FTT: The Cost of Business on Wall Street

Just like that perfect sweater, a financial transactions tax
(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. 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.
They start huffing and puffing and get out their best indignant voices
to quickly dismiss such naive 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
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
(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. 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, the head of President Barack Obama's national economic council, even argued that a FTT was a good idea.

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