Financial Taxes Can Raise Revenues, May Help Stabilize Markets

The congressional Super Committee, tasked with forging a $1.2 trillion deficit reduction package by Thanksgiving, is currently deliberating on which revenues – if any – to raise and to include in its plan. With Wall Street at the center of the 2008 economic collapse, the committee should look to a pair of revenue options that would fulfill the dual roles of addressing risks to the economy posed by Wall Street and raising much needed revenue: a financial speculation tax and a financial crisis responsibility fee on large financial institutions.

A financial transactions fee, or financial speculation tax, would affix a small fee to purchases and sales of certain financial products. The fee is based on the price of the product, and generally, the buyer and seller split the cost of the fee equally. The tax can focus on stock and stock options trading, or it can cover the vast array of financial transactions, including bonds, derivatives, foreign exchange, futures, and swaps trading.

Advocates of a financial transactions fee generally propose a tax of between 0.1 and 0.5 percent on stock and stock options trading, and much smaller taxes – between 0.002 and 0.005 percent – on other transactions. Taxing all transactions and taxing both sellers and buyers would produce a high-end estimate of $1.3 trillion over 10 years, according to Dean Baker, founder of the Center for Economic and Policy Research. This tax on Wall Street would fill the aggregate gap between state budgets and state revenues across the country in 2012.

On the lower end, Rep. Peter DeFazio (D-OR) introduced the Let Wall Street Pay for the Restoration of Main Street Act in 2009. The bill would have imposed a 0.25 percent tax on stock transactions and a 0.02 percent tax on futures, swaps, and credit default swap transactions, excluding investments made by retirement accounts and mutual funds. It would also provide a credit to taxpayers for the first $100,000 of stock transactions per year, helping to shield the middle class. These exemptions would have reduced the revenue raised by a third ($100 billion a year rather than the $130 billion from the Baker proposal). DeFazio proposed that half the funds be used for a Job Creation Reserve linked to transportation funding, and the other half for deficit reduction.

A financial transactions tax could also cut down on the amount of speculative trading that occurs and help stabilize financial markets. Over the last several decades, the financial sector – narrowly defined as security and commodity trading and investment banking – has accounted for an ever-increasing share of the private economy, and questionable transactions helped to drive the financial collapse of 2008. The immediate impact of a transactions tax would be to lower trading volumes in markets, thereby tamping down an inefficient use of resources, freeing them up to "be employed in a sector where [the resources] can have measurable economic benefit."

A financial transactions tax would also raise the cost of trading, making short-term trading, which serves little to no productive purpose, less profitable. This would force "actors in financial markets to focus on more long-term investment opportunities rather than opportunities for short-term gains," helping financial markets "more effectively allocate capital in ways that support growth" in the productive economy. What’s more, technological advancements over the last few decades have made the transactions tax one of the easiest and cheapest taxes to collect. The United Kingdom’s transactions tax, which costs 0.05 percent of revenue collected to manage, is thrifty compared to the administrative costs of the UK’s income tax, which costs 0.7 percent of personal income tax collected.

A second tax on Wall Street – the financial crisis responsibility fee, or systematic risk fee – would apply to financial institutions with assets above $50 billion. A 2010 Congressional Budget Office (CBO) study estimated that the tax would affect roughly 60 bank holding and insurance companies. Originally proposed by President Obama in his fiscal year (FY) 2011 budget, the responsibility fee would apply a tax of 0.15 percent to the total liabilities of these financial institutions each year, less any banks’ deposits assessed by the Federal Deposit Insurance Corporation (FDIC) and any insurance companies’ insurance policy reserves.

Proposed by the president in the wake of the financial collapse and the use of public funds to rescue some of the nation’s largest financial firms through the Troubled Asset Relief Program (TARP), the responsibility tax attempts to recoup taxpayer losses due to the bailout. The tax would run until the covered financial firms repay the costs associated with TARP – currently estimated at $117 billion – likely taking about 12 years. The Office of Management and Budget (OMB) projected the responsibility fee to raise $9 billion in 2015 and $90 billion over 10 years.

The CBO observed that because the fee would represent "a small fraction of the rate charged on an average bank loan to businesses, which currently is in excess of 3 percent," the tax "would not have a significant impact on the stability of financial institutions or significantly alter the risk that government outlays will be needed to cover future loses." Also, "[b]ecause of its modest size, the fee would probably not have a measurable impact on" economic growth.

For these reasons, both financial taxes enjoy significant support within political and economic communities. Noted conservative economists Greg Mankiw (President George W. Bush’s chair of the Council of Economic Advisers) and David Stockman (a director of OMB under President Ronald Reagan) have supported the responsibility tax. The transactions tax is also widely supported within the economics community; a 2009 letter calling on Congress to adopt the tax drew the signatures of over 200 highly respected economists. Moreover, nearly half of the deficit reduction plans released by nonprofits and think tanks over the last year in reaction to the president’s fiscal commission included one or both of the taxes.

The public also supports both the speculation and crisis responsibility taxes. A January 2010 Lake Research poll found that 8-in-10 Americans supported a transactions tax. Similarly, the Wall Street Journal reported around the same time that nearly 6-in-10 voters supported a "responsibility fee" that would "discourage big bonus payouts and ensure big banks that caused the crisis [to] pay for the bailout."

Detractors of these financial taxes exist, however. Ken Rogoff, former chief economist at the International Monetary Fund (IMF), recently opined against a financial transactions tax for the European Union (EU), arguing that the tax would significantly reduce market liquidity with "no obvious decline in volatility" and "increase the cost of capital, ultimately lowering investment."

Baker counters that because "[c]omputerization and deregulation has led to a sharp decline in transactions costs over the last three decades," the small fees the EU is considering charging would only raise transactions costs and liquidity back to levels seen in the early to mid nineties.

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