A financial transactions tax is more strategic than a high wealth tax

Freeing up fiscal space to accommodate central government spending
Dean Baker

U.S. presidential candidate Joe Biden is considering to propose a financial transactions tax as part of his campaign for the Democratic nomination, according to a recent report appearing in The Washington Post. This is big news for those who have long advocated such a tax.

Senator Bernie Sanders has taken the lead on this issue among presidential candidates, and includes a financial transactions tax (FTT) as part of his plan for making college tuition free.

Several other candidates also support a financial transactions tax, but if the Democratic Party’s leading centrist candidate endorses the tax, it would mark a new degree of acceptance within the mainstream of the current political debate.

Interestingly, Senator Elizabeth Warren is not among those supporting a financial transactions tax. This is certainly not due to a reluctance to challenge the interests of the wealthy, because she has proposed an ambitious wealth tax that would tax wealth above $1 billion at the rate of 3 percent a year. While there are good reasons for wanting to tax the very rich (including reducing inequality), a financial transactions tax is almost certainly a better economic policy and in my view would have much better political prospects.

We can see the economics of a financial transactions tax are superior when we consider the motivation for taxation by the federal government.

The federal government doesn’t need taxes in order to spend money; it can just create and issue the money that it needs. It imposes taxes primarily to reduce consumption – in effect, to allow the fiscal space for spending.

To appreciate this point, imagine that the federal government were to spend another $1 trillion next year on Green New Deal policies (a bit more than 20 percent of current federal spending), such as clean energy and mass transit subsidies. If there were no increase in taxes, we would expect to see a huge surge in demand in the economy, likely leading to inflation. (Assume that the Federal Reserve Board simply creates more money so that interest rates are little changed.)

Now suppose that the federal government handed another trillion dollars next year to Jeff Bezos, Bill Gates and other incredibly rich people. Again, let’s suppose there is no increase in taxes. In this case, we almost certainly don’t have to worry about inflation. Because Jeff Bezos, Bill Gates and other multi- billionaires already have pretty much all the money they can possibly spend.

This government handout will fatten stock portfolios but will have little effect on demand in the economy.

Now let’s flip this over and imagine that instead of handing money to our billion- aires, we are taxing away their wealth at the rate of 3.0 percent annually. With Bezos, Gates and the rest still earning money on their assets, their wealth is likely to be little affected. The impact on the consumption of the very wealthy is likely to be minimal, meaning that we have created little room for additional government spending.

And in fact, it’s possible the effect on demand will go the other way. Most billionaires like their money. A wealth tax gives them a strong incentive to hire accountants, lawyers and other people engaged in the tax avoidance/evasion industry.

This is real spending by the wealthy that will create demand for goods and services, no matter how nefarious. It’s quite possible that a wealth tax will end up increasing demand in the economy.

By contrast, imposing a FTT is likely to reduce trading, so that we would see less demand for goods and services in the financial sector. Most estimates show that if we raise the cost of trading with a FTT, a roughly proportionate decline in trading will occur, meaning that the financial sector will bear pretty much the full cost of the tax. And this is what we want a tax to do: free up some resources in the economy to allow the government to spend on other priorities.

The politics of any increase in taxation will always be difficult. The rich can be expected to use their political power to scare people into believing the world will end if they are forced to pay more taxes, and this presents a unique problem.

The size of the narrow financial sector (securities and commodities trading) has exploded over the last 4 decades, going from roughly 0.5 percent of GDP to more than 2.0 percent of GDP. A financial transactions tax would partially reverse this rise. By my calculations 2 it could extract an amount roughly equal to 0.6 percent of GDP, which comes to $1.6 trillion over the next decade, with the money largely corresponding to a shrinkage of the financial sector.

Since the bulk of the money comes from a very small group of people, this small group of people has the option to announce that they will not pay the tax, by renouncing their citizenship. If that sounds strange to people, they have not been following the political behaviour of the very rich in recent years. Can anyone say it’s worth $5 billion a year to Jeff Bezos to be a U.S. citizen?

On the other hand, suppose that 1,000 very rich people – representing $10 trillion in wealth – sent a letter to the U.S. Congress proclaiming their plan to renounce their citizenship if lawmakers moved ahead with President Warren’s wealth tax. My guess is that Congress would not move it forward (even if it otherwise were inclined to endorse such a measure). If Congress did move it forward, and a substantial share of these billionaires carried through with their threat, the Warren administration would face a major embarrassment.

It’s great to see leading presidential contenders proposing measures to seriously address the rise in inequality.

over the last four decades. However, the implications of these policies have to be considered carefully. In my view, a financial transactions tax is likely to prove far more effective than a wealth tax.

Sources:

Real World Econ Rev, 11 Oct 2019 Dean Baker, https://rwer.wordpress.com/2019/10/11/taxing-financial-transactions-is-more-strategic-than-taxing-high-wealth/
Dean Baker, http://cepr.net/images/stories/reports/reining-in-wall-street-to-benefit-all-americans.pdf?v=2

Comments

There has been considerable interest in FTTs in the U.S. and other wealthy countries in the years since the financial crisis. An FTT can be a way to collect a large amount of tax and also to rein in the financial sector. This report examines the evidence on its impact on the economy, and also the possibility of using it to accommodate in particular the cost of higher education.

The report by Dean Baker [2] argues:

1. A financial transactions tax could likely remove from the U.S. economy $105 billion annually (0.6 percent of GDP) based on 2015 trading volume. This estimate is roughly in the middle of recent estimates that ranged from as high as $580 billion to as low as $30 billion.
2. The full amount of this tax would be borne by the financial industry, and not individual holders of stock or pension funds and other institutional investors. Evidence suggests that trading volume is elastic with respect to price, meaning that any drop in trading volume resulting from the tax would reduce costs for end users by a larger amount than the tax would increase them.
3. It is reasonable to believe that the industry would be no less effective in serving its productive use (allocating capital) after the tax is in place. This means that one of the primary effects of the tax would be to reduce waste in the financial sector, reducing costs while having little or no effect on its principal purpose: to allocate capital effectively.
4. The volume of tax realised through an FTT would easily be large enough to accommodate spending on free college tuition (among other social programs), although if nothing were done to stem the growth rate of college costs then it might eventually prove inadequate.

The report also notes that the financial sector is the main source of income for many of the highest earners in the economy. This means that downsizing the industry through an FTT could play an important role in reducing income inequality.

From Wikipedia: A financial transaction tax is a levy on a specific type of financial transaction for a particular purpose. The concept has been most commonly associated with the financial sector; and it is not usually considered to include consumption taxes paid by consumers.

A transaction tax is not a levy on financial institutions per se; rather, it is charged only on the specific transactions that are designated as taxable. As such, this tax is neither a financial activities tax (FAT), nor a Financial stability contribution (FSC), or “bank tax”, for example. This clarification is important in discussions about using a FFT as a tool to selectively discourage excessive speculation without discouraging other activity (as John Maynard Keynes originally envisioned it in 1936).

Transaction taxes can be applied on the sale of specific financial assets, such as stock, bonds or futures; they can be applied to currency exchange transactions; or they can be general taxes levied against a mix of different transactions.