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A Financial Transactions Tax

Just like that perfect sweater, a financial transactions tax (FTT) would look just great on those Wall Street bankers and financiers. A modest tax, which would be too small for normal investors to even notice, could easily raise more than $100 billion a year. That’s real money even in the land of AIG and Citigroup bailouts.

The Wall Street boys and the politicians they support just hate it when people talk about an FTT. They start huffing and puffing and get out their best indigent voices to quickly dismiss such naïve notions by those not initiated in the ways of finance. These arrogant dismissals are usually sufficient to scare reporters away from writing about the idea and to keep most interest groups and politicians from seriously pressing the idea.

But for those not easily intimidated by blowhard bankers and their hired flacks (which include many economists), an FTT makes a huge amount of sense. The basic point is quite simple.

A tax of 0.25 percent on the sale or purchase of a share of stock will make little difference to a person who intends to hold the share for 5-10 years as a long-term investment. This tax would cost someone buying $10,000 of IBM stock $25 when they purchase their shares. If the price doubles in ten years, then they will have to pay $50 when they sell. These fees would be dwarfed by their capital gains taxes.

Similarly, if a farmer had to pay a tax of 0.02 percent on purchasing futures to hedge her wheat crop, the cost for hedging a $400,000 crop would be $80. This expense would have little impact on her decision to hedge her crop or on her income from farming. In fact, since the price of trading share of stock, futures, and other financial assets has fallen sharply in the last three decades, a modest transactions tax would just raise the cost of trading back to where it was 15 to 20 years ago.

A small increase in trading costs would be a very manageable burden for those who are using financial markets to support productive economic activity. However, it would impose serious costs on those who see the financial markets as a casino in which they place their bets by the day, hour, or minute. Speculators who hope to jump into the market at 2:00 and pocket their gains by 3:00 would be subject to much greater risk if they had to pay even a modest financial transaction tax.

Similarly, the financial engineers who specialize in constructing complex financial instruments may find an FTT to be a nuisance. An FTT could cause their derivative instruments to be taxed at several points. For example, the trade of an option on a stock would be taxed, as would the purchase of the stock itself if the option was exercised. More complex derivatives could be subject to the tax many times over, substantially reducing the potential profits from complexity.

The Wall Streeters and their flacks will insist that an FTT is unenforceable and will simply result in trading moving overseas. There is a small problem with this argument call the “United Kingdom.” The U.K. has had a tax on stock trades (trades of derivatives and other financial instruments are untaxed) for decades. The revenue raised each year would be equivalent to $30 billion in the U.S. economy. Obviously, the tax is enforceable.

In fact, we can go beyond the U.K. and add other measures to make enforcement more fun. For example, we can give workers an incentive to turn in their cheating bosses by awarding them 10 percent of any revenue and penalties that the government collects. There are surely many clerical workers in the financial industry who would welcome the opportunity to become millionaires by turning in their bosses.

Of course, the prospect of the financial industry moving overseas should not be troubling any case. Why should we be any more bothered by buying our financial services from foreigners than by buying our steel from foreigners? If the industry moved overseas, then it could corrupt some other country’s politics.

The basic point is simple. A FTT can allow us to raise more than $100 billion annually to finance health care or any other budget item that we consider important. It does so in a way that is very progressive and will weaken the financial industry both economically and politically. In fact, even Larry Summers, the head of President Obama’s National Economic Council, even argued that a FTT was a good idea.

As President Obama reminded us in reference the AIG bonuses, we can’t govern out of anger. However, we can govern with a clear sense of both justice and sound economics. A financial transactions tax fits the bill.

DEAN BAKER is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy.

More articles by:

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

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