Why a Financial Transaction Tax Is a Bad Idea

This article was originally posted on TabbForum here

By Holly A. Bell

Former Secretary of Labor Robert Reich claims financial transaction taxes are simply sales taxes on Wall Street traders and won’t harm markets or cause capital to flee. Yet studies of FTTs in other countries show they harm Main Street and distort markets.

Former Secretary of Labor Robert Reich recently produced a snappy video about why financial transactions taxes (FTTs) as proposed by Bernie Sander’s on the campaign trail should be retained and turned into law. Unfortunately, his pithy presentation is wrought with inaccuracies.

He begins by modifying the language of FTTs by shruggingly telling us it’s just a sales tax. We pay sales taxes on many things and it’s only “fair,” he claims, that anyone who sells a stock should pay a tax too. Yet it’s not exactly like a sales tax. For one thing, it’s not transparent. When you go to a local store and buy a sweater, does the seller pay the sales tax? No; the person buying the sweater pays the tax and can see the amount paid on the receipt.

While Mr. Reich would have you believe this is a tax that will be paid by greedy Wall Street types when they profit from selling stocks, that’s not how it actually works. When a Wall Street trader sells equities, he or she (the seller) doesn’t ultimately pay the tax; it becomes non-transparently built into the price of securities and other financial assets.

The IMF has warned that because FTTs are not well targeted, “The cumulative, ‘cascading’ effects of an FTT … can be significant and non-transparent,” with costs falling primarily on final consumers rather than financial institutions. These compounding impacts include lower returns on savings, higher costs of borrowing, and increases in final commodity prices. All that money Professor Reich tells you they’ll generate to pay for education and other government programs is coming right out of your pension fund or 401k and makes it more expensive to borrow money to buy a car or a home. Wall Street doesn’t bear the burden of the tax; Main Street does.

Canada implemented a form of FTT on order submissions and cancellations in April 2012, which is similar to the type of plan supported by Hillary Clinton. An October 2013 study by Katya Malinova and Andreas Park of the University of Toronto and Ryan Riordan of Queen’s University found that while the trades, quotes and order cancellations that Mrs. Clinton and Mr. Reich find problematic were immediately reduced by 30%, bid-ask spreads increased by 9%. Higher bid-ask spreads are one way sellers can cover the cost of taxation.

The same study also found that institutional “Wall Street” traders actually saw increased intraday returns for market orders, while “Main Street” retail traders were negatively affected through lower limit order returns. This is obviously not a tax imposed on Wall Street.

Professor Reich also tries to convince us that the prospect of FTTs driving capital offshore is untrue. He cites as an example that London has had a form of FTT “for decades” while remaining a major financial center. What he doesn’t tell you is that while a 2% FTT was implemented in 1974, it was reduced to 1% in 1984 and again to half a percent in 1986, and that there is a growing list of exemptions to the tax or that removing the tax entirely has been seriously discussed in recent years. Why? The tax has caused market distortions, as investors have fled taxed investments for tax-exempt options.

Investments in registered securities declined while bearer securities investments increased. Investors switched from trading in equities to trading in equity derivatives with similar returns. According to a 1996 report by the Canadian Parliamentary Information and Research Service:

“Investors also increasingly used American Depository Receipts (ADRs) which allowed British active nominees to trade assets on American stock markets without incurring British registration duties.”

Investors fled – they just fled to the many exemptions within London markets. Absent such internal exemptions, capital will flee the country. Last year TABB Group estimated that Canadian brokers who desire to avoid fees and take advantage of liquidity incentives were routing about 40% of Canadian retail trade orders to the U.S., representing about half of all Canadian interlisted trading.

In Sweden an FTT implemented in 1984 significantly diminished market quality before it was finally repealed in 1991. A 1993 study published by Steven R. Umlauf in the Journal of Financial Economics concluded: “Volatility did not decline in response to the introduction of taxes although stock price levels and turnover did. Large proportions of trading activity migrated overseas to London when the tax rate was increased.” How bad was the exodus? About 60% of the trading volume of the 11 most actively traded Swedish trade classes migrated to London between 1984 and 1991 where tax burdens were lower and exemptions were plentiful. While the tax was designed to increase government revenue, Sweden actually saw tax revenue decline.

Both Italy and France also implemented FTTs in 2012. In 2013, a study of year-over-year liquidity by TABB Group found Italy’s share of European equity turnover had declined 51%, while France’s declined 44%. France experienced decreases in market liquidity and a slight increase in volatility. The equity turnover declines in both countries occurred at a time when European volume was up 7% overall. Surprisingly, the European Union saw the light in 2012 and rejected a transaction tax across all 28 EU nations. A smaller group of 10 countries seeking a tax under the EU’s enhanced cooperation rules is also at risk of not having enough members to move forward.

The evidence is everywhere that financial transaction taxes harm Main Street by promoting higher costs for retail investors, less transparency, shrinking productivity, more market volatility, higher costs of capital, less availability of buyers and sellers at the time of trade, higher unemployment and capital flight. So you have to wonder what FTT supporters really hope to accomplish with one.

Dr. Bell is an associate professor at the University of Alaska Anchorage and a consulting scholar on financial market structure and regulation. Her financial thriller “Trading Salvos,” is available on Amazon. Follow her on Twitter @HollyBell8

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