The Benefits of a Financial Transactions Tax
The recent economic turmoil has generated renewed interest in a financial transactions tax (FTT). While such a tax will be vigorously opposed by the financial industry, it offers a very attractive mechanism for raising revenue that is arguably efficiency-enhancing. Calculations based on 2000 trading volumes showed that a set of scaled transactions taxes, imposed on transfers of stock and other financial assets, could raise more than $100 billion a year, even assuming large reductions in trading volume.
This article briefly outlines the case for a financial transactions tax. The following section discusses basic design issues, and the section after that discusses the revenue potential for such a tax. The final section summarizes the potential benefits from financial transactions taxes.
There has been a long historical experience with FTTs in both the United States and around the world. Substantial transactions taxes were imposed in most financial markets until the last two decades, when political pressure from the financial sector, coupled with the threat from increased global competition, led most countries to substantially reduce or eliminate their taxes. Nonetheless, many taxes still remain in place, most notably the 0.5 percent stamp tax imposed on each trade on the London stock exchange. This tax raises more 4 billion pounds annually, the equivalent of almost $40 billion in the U.S. economy. 1
There are two reasons that it is noteworthy that the UK continues to impose its stamp tax, and manages to raise a substantial amount of revenue. First, it indicates that the tax is indeed collectable.2 The UK tax applies to stock trades for firms that are incorporated in the UK, regardless of where the trades take place. While enforcement of the tax on trades that take place outside of the UK is undoubtedly poor, this law limits the extent to which firms would have incentive to list elsewhere to escape the tax.
The other important point that is demonstrated by the stamp tax in the UK is that a modest FTT is not inconsistent with maintaining a vibrant stock exchange. The London market remains one of the largest stock exchanges in the world, in spite of the stamp tax. The other benefits of the London exchange obviously outweigh the burden of the tax so that it is still an attractive venue for raising capital and trading shares.
As a successful model, the stamp tax has two important features that are worth emulating. First, the dealer is responsible for collecting the tax. Obviously the dealer is the party best able to ensure that the tax is paid. In the United States, the dealer already has the obligation to collect the very small
Data on revenue raised from the tax in the United Kingdom can be found at http://www.hmrc.gov.uk/stats/stamp_duty/table15-1.pdf. 2 The administrative cost of collecting the stamp tax are extremely low. The UK’s Inland Revenue Service estimated that the cost is equal to less than 0.05 percent of the revenue collected. By comparison, it estimated that the administrative costs for the income tax is equal to 0.7 percent of the revenue collected (cited in Bond et al., p 4). 1