Representative Chris Van Hollen’s proposal for a financial transactions tax, a key part of the new tax plan that he revealed this morning, is a move towards establishing a 21st century structure for financial markets. In the last four decades there has been an enormous reduction in the cost of financial transactions due to the development of computers and information technology. This has led to an explosion in trading volume. Much of this trading volume serves no purpose from the standpoint of the productive economy, yet it generates enormous incomes for the financial industry.
Representative Van Hollen’s proposal is a step to reduce this source of economic waste. As even the International Monetary Fund has recognized, the financial sector is a grossly under-taxed sector in the United States and other wealthy countries. So rather than 'picking winners and losers,' this tax would help even the playing field between the Wall Street and Main Street.
While it will be important to see the specifics of the proposal, even a modest tax on financial transactions can raise a substantial amount of money almost exclusively by eliminating waste in the financial industry. Many analysts have noted that the 0.1 percent fee on stock trades in the Van Hollen proposal will imply a small cost to the vast majority of middle income savers. However, their assessment generally fails to note the decline in trading volume that would be expected to result from a rise in trading costs.
Most research shows that the elasticity of trading volume to trading costs is close to one, which means that trading will decline in roughly the same proportion to the increase in trading costs. This means that if per-trade costs were to increase by 50 percent as a result of the proposed tax, then the typical 401(k) holder would reduce their number of trades by roughly 50 percent, leaving their total trading costs little changed. This means that virtually all of the cost of the tax free up resources for the productive sectors of the economy. In addition to reducing inequality, this should provide a boost to economic growth.
It is important that Representative Van Hollen and the rest of the Democratic leadership have shown the courage to raise this issue. It can have a substantial impact in making a stronger economy with more widely shared prosperity.