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A Financial Transaction Tax Would Help Ensure Wall Street Works for Main Street

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A Financial Transaction Tax Would Help Ensure Wall Street Works for Main Street A financial transaction tax would help ensure Wall Street works for Main Street Report • By Josh Bivens and Hunter Blair • July 28, 2016 • Washington, DC View this report at epi.org/110651 Summary What this report finds: A well-designed financial transaction tax (FTT)—a small levy placed on the sale of stocks, bonds, derivatives, and other investments—would be an efficient and progressive way to generate tax revenues. Gross revenues from a well-designed FTT would likely range from $110 billion to $403 billion. And net revenues (including offsets from reduced income, payroll and capital gains taxes, and increased borrowing costs) would likely be substantially higher than some other recent estimates indicate. This is mainly because other estimates’ assumptions about the volume of financial transactions an FTT would crowd out are too high, and because an FTT is likely to redistribute rather than reduce overall incomes. Regardless of the level of revenues raised, an FTT would be a win-win for the U.S. economy. Higher revenues would result in more funds for social insurance programs and much-needed public investments. Lower revenues would be the result of the FTT crowding out financial transactions of little value to the U.S. economy. This would boost Americans’ incomes through lowering fees on financial services, such as the management of 401(k)s and other accounts. Why this matters: As the U.S. economy continues to recover from the 2008 financial crisis and the ensuing Great Recession, an FTT would help ensure the financial sector compensates other sectors of the economy (particularly U.S. households) for the damage the sector inflicted. Through generating tax revenues, decreasing the fees Americans pay on their investments, and shrinking unproductive parts of the financial sector, an FTT would help Wall Street work for Main Street. Introduction and key findings The financial crisis of 2007–2009 and the ensuing bank bailouts have led to widespread calls to ensure a “fair and substantial contribution” from finance for the damage this sector inflicted.1 In addition, given that the key rationales 1 for a large financial sector are risk-management and macroeconomic stability, the crisis inspired questions about whether the financial sector’s decades-long pre-crisis expansion was beneficial for the potential growth and efficiency of the American economy. Given the twin goals of raising revenue and ensuring that financial transactions actually do provide good value to the economy, the idea of a financial transactions tax (FTT) has recently gained popularity. A number of bills have been put forward in Congress to institute an FTT, most recently the Inclusive Prosperity Act introduced by Rep. Keith Ellison (D-Minn.). Rep. Ellison’s bill would tax the sale of stocks at 0.5 percent, bonds (with maturity over 60 days) at 0.1 percent, and derivatives and other investments at 0.005 percent. In 2014, Rep. Chris Van Hollen (D- Md.)—a member of the House Democratic leadership—introduced a bill that included a transactions tax. Sen. Bernie Sanders (I-Vt.) has introduced an FTT proposal in the Senate that mirrors Ellison’s House bill. In addition, a centerpiece of Sen. Sanders’s presidential campaign was an FTT that would fund an expansion of debt-free college tuition. At the same time that the FTT has gained some momentum in policy and political spheres, recent estimates of an FTT’s potential revenue-raising capacity have been smaller than those of earlier studies. Early estimates of the potential revenue that could be raised with an FTT frequently exceeded 1 percent of gross domestic product (GDP) annually (see, for example, Pollin, Baker, and Schaberg 2003). But in a series of papers for the Tax Policy Center (TPC), Burman et al. (2016) and Nunns (2016) report much lower estimates. These recent estimates are not trivial—Burman et al. (2016) find an FTT could raise between $50 billion and $70 billion annually (or between roughly 0.25 and 0.4 percent of GDP). But they are significantly lower than many previous estimates. Besides revenue estimates, Burman et al. (2016) also provide a good accounting of the potential pros and cons of the economic consequences of an FTT. The potential downsides they highlight, as well as the smaller revenue estimates, have led too many to wield their reports as clarion calls against the desirability of an FTT. This is not a warranted conclusion. This report examines some of the issues raised by the prospect of an FTT. Its principal finding is that the essential logic for supporting an FTT remains strong: It would raise revenue and crowd out transactions that direct income to the financial sector