Don't believe Wall Street's scare stories about a financial transactions tax

Thanks in large part to Sen. Bernie Sanders, the Democratic Party recently added a financial transactions tax to its platform. In his run for the presidential nomination, Sanders had promoted the idea of an FTT — a small sales tax on the purchase of stocks, bonds or other financial assets — as a way to finance free college for everyone, with money left over for infrastructure and other important needs.  The idea has currency beyond the platform, too: Rep. Peter A. DeFazio (D-Ore.)  recently reintroduced an earlier proposal for a tax of 3 cents on every 100 dollars on most financial transactions.

Talk of FTTs scares the financial industry: They would significantly reduce the industry’s revenue and profits. As soon as anyone starts taking FTTs seriously, the industry immediately begins issuing dire warnings — which, unsurprisingly, almost always amount to nonsense.

Of late, the industry has taken to pretending that the real victims of an FTT won’t be the high rollers on Wall Street, but rather middle-class families. If families have 401(k)s, industry complainers say, they will have to pay more for the trades done by the people who manage their funds. Likewise, if they have a traditional pension, each trade made by the pension will cost more.

There’s  a basic  problem with the industry’s logic. A great deal of research shows that trading of stock and other financial assets is hugely responsive to the cost of trading. In fact, most research shows that if the cost of trading goes up by a certain amount — say 20% — the number of trades will fall by an even larger amount, say 25%.

The implication is that however much a tax raises the price of trading, it will reduce the volume of trading by even more. That means the total amount that a typical manager of a 401(k), mutual fund or a pension fund spends on trading will actually fall as a result of the tax.

In the example above, families would find themselves paying 20% more on each trade ordered by their fund manager, but the manager would order 25% fewer trades, meaning the total trading expenses charged to their 401(k) would fall by roughly 10%. (They would be trading 75% as much as they had previously, but paying 120% as much on each trade.) It follows that, in this story, most families end up saving money as a result of the tax, at least assuming that they aren’t giving up anything by trading less.

That, by the way, is a pretty safe assumption. Some people will win on a trade, for example, by selling a stock at a temporary high. But that means someone else lost, by buying an over-valued stock. On the whole, trading is a wash.

Nor should we worry that an FTT would make the market dramatically less vibrant. Trading costs have plummeted in the last four decades as a result of computerization. The FTTs on the table would just raise trading costs back to where they were 10 or 20 years ago; they won’t shut down financial markets.

Of course there is one group that does stand to lose in this story: the financial industry. The lost trading volume is money directly out of their pockets. If a tax like the one proposed by DeFazio raises $40 billion a year, as projected by the Joint Tax Committee of Congress, it would reduce the revenue of the financial industry by at least this amount.

Look for scare stories about FTTs in the coming months. They may not make a lot of sense to those familiar with the issue, but they can go far in shaking the public’s confidence. Legislators shouldn’t lose sight of the bottom line: FTTs can raise a lot of money by making the financial industry more efficient.   

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C.

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