industry, the financial industry has exploded
over the past three decades relative to the size of the economy and is
now five times as large as in the 1970s.

"Are we more secure in our savings? Do we think capital has been
allocated better? It's hard to argue that that is the case," Baker
said. "Why would we want more people employed in trucking if they are
not better able to bring goods from point A to point B? If we reduce
the volume of trading, without impeding the financial sector in
securing our savings, allocating capital, that's a benefit for the

High-frequency trading has its place

However, Georgetown University Professor James Angel argues that
high-frequency investors would be discouraged from conducting trades if
a financial transaction tax were imposed, raising investor costs. He
argues that these traders improve market efficiency and reduce costs
for all investors by slicing away the spread price between what a buyer
is willing to pay and a seller is willing to sell for.

"The bid-ask spread is a major transaction cost that has gone down
significantly, in part, because of high-frequency traders and that
helps all investors," Angel said.

The removal of high-frequency traders from the markets would lead to
small differences in prices, known as mispricings, of stocks trading on
different exchanges, he added, as well as distorting the price of
exchange-traded funds.

"You would see a lot more noise in the markets," Angel said.

A transaction tax, he argues would have a negative impact on the
markets because these arbitrageurs take advantage of mispricings,
between different markets and stock exchanges, leading to corrections
in prices. For example, a high-frequency trader who sees the same stock
trade on different exchanges -- a corporation's ordinary stock in the
U.K. and its American Depository Receipt, or ADR, in the U.S -- at
different prices will make investments that ultimately bring the prices
in line with each other.

"That linkage between a stock in the U.S. and the U.K. makes it
possible for U.S. investors to diversify their portfolio globally,"
Angel said. "It allows you to trade something that looks like a U.S.
stock in the U.S. hours for a company that might be housed in a
different country, with a different language."

With even a small transaction tax, these high-frequency traders would
lose their incentive to trade, in part, because the pennies they earn
on a trade would be offset by the tax.

Pension fund investors

DeFazio's bill -- on its face-- would exempt pension funds, mutual
funds, education and health savings accounts. It also exempts the first
$100,000 of annual transactions, as a means of helping out smaller

However, Georgetown's Angel argues that the average pension fund would
not be free from the impact of a transaction tax even with exemptions
for pension fund investors in the bill.

That's because mutual fund managers buying and selling stock on behalf
of pensioners would pay the tax, plus suffer from wider bid-ask
spreads, Georgetown's Angel points out.

International cooperation?

Most observers of the proposed tax contend that it would likely need to
be proposed jointly by a number of countries. Baker points out that
France, Germany and other European countries have expressed an interest
in their own financial transaction tax.

"There seems little doubt that if the United States pushed for such
taxes at the G-20 or other international forums that it could count on
considerable cooperation from other countries," Baker said.

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