The Benefits of a Financial Transactions Tax
The revenue calculations (based on 1997 trading volumes) in these three scenarios were $132.1 billion, $66.1 billion, and $99.2 billion, respectively. Approximately 40 percent of the projected revenue was derived from taxing stock trades, with trades of government bonds accounting for approximately 35 percent of the projected revenue.
The projected revenue would be approximately 25 percent higher in 2008 dollars, although the increase in trading volume over the last decade would have an even larger impact. Trading in all of these assets was far larger in 2007 than in 1997. In the case of CDS, the nominal value of the stock of these assets exceeded $60 trillion by 2007, while the asset did not even exist in 1997.
Clearly a fee structure comparably to the one described above would produce considerably more revenue based on the trading volume just prior to the recent financial collapse than the calculations in Pollin et al. show. While trading will almost certainly not recover to pre-collapse levels any time soon, $60 to $100 billion a year in revenue would not be an unreasonable target for a broad-based tax, given the experience in the United Kingdom and other countries that have imposed financial transactions taxes. 3
Taxation generally leads to economic distortions, with the possible exception of cases where the activity being taxed is itself harmful, such as smoking or drinking alcohol. While there are undoubtedly distortions associated with financial transactions taxes (it will have some impact on the cost of capital), much of the economic activity that will be lost as a result of the tax has the character of gambling. It will have very little effect on the effectiveness of capital markets.
In this sense, a financial transactions tax can actually increase the efficiency of financial markets. If the sector can just as effectively fill its function as an intermediary while employing fewer workers and requiring less capital, then the tax will have increased the efficiency of the financial sector. In this respect, it is worth noting the explosive growth of the financial sector over the last three decades. In the years from 1977 to 2007, the share of private sector wages in the narrowly defined securities and investment sector grew from less than 0.6 percent to more than 2.3 percent. 4
There is a real economic benefit to this growth insofar as it improved the allocation of capital, allowing firms to better gain access to capital markets or for individuals to better adjust their saving and spending patterns over their lifetimes. However, if this growth in resource use was only associated with additional trading and did not actually lead to better allocations of capital, then the resources were wasted. If a financial transactions tax reduces the volume of trading, and therefore the resources used by this sector, without harming the sector’s ability to allocate capital, then it will be making the sector more efficient and freeing up resources for more productive uses.
Prior to the collapse of its stock bubble in 1989, the financial transactions taxes in place in Japan raised more than 4 percent of all government revenue. This would be the equivalent to $120 billion a year in the United States (Japanese Securities Research 1992, p 244). This is taken from the Bureau of Economic Analysis, National Income and Product Accounts, Table 6.3B ([line 55 + line 59]/ line1) and Table 6.3C (line 59/line 1).