without providing much boost to most households’ living standards. Specific findings include: FTTs hold much promise as significant and progressive revenue raisers, and some recent revenue estimates may be excessively pessimistic. We find that potential gross revenues from an FTT range from $110 billion to $403 billion (depending on the responsiveness of financial transactions volume to costs). This estimate is widely agreed upon. There may be some revenue offsets to this gross amount, but these offsets may be overestimated, and the overall revenue potential of an FTT is considerable. One key parameter for how much revenue an FTT can raise is how responsive the volume of financial transactions is to changes in transaction costs. The higher this 2 responsiveness—or elasticity, in economic jargon—the more trading volumes are crowded out by an FTT and the less revenue it raises. There is ample reason to think financial transaction volume will fall less in response to an FTT than Burman et al. (2016) allow. Current elasticity estimates are based on FTTs that are not particularly well-designed to discourage arbitrage among asset classes or among national trading exchanges. If an FTT is well-designed to avoid this type of tax avoidance among asset classes, and if a U.S. FTT spurs further progress in other countries’ adoption of FTTs (as is happening in the European Union), then there is potential to reduce the scope for financial transaction crowd-out and to boost potential FTT revenue. The Burman et al. (2016) estimates of the net revenue potential of an FTT are also likely too pessimistic. This is because they assume too-high revenue offsets stemming from reduced national income from an FTT, as well as increases in government borrowing costs. The offsets estimated by Burman et al. (2016) depend largely on viewing the financial sector as efficient, with each transaction delivering value. If the financial sector (or at least the marginal transactions crowded out by an FTT) is not efficient and value-creating, then these offsets to the gross revenue collected by the FTT could be considerably smaller. Much evidence strongly suggests that the marginal value of financial transactions in the U.S. economy are near-zero, or even negative. If this is true, then U.S. households would strongly benefit from an FTT even if it raised very little revenue. In fact, in the case of zero marginal value of financial transactions, every dollar “crowded out” from financial transactions by an FTT would boost American households’ incomes one-for- one. Alternative ways of extracting a “fair and substantial contribution” from finance (a financial activity tax, or AF T, for example) could in theory raise as much revenue as a well-designed FTT. However, the FTT currently is much better-developed as a concrete policy and has greater political momentum. Further, it is far from obvious that a FAT could be better-targeted at displacing low-value transactions than an FTT while still raising an equivalent amount of revenue. Background As the name suggests, a financial transaction tax is a tax levied on the transfer of ownership of designated financial assets. Depending on the design, these taxes can be levied on the transfer of any number of assets, including stocks and equities, bonds, international currencies, and derivatives and securities (such as futures, options, and credit default swaps). FTTs generally levy a tax that is a percentage of the value of the traded asset, though they can also take the form of a flat fee applied to each transacted asset. FTTs can be assessed on assets in their original issuance, such as the stocks in an initial public offering, on trades in the secondary market, or on both. FTTs may be limited to trades on official exchanges, “over-the-counter” trades transacted directly between two parties, or both. As a general rule, both to prevent tax avoidance and to boost efficiency of collection, FTTs 3 are most effective when applied to as broad a base as possible instead of to particular classes of assets or financial marketplaces. The case for hoping that an FTT with a small base rate can raise substantial revenue rests on the utterly enormous volume of financial transactions that take place in the U.S. economy in a given year. Table 1 shows the volume of financial transactions by type for 2015. The table also shows transaction costs and the potential revenue that would have been raised under an FTT rate of 0.5 percent on stock trades, bond trades, and options premiums, and 0.05 percent on the notional value of futures, swaps, and foreign exchange.2 4 Table 1 Transactions costs, volume, and revenue estimates from a financial transaction tax Financial transaction Transaction Volume reduction times transaction costs, by type costs Volume FTT rates Revenue, by elasticity (billion of dollars) Revenue, by elasticity (% of GDP) elasticity
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