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Research desk answers: How to raise $100 billion from a financial transactions tax

By Dylan Matthews

srw3 asks:

How high would a financial transactions tax have to be to raise 100 billion a year? The tax should target high frequency trades. Retirement accounts under 1,000,000 would be exempt. 10 Trades a day per account would be the floor before the tax kicks in.

While the numbers haven't been run on srw3's specific plan, economists Dean Baker, Robert Pollin, Travis McArthur and Matt Sherman have looked at the revenue possibilities (PDF) of a financial transactions tax (FTT), and the the numbers are encouraging. Their proposal would tax stock sales at 0.5 percent (with half paid by the buyer and the other half by the seller), and bonds and swaps at 0.01 percent for each year to maturity the bond or swap has reached. Options would be taxed at the same rate as stocks, foreign exchange trades would be taxed at 0.01 percent per transaction, and futures trades would be taxed at 0.02 percent per transaction.

Given those, the authors estimated the revenue it would create if it does not reduce trading at all, if it reduces trading by 25 percent, and if it cuts trading in half. Here's what they found:

ftt_revenue.png

As you can see, the main revenue sources would be in stocks, bonds and swaps. Even if trading is cut in half, the tax still raises $176.9 billion a year, which would make it the federal government's third-largest revenue stream after individual income and payroll taxes (see Table 1-8 in the CBO's FY2011 budget analysis).

How much trading would actually be affected is an open question; the authors have in the past called (PDF) a 25 percent drop "implausibly high," suggesting that the probable revenue would be somewhere between $353.8 billion (the figure for no drop in trading) and $265.3 billion (the figure for a 25 percent drop). Proponents hope that at least some meaningful drop in trading would occur. One point of the tax is to deter high-frequency trading and to reduce the size of the financial services industry, which would not be accomplished if trading does not fall. There's thus a trade-off between the revenue gains to be had from an FTT and the size of its effect on the financial sector.

In any case, an FTT would produce far more revenue than alternative taxes on the banking sector. A new Institute for Policy Studies paper, set to be released tomorrow, shows that FTT revenue (as measured in the Baker et. al. paper) pales in comparison to what would be generated by the Obama administration's proposed bank levy ($9 billion a year) and the IMF's proposed financial activities tax ($28 billion a year). Of the three, only an FTT would make a big dent in the deficit.

By Ezra Klein  |  June 16, 2010; 10:53 AM ET
Categories:  Financial Regulation , Taxes  
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Comments

I am absolutely all for this. If it cut trading in half that would be a good result too, not an unintended consequence. The markets right now are a casino dominated by machines with algorithms. They are not a way to rationally allocate capital. We should have a transaction tax like this ASAP. I see no downside if it is structured this way. But we need the estate tax too.

Posted by: Mimikatz | June 16, 2010 11:02 AM | Report abuse

Ezra and Dylan: Thanks for the prompt work on this. Wouldn't a side benefit be making computer arbitrage trading less appealing for minute differences in currency or asset values? This seems like a great way to ease the deficit through taxing what is essentially a business that generates profits but doesn't really encourage actually making things or providing services. I can't wait for the trolls to whine about how this would stifle incentives to make money. Well, I want to stifle making money by finding tiny value differences and making money by having computers make hundreds of millions of trades to exploit that tiny difference.

Posted by: srw3 | June 16, 2010 11:23 AM | Report abuse

The stock market gets vastly too much attention because it is so superficially simple to report on. (DOW up/down, etc.) It's really not the driver of the economy that it is made out to be.

What are the opportunity costs of these taxes?

What is the effect on the liquidity and price of the market as a whole (i.e., will you be able to sell stocks and bonds at a fair price, or will it cause prices to drop because the cost of the tax has to factored into the purchase)? Looking at it in raw terms, I would expect it to cause at least a permanent 0.5% drop in the value of the market as a whole, because everyone that currently owns stock would have to sell it for less.

If you want to fix the stock market, fix the imbalance between dividend and short term capital gains. Rather than people trying to get rich quick off of capital gains, which lead to price volatility, we should modify the existing tax structure to make dividends vastly much more attractive. than short term capital gains.

Posted by: staticvars | June 16, 2010 11:24 AM | Report abuse

Great question and great answer. Personally, I'm just happy I could comprehend the whole thing.

But I would be interested in a response to some of staticvars' questions. Specifically, "will you be able to sell stocks and bonds at a fair price, or will it cause prices to drop because the cost of the tax has to factored into the purchase?" I've never been able to determine what a "fair price" for stocks and bonds might be, so I have no idea what the true "value" of the stock market is (if anything). While I have some understanding of what guides the pricing of stocks and bonds, I don't have an adequate understanding of the whether those guides are substantively useful.

Taken as a whole, the stock market seems to be very little more than a giant casino to me. So, a discussion of "fair price" and "value" seems either woefully out of place here or woefully overdue here. I honestly don't know which.

Posted by: slag | June 16, 2010 12:04 PM | Report abuse

I would trade a .5% drop in market prices for the 200 billion + revenue stream. A drop of this size is almost within the normal price volatility we see daily in the major indices.

"Rather than people trying to get rich quick off of capital gains, which lead to price volatility, we should modify the existing tax structure to make dividends vastly much more attractive. than short term capital gains."

Its not people that trade millions of times per second, it is the computer farms of the biggest investment firms. This bill could be structured so that individuals would get x number of free trades per day/week/month to minimize the impact on small investors.

Besides short term capital gains are already taxed at a higher rate than long term gains or dividends.

Posted by: srw3 | June 16, 2010 12:20 PM | Report abuse

@slag : the transactions tax would remove some of profits from the casino style computer arbitrage trading that can lead to so much volatility.

Posted by: srw3 | June 16, 2010 12:25 PM | Report abuse

i think actually implementing such a tax w/o affecting spreads and distortions of normal end users, as opposed to isolating on high frequency traders, could be a huge problem. rather than just rest with a Dean Baker et. al reports, i'd appreciate if Klein and co. could link to other (more centrist?) prespectives like Malkiel or even historical examples like Sweden (which did lead to a market drop approximating the discounted value of future tax rakes, a rational result). Moreover, what about ETFs and index funds? What's Vanguard's position here (well I actually know their position, but still, would be interesting to mention)

Posted by: stantheman21 | June 16, 2010 12:26 PM | Report abuse

You should google the expression "dark pool" then reconsider. High frequency traders will find a way to transact in secret if public exchanges are closed to them.

I'm all for finding a way to slow down trading, limit the skimming, and increase tax revenue to the government. But good intentions are not enough. You need a plan that can work.

Posted by: congm | June 16, 2010 12:44 PM | Report abuse

@congm: High frequency traders will find a way to transact in secret if public exchanges are closed to them.

The exchanges are not closed, there is just a very small tax appended to each transaction. If they want to skirt the law, well that is what the SEC is for. Hopefully it will be fully funded, not like in the Bush years...

Posted by: srw3 | June 16, 2010 1:45 PM | Report abuse

--"I would trade a .5% drop in market prices for the 200 billion + revenue stream."--

Of course you would, because it's not your money.

It's a scheme to make America poorer for the sake of giving politicians more money to waste.

What a deal.

Posted by: msoja | June 16, 2010 1:53 PM | Report abuse

msoja, these are the jokers that melted down the financial system. I don't feel too sorry for them, considering most of them still have their jobs and second houses while their actions caused millions to be unemployed. If nothing else, it is payback for saving their asses through tarp, the fed buying trash securities to get them off their books, and their exclusive access to 0% money at the fed discount window.

Besides, this provides money to lower the deficit, which is the conservative meme when Democrats control congress and/or the Whitehouse.

Funny how in the 8 years of bush rule, it was customary to not pay for things (ie allow the deficit and debt to skyrocket funding unnecessary wars and giving tax breaks to the top 5%), as Hatch said.

Posted by: srw3 | June 16, 2010 2:12 PM | Report abuse

--"If nothing else, it is payback for saving their asses through tarp, the fed buying trash securities to get them off their books, and their exclusive access to 0% money at the fed discount window."--

More wrongs don't make it more right.

If someone doesn't stop and start doing what's right, the whole thing is going to crash.

How many straws do you think the camel can tote?

Posted by: msoja | June 16, 2010 2:23 PM | Report abuse

MS I am not going to feel sorry for the giant investment firms that use computer farms to do arbitrage trading on tiny asset value differences or currency fluctuations. These firms are among the most profitable in the country. The tax also discourages practices that are bad for the market (increased volatility) and also hurt individual investors that can't buy giant computer farms to trade millions of shares per second. Feel free to defend the Goldman Sach's of the world, but I won't.

Posted by: srw3 | June 16, 2010 2:28 PM | Report abuse

@msoja:

More wrongs don't make it more right.

I don't see anything wrong with a FTT. We have real estate and car transaction taxes. Why should this class of assets be treated differently...

If someone doesn't stop and start doing what's right, the whole thing is going to crash.

Wait a sec! Didn't the whole thing crash in 2008? Discouraging this kind of computer arbitrage trading will make the whole thing crashing less likely by making computer trading slightly less profitable. Its not the FTT is eliminating computer trading after all.

And don't you want to lower the deficit or are you in the Bush (put it on the national credit card and let the next guy deal with it) school of budgeting?

Posted by: srw3 | June 16, 2010 2:34 PM | Report abuse

srw3,


WHOA there. $1,000,000???

You do know that what's $1,000,000 in the South isn't $1,000,000 in the Northeast right?

Can we have a little variance for areas with higher cost of living please? You're gonna ensnare a lot of union folks in that trap of yours.

I'd personally rather have it be on a monthly or rather annual basis. You could have a poor union schlub with $1MM easy in the Northeast at age 70 and if at any time his broker made 10 trades he'd be hit. I'm pretty sure that's not your intent.

As always beware of unintended consequences.

Posted by: visionbrkr | June 16, 2010 2:40 PM | Report abuse

@vb: I would exempt retirement plans from the law up to 1000K. How many people have a retirement account that big? I bet less than 10% of people have retirement accounts in excess of 1000k.

from Forbes.com

The nest eggs are cracked. Nearly 28 million U.S. households--37% of the total--do not own a retirement savings account of any kind. Among the households who owned a retirement savings account of any kind as of 2001, according to a 2004 report by the Congressional Research Service, the average value of all such accounts was $95,943. That number was distorted by the relatively few large accounts, and the median value of all accounts was just $27,000.

The median value of the retirement accounts held by households headed by a worker between the ages of 55 and 64 was $55,000 in 2001, the CRS says. To that, Stein adds that just 11% of all Americans have retirement savings of $250,000 or more.

So I am not too worried about that <10% with accounts over 250k. I bet less than 5% have over 1000k given the forbes article.

I could go with a monthly basis, but I don't think it is really necessary How about 70 trades per week?.

Who does more than 300 trades a month?

Posted by: srw3 | June 16, 2010 3:01 PM | Report abuse

A 0.5% FTT on stock purchases and sales, half to be paid by the buyer and half by the seller: 1) 500 shares of GE stock is priced at ~$8,000 today; the FTT on that transaction would be $40, with $20 charged to the buyer and seller; 2) 200 shares of Netflix goes for $25,000; the FTT would be $125.

The high frequency traders who trade tens of millions of dollars worth of stock every day would take a big hit. Their profit is often pennies per share and the FTT would obliterate their profits. A 0.5% FTT would be a very noticeable tax to even retail customers who buy and sell shares a few times per year. The tax would dwarf the $5 or $10 sales commission typically charged to retail customers nowadays.

Posted by: tuber | June 16, 2010 3:08 PM | Report abuse

@tuber:The high frequency traders who trade tens of millions of dollars worth of stock every day would take a big hit. Their profit is often pennies per share and the FTT would obliterate their profits.

Well that is the point. High frequency traders are supposed to see their profit margins fall to make trading a million shares to make $.01 on each share less profitable.

A 0.5% FTT would be a very noticeable tax to even retail customers who buy and sell shares a few times per year. The tax would dwarf the $5 or $10 sales commission typically charged to retail customers nowadays.

I would exempt some small number of trades per day/week/month so that the occasional trader isn't caught up in this. Another way to do this is to rebate the tax if the stock is held for more than 60 days. I would also exempt retirement accounts under 1000k. that eliminates 95% of all traders.

Posted by: srw3 | June 16, 2010 3:22 PM | Report abuse

what about ETFs?

Posted by: stantheman21 | June 16, 2010 3:31 PM | Report abuse

An FTT could probably be justified if the revenues were earmarked for agencies like the SEC, CFTC, and the other mishmash of federal regulatory bodies that oversee the securities industry. But a 0.5% FTT on stock trades alone would raise much more than those agencies currently receive combined by more than a 100-fold if not much more (just a guess).

Whether you like the high frequency traders or not, imposing a large FTT just to put them out of business seems punitive. For occasional trades, allowing exemptions for certain numbers trades or a rebate system would seem to make things more complicated. Who would determine whether a trade was exempt or not? Would the brokerage house have to count the number of trades? What if a person had more than one brokerage account? For a rebate mechanism, would the occasional trader have to pay the FTT upfront and file for a rebate? How about people who move their 401(k)s? Just messy.

Posted by: tuber | June 16, 2010 3:59 PM | Report abuse

srw3,

deal ;-) anyone doing more than 70 trades per week wouldn't be unjustly hit IMO.

Posted by: visionbrkr | June 16, 2010 4:27 PM | Report abuse

@tuber: FTT just to put them out of business seems punitive.

No one is putting them out of business. They just have to only trade bigger spreads to make money. That is the point. Stop hyperfast trading of 100s of millions of shares with miniscule differences in value.

I am sure that a brokerage house can set an alert when a client exceeds a certain # of trades. Whether it is keyed to accounts or say the SS# of the owner is a technical detail that can be worked out. 99% of stock owners don't do 10 trades a day or 70 per week.

whether or not it is messy, it is necessary. Moving an account from one firm to another doesn't necessarily involve selling the assets in the account, so no problem there.

Posted by: srw3 | June 16, 2010 5:38 PM | Report abuse

@vb: no comment on the # of people affected by the 1000k limit on retirement accts?

Posted by: srw3 | June 16, 2010 5:47 PM | Report abuse

srw3,

i would be more upset if i thought this had a snowball's chance in he_ _ of happening ;-)

Posted by: visionbrkr | June 16, 2010 6:01 PM | Report abuse

@staticvars:
"If you want to fix the stock market, fix the imbalance between dividend and short term capital gains."

But a tax on selling stock would act as a tax on capital gains, no?

Posted by: hunterw1 | June 16, 2010 6:06 PM | Report abuse

--"hyperfast trading of 100s of millions of shares with miniscule differences in value"--

See Wikipedia: http://en.wikipedia.org/wiki/Algorithmic_trading

So called hyperfast trading accounts for 73% of U.S. volume. It enhances liquidity, and reduces volatility.

Also, it's estimated that the 300 firms that practice it earned $21 Billion in 2008. It would be a bit tough to rake $200 Billion off the top of that, as Klein wishes he could.

Posted by: msoja | June 16, 2010 10:03 PM | Report abuse

Actually, trading volumes in actively traded stocks would go down 80+%.

At least that much volume is related to market-making, statistical arbitrage, option arbitrage, other fast-money types who adjust exposures constantly and have less than 0.5% expected return on a given trade.

If a $50 stock currently trades with a nickel effective bid-ask, the 0.5% is a quarter so the bid-ask becomes 30 cents... but there's a snowball effect because the reduction in volume makes it harder to get in and out and hedge, hence more risky, so market makers will back off and the spread will go to fifty cents or higher.

It's a dumb tax that gives a quarter to the government but costs the investors in the trade fifty cents by making the markets less efficient; politically expedient because it seems like no one pays, but in fact every investor pays a deadweight loss and can't adjust their risk the way they want without giving up a sizable chunk of return.

Looking at it another way, if you turned over your portfolio every year you lost 0.5% every year on the tax alone; plus stocks are that much less liquid, so stocks are less than desirable relative to bonds, real estate etc., so stocks would have to go down quite a few percent to be equally attractive post-tax. The politician who brings it up and spooks the market will not endear himself to the investing classes.

Posted by: curmudgeonlytroll | June 16, 2010 10:05 PM | Report abuse

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