In the wake of the GameStop stock trading frenzy, the Biden administration recently said it’s worth evaluating the impact of a tax on financial transactions, which would include the purchases and sales of stocks, bonds and derivative contracts, such as options and futures. Some claim such a tax could stabilize markets and raise revenue. They say it’s a simple and easy way to raise billions of dollars at the expense of Wall Street and the wealthy. However, history suggests that a financial transaction tax will not raise anywhere near the amount of funds its proponents suggest. And what money it does raise will largely come from Main Street investors, even as it also raises the cost of capital for American corporations.
The US capital markets are the largest, most liquid and most efficient capital markets in the world. According to a study by Aaron Klein of the Brookings Institution, these markets finance more than 60% of the US economy. The US capital markets became this way through a combination of smart regulation, robust competition and advances in the use of technology. Imposing a financial transaction tax into this intricate ecosystem is like throwing sand into the gears of a finely tuned machine. The result will reduce market liquidity, given the higher cost to conduct transactions. And less liquidity, in turn, traditionally widens bid/ask spreads, which would increase the cost of capital for American businesses and slow US economic growth.
To be sure, proponents of a financial transaction tax come from a reasonable place. They want to raise revenue for critical investments like infrastructure, and at the same time, protect retail investors from volatile markets. But in a host of countries, like Sweden, Italy and Japan that initiated such taxes, investors shifted capital to new investment products that were not covered by the policy or moved their transactions out of country altogether.
Also, it won’t just be Wall Street that bears the burden of this tax. In my experience, taxes on Wall Street rarely, if ever, remain a tax on Wall Street. Just like a gas tax is passed from oil companies on to people at the pump, taxes on financial transactions will be passed from financial services firms on to individual investors — in this case as a higher cost to retail investors when the firms execute a trade or increase fees on mