The European Commission, desperate to raise revenue, has recently floated the idea of establishing a new financial transactions tax. Avinash Persaud argues that such an FTT might work if it were structured as a stamp duty:
Since 1986, and before in other guises, the UK government has unilaterally, without waiting on others, levied a Stamp Duty Reserve Tax of 0.50% on transactions in UK equities. Despite not updating this tax to take into account derivatives and other innovations, or reducing it to improve competitiveness, it still raises $5 billion per year.
The reason why this tax works and others, like the 0.5% transactions tax introduced in Sweden in 1984, did not, is that it is a stamp duty on the transfer of ownership and not based on tax residence. If the transfer has not been ‘stamped’ and taxes paid, the transfer is not legally enforceable. Institutional investors who hold most assets around the world do not take risks with legal enforceability. Forty percent of the UK Stamp Duty Reserve Tax receipts are paid by foreign residents. Far from sending taxpayers abroad, this tax gets foreigners to pay.
Even if a stamp duty is feasible, is it wise? Persaud believes that it might actually improve systemic resilience:
The principal victim of transaction taxes are those engaged in very high-frequency trading, as opposed to traditional pension funds, insurance companies and individual investors who turn over their portfolios less frequently. This is good news as it means that while bankers will try to pass on the tax to their customers, the brunt of the tax will not be paid by ordinary pensioners and savers but hedge fund managers and investors.
High-frequency traders argue that they provide critical liquidity to markets, but this is deceptive. During calm times, when markets are already liquid, high-frequency traders are contrarian and support liquidity, but during times of crisis, they try to run ahead of the trend, draining liquidity just when it is needed most, as we saw with the Flash Crash on 6 May 2010. If a transaction tax limits high-frequency trading it may even provide a bonus in improving systemic resilience.
Ken Rogoff takes the opposite view. It’s not to strong to say that in Rogoff’s view, the FTT is being pushed primarily for political reasons, not because it is sound on economic grounds:
Such taxes surely reduce liquidity in financial markets. With fewer trades, the information content of prices is arguably reduced. But both theoretical and simulation results suggest no obvious decline in volatility. And, while raising so much revenue with so low a tax rate sounds grand, the declining volume of trades would shrink the tax base precipitously. As a result, the ultimate revenue gains are likely to prove disappointing, as Sweden discovered when it attempted to tax financial transactions two decades ago.
Worse still, over the long run, the tax burden would shift. Higher transactions taxes increase the cost of capital, ultimately lowering investment. With a lower capital stock, output would trend downward, reducing government revenues and substantially offsetting the direct gain from the tax. In the long run,, wages would fall, and ordinary workers would end up bearing a significant share of the cost. More broadly, FTTs violate the general public-finance principle that it is inefficient to tax intermediate factors of production, particularly ones that are highly mobile and fluid in their response.
All of this is well known, even if prominent opinion leaders, politicians, and philanthropists prefer to ignore it.
I don’t have a theological view on a financial transactions tax. If Persaud is right and it improves systemic resilience, I’d be inclined to support it. If Rogoff is right, as I think he might be, I’d oppose it. One wonders if a tax on bank leverage might be a more effective strategy if our actual goal is to improve systemic resilience.