The Specious Case Against a Financial Transactions Tax

by DEAN BAKER

With the European Commission seriously considering a tax on financial transactions (sometimes referred to as a “speculation tax”), the opponents of such a tax are shifting their campaign into high gear. We are hearing predictions of disaster from the financial industry and friendly economists if the European Union goes this route.

The opponents’ claims go along three lines:

  1. The tax will not be enforceable;
  2. The tax will just be passed on to consumers and therefore will not be taking money from the intended targets in the financial industry;
  3. It will raise the cost of capital and therefore slow growth.

Each of these objections are either altogether wrong or hugely exaggerated.

The claim that financial transactions taxes are not enforceable is disproven by the fact that many countries — including China, Hong Kong and the United Kingdom — have financial transactions taxes in place and raise substantial revenue through the tax. In the UK, the tax raises an amount that is between 0.2 and 0.3 percent of GDP each year ($30-$40 billion in the United States). This is done by just taxing stock trades. It does not tax bonds, options, futures or the other derivative instruments that would be subject to the tax being considered by the EC.

Furthermore, the HM Revenue and Customs in the UK reports that the stock transfer tax has the lowest administrative cost of any of the taxes it administers. One factor helping compliance is that a party does not have legal ownership of shares of stock unless they can show that they have paid the tax. This sort of creativity can substantially reduce enforcement problems.

The second objection is that brokers and dealers will simply pass the cost of the tax on to their customers, so that ordinary investors bear much of the brunt of the tax, not the financial industry. This argument ignores basic economics. While the price of trades will likely rise more or less in step with the tax, investors will respond by trading less. There are a range of estimates of sensitivity of trading volume to the cost of trading; most research indicates that it is highly responsive.

For simplicity let’s assume that the elasticity is one. This means that if trading costs double, then the volume of trading will be reduced by 50 percent. In this story, investors would end up bearing none of the cost of the tax even if it were passed on in full. The reduction in trading volume would fully offset the higher cost per trade.

In this context it is important to remember that finance is an intermediate good, like trucking. We don’t in general derive pleasure directly from finance like we might with food, entertainment or housing; finance is a means to an end. This means that if we cut our trading in half in response to higher trading costs, this has no obvious negative impact for the economy or society unless it somehow means that we are less secure in our saving or that capital is being less well-directed to its best uses.

It would be difficult to maintain that the innovations of the last three decades have accomplished either of these goals. If investors end up turning over their portfolios less frequently as a result of a transactions tax, it is difficult to see any obvious negative economic effects that would result.

This brings up the final point, that the tax will raise the cost of capital and thereby reduce investment and growth. While some opponents of a tax seem to believe that this is a very potent argument, it is important to remember that the tax rates being discussed would just raise transactions costs back to where they were 10 or 15 years ago.

No one in 1995, or even 1985, felt that the high cost of financial transactions was a serious impediment to economic growth.  Furthermore, one would be hard-pressed to find any economic research that shows that the sharp drop in transactions costs was a major factor propelling growth over the last three decades. If the drop in costs was not an important factor raising growth rates then it is difficult to see how raising transactions costs back to their former levels can have a substantial effect in slowing growth.

It is also important to remember that if trading were reduced roughly in proportion to the rise in transaction costs, then there would be little change in the cost of capital to borrowers. There would be less trading, but total trading costs remain roughly constant, which means that the cost of capital should stay roughly constant.

Of course the revenue from the tax must come from somewhere and in this case it is coming from the rents earned in the financial industry. There will be many fewer employed in the industry as a result of the tax. If this does not prevent the industry from performing its essential role of financial intermediation, then the tax will have effectively made the industry more efficient. This would be comparable to cutting the number of people employed in the trucking industry by a third or a half and still being able to ship products every bit as quickly. Who would not support this?

There will be negative aspects to any tax and a financial transactions tax is no exception. However, when we look at ways to raise large amounts of revenue, either to curtail budget deficits or to support new public services, it is difficult to envision a better route than a financial transactions tax.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of False Profits: Recovering from the Bubble Economy . He also has a blog, ” Beat the Press ,” where he discusses the media’s coverage of economic issues.

This article was originally published by International Relations and Security Network.

Exclusively in the New Print Issue of CounterPunch

THE SLOW DEATH OF THE ROMAN CATHOLIC CHURCH – Nancy Scheper-Hughes on Clerical Sex Abuse and the Vatican. PLUS Fred Gardner on Obama’s Policy on Marijuana and the Reform Leaders’ Misleading Spin.  SUBSCRIBE NOW

Order your subscription today and get
CounterPunch by email for only $35 per year.

 

Like What You’ve Read? Support CounterPunch
September 01, 2015
Mike Whitney
Return to Crisis: Things Keep Getting Worse
Michael Schwalbe
The Moral Hazards of Capitalism
Eric Mann
Inside the Civil Rights Movement: a Conversation With Julian Bond
Pam Martens
How Wall Street Parasites Have Devoured Their Hosts, Your Retirement Plan and the U.S. Economy
Jonathan Latham
Growing Doubt: a Scientist’s Experience of GMOs
Fran Shor
Occupy Wall Street and the Sanders Campaign: a Case of Historical Amnesia?
Joe Paff
The Big Trees: Cockburn, Marx and Shostakovich
Randy Blazak
University Administrators Allow Fraternities to Turn Colleges Into Rape Factories
Robert Hunziker
The IPCC Caught in a Pressure Cooker
George Wuerthner
Myths of the Anthropocene Boosters: Truthout’s Misguided Attack on Wilderness and National Park Ideals
Robert Koehler
Sending Your Children Off to Safe Spaces in College
Jesse Jackson
Season of the Insurgents: From Trump to Sanders
August 31, 2015
Michael Hudson
Whitewashing the IMF’s Destructive Role in Greece
Conn Hallinan
Europe’s New Barbarians
Lawrence Ware
George Bush (Still) Doesn’t Care About Black People
Joseph Natoli
Plutocracy, Gentrification and Racial Violence
Franklin Spinney
One Presidential Debate You Won’t Hear: Why It is Time to Adopt a Sensible Grand Strategy
Dave Lindorff
What’s Wrong with Police in America
Louis Proyect
Jacobin and “The War on Syria”
Lawrence Wittner
Militarism Run Amok: How Russians and Americans are Preparing Their Children for War
Binoy Kampmark
Tales of Darkness: Europe’s Refugee Woes
Ralph Nader
Lo, the Poor Enlightened Billionaire!
Peter Koenig
Greece: a New Beginning? A New Hope?
Dean Baker
America Needs an “Idiot-Proof” Retirement System
Vijay Prashad
Why the Iran Deal is Essential
Tom Clifford
The Marco Polo Bridge Incident: a History That Continues to Resonate
Peter Belmont
The Salaita Affair: a Scandal That Never Should Have Happened
Weekend Edition
August 28-30, 2015
Randy Blazak
Donald Trump is the New Face of White Supremacy
Jeffrey St. Clair
Long Time Coming, Long Time Gone
Mike Whitney
Looting Made Easy: the $2 Trillion Buyback Binge
Alan Nasser
The Myth of the Middle Class: Have Most Americans Always Been Poor?
Rob Urie
Wall Street and the Cycle of Crises
Andrew Levine
Viva Trump?
Ismael Hossein-Zadeh
Behind the Congressional Disagreements Over the Iran Nuclear Deal
Lawrence Ware – Marcus T. McCullough
I Won’t Say Amen: Three Black Christian Clichés That Must Go
Evan Jones
Zionism in Britain: a Neglected Chronicle
John Wight
Learning About the Migration Crisis From Ancient Rome
Andre Vltchek
Lebanon – What if it Fell?
Charles Pierson
How the US and the WTO Crushed India’s Subsidies for Solar Energy
Robert Fantina
Hillary Clinton, Palestine and the Long View
Ben Burgis
Gore Vidal Was Right: What Best of Enemies Leaves Out
Suzanne Gordon
How Vets May Suffer From McCain’s Latest Captivity
Robert Sandels - Nelson P. Valdés
The Cuban Adjustment Act: the Other Immigration Mess
Uri Avnery
The Molten Three: Israel’s Aborted Strike on Iran
John Stanton
Israel’s JINSA Earns Return on Investment: 190 Americans Admirals and Generals Oppose Iran Deal