Financial Transaction Tax: An Oversold Idea That Won't Die

The 2020 Democratic Party presidential primaries are bringing out a litany of horrible public policy ideas: the wealth tax, baby bonds, expanding national service programs, capping credit card interest rates, and forgiving student debt. I have another one to add to the list: the financial transaction tax (FTT). Back in May, Senators Bernie Sanders (I-VT) and Kristine Gillibrand (D-NY) introduced the Inclusive Prosperity Act. This Act sets up a few FTTs: 0.5 percent for stocks, 0.1 percent for bonds, and 0.005 percent for derivatives. The United States is not the only country eyeing the financial transaction tax. Last month, France and Germany set out to persuade other European Union member states to enact a 0.2 percent FTT on equity trades in the EU from 2021.

What exactly is the FTT? It is like it sounds. It is a levy imposed on the buyer or seller of a financial instrument (e.g., stock, bond, FX, derivative, security). There are three common policy justifications: reducing financial market volatility, more tax revenue, and pay for the federal assistance to the institutions that are viewed by some as the source of the financial instability, a.k.a. Wall Street. In the case of Sanders, he would like to take the tax revenue to fund his proposal for free college tuition and erasure of college student debt. Sanders hopes that such a tax would generate up to $2.4 trillion over the next decade. Sanders would like to mitigate income inequality while "sticking it to Wall Street." What could possibly be wrong with a financial transaction tax? Non-rhetorically, I can think of a few reasons.

1. It is not clear as to whether it would mitigate financial volatility. The main argument used is to prevent another financial downturn similar to the Great Recession. However, financial transaction taxes might not work so well. In 2012, the Bank of Canada released a study on FTTs. They concluded there is little evidence that it would mitigate financial volatility. If anything, it would likely "increase volatility and bid-ask spreads and decrease trading volume." Jared Bernstein, the former economic adviser of Vice President Joe Biden, came to a similar conclusion, as did the International Monetary Fund [IMF] (Matheson, 2011; also see Wang and Yau, 2012; Habermeier and Kirilenko, 2001; Hau, 2003).
2. It is a poorly targeted tax. Sanders would like to target the more speculative aspects of Wall Street that supposedly got us into trouble. The problem is that the FTT would indiscriminately target speculative and productive trading, thereby disincentivizing investment. 
3. Revenue Estimates are Too Optimistic. This is not the first time that Sanders proposed a FTT. He previously did so in 2016, and estimated it would bring in $3 trillion over a decade. The left-of-center Tax Policy Center found that Sanders' 2016 version would only bring in $400 billion. This means that Sanders exaggerated by a near ten-fold! The Congressional Budget Office also estimated the tax revenue back in December, and it was only $776 billion over ten years. This phenomenon is not unique to Bernie Sanders. The European Union has come across similar issues with rosy FTT revenue estimates. France and Italy also did not acquire the revenue they anticipated.
4. It would negatively affect retirement savings. As the Tax Policy Center points out, financial transaction costs have lowered since the 1970s. This has made way for such retirement vehicles as the 401(k), mutual funds, and the IRA, which has made retirement more accessible for those who aren't rich. Sanders' FTT would increase transaction costs by ten-fold, which would make retirement more difficult for the working class that Sanders purports to help. This means that the FTT doesn't target Wall Street speculators like Sanders would like because the costs are passed on to the investors. 
5. There would be significant tax avoidance. A paper from an economist at the University of Berkeley outlines how the FTT incentivizes tax avoidance, and uses Italy and France as examples (Coelho, 2016). Some forms of tax avoidance are portfolio substitution, market-making exemptions, platform and derivative shifting, and geographic evasion.
6. This would negatively affect liquidity and price discovery. This might sound like some financial jargon, but ensuring liquidity, or the ability to purchase or sell an asset without causing a drastic change in the asset's price, is important. As the IMF found, a decrease in liquidity increases the price impact of trade, which increases price volatility (Matheson, 2011). This same paper also found that the reduction in liquidity makes it more difficult to "incorporate the effect of new information into asset prices," which only makes it more difficult to prevent asset bubbles. 
7. European Case Studies. While the United States has yet to implement the FTT on the level that Bernie Sanders would like, there have been some European countries that have implemented the FTT. How did it fare?
• Sweden: Sweden introduced a FTT in the 1980s, and it ended up reducing 60 percent of the trading volume (Umlauf, 1993). 
• France: France's attempt at the FTT in 2012 resulted in lower trading volumes and reduced market liquidity (Colliard and Hoffman, 2017). 
• Italy: The Italian government imposed a FTT in 2013. A 2016 report from the European Central Bank found a "reduction in liquidity for the stocks hit by the reform (Cappeletti et al., 2016)." Credit Suisse also estimated that Italy's stock trading fell 34.2 percent two years later as a result of the FTT.
• United Kingdom: To be fair, the United Kingdom has had a stamp tax since 1694 [on stock transactions], and it doesn't seem worse for wear (Burman et al., 2016). On the other hand, a paper from the IMF shows that the market for "contracts for difference" in the U.K. grew rapidly when they were exempted from the stamp tax (Matheson, 2011). The U.K. stamp duty has also been found to depress share prices and distort how investors interpret share prices (Bond et al., 2004; also see 2008 European Commission paper).

Conclusion
In theory, a FTT could be broad-based and low enough where it could minimize damage to investing. What is observable in practice is that the FTT does not create nearly as much tax revenue as estimated. As Professor Moorad Choudhry from the Bank of Scotland points out, "An FTT would actually produce lower government revenue due to falling profits in the financial industry. And that benefits precisely no one." On top of that, the FTT depresses trade volumes, damages savings, incentivizes trading in other countries, and increases transaction costs. The irony is that those who advocate for the FTT do not realize that the FTT increases market volatility, which is the very thing they are trying to avoid. It would behoove the Democrats, and indeed anyone advocating for the FTT, to think twice before trying to enact this atrocity.