The Common Sense Tax

Wall Street needs a Financial Transaction Tax. (Credit: Ahmad Nawawi/Flickr)

The Common Sense Tax

A speculation tax is highly progressive, has huge revenue potential, and could curb Wall Street recklessness.

It's nothing new for Wall Street to work every possible angle so it can squeeze additional profits out of trades. It's the job of lawmakers and regulators to make sure that Wall Street does not rip off investors or endanger the financial system's stability.

Perhaps you've heard about high-frequency trading (HFT), one of the ways traders have been gaming the system. This gimmick is finally getting much-deserved attention from regulators, the public and the media. The next step is getting Congress to pay attention.

Newly spotlighted by Michael Lewis' book, Flash Boys: A Wall Street Revolt, high-speed computerized trading has made a mockery of the notion of "investing" in the economy. Investors may hold an asset for far less than a second when they engage in high-frequency trading.

This dizzyingly fast trading devoid of human intervention sows systemic fragility. A glitch in the lightning-quick computer trades caused the Flash Crash of 2010, when the stock market plunged about 10 percent in a matter of minutes.

Although only a few firms engage in high-frequency trading, it is no small-scale activity. About half of all market activity is generated by computers run by high-frequency traders.

Lewis and other critics claim that much of high-frequency trading amounts to "front running," a form of illegal insider trading. The Department of Justice, the Securities and Exchange Commission and the Commodity Futures Trading Commission are each reportedly investigating claims of unlawful behavior.

As regulators work out the legality of this practice, Congress should seek legislative solutions to the problem. The leading long-term solution is a modest Wall Street speculation tax -- a very small levy on transactions involving stocks, bonds, and other assets.

Proposals to implement a tax of this kind on financial transaction are pending before Congress. One proposal calls for a tax of 0.03 percent of the transaction. That might be enough to eliminate much of the profit of high-frequency traders, who earn fractions of a penny on each trade but see huge profits after such gains are multiplied by billions of trades.

A speculation tax commands broad support. Proponents include Nobel Prize-winning economists Joseph Stiglitz and Paul Krugman, and billionaires Warren Buffett and Bill Gates. More than 30 countries already levy taxes like this that raise billions of dollars every year in revenue.

Examples include the UK, South Africa, Hong Kong, Switzerland, and India. Ten European nations announced on May 6 an agreement to move forward with a unified tax on financial transactions by January 2016.

There's a precedent in our own country. In the United States, we taxed stock trades at a 0.04 percent rate from 1914 to 1966.

Detractors argue that taxing financial transactions will harm struggling mom-and-pop investors. Wrong.

A Wall Street speculation tax will have only a very modest impact on average people. A recent report from Public Citizen, the organization I lead, noted that the average 401(k) retirement account is $84,500. With average turnover in such a portfolio, a 0.03 percent tax would amount to about $24. Investors with less invested wealth would not even pay that amount.

Public Citizen's report additionally makes an important point about "perspective." The same investor with an $84,500 portfolio is already paying $1,144 in disclosed and hidden costs charged by investment companies such as mutual funds. In other words, the transaction tax cost would amount to about 1/50th of the fees Wall Street already charges mom and pop.

Although the impact of a speculation tax would be modest for those not engaging in billions of high-speed trades, the tax would raise substantial revenue. A 0.03 percent tax (only 30 cents per $1,000) would raise $352 billion over 10 years.

A speculation tax is highly progressive, has huge revenue potential and diminishes socially harmful activity. And it has been called many names over the years. Maybe the best one would be "common sense."

This column was distributed by OtherWords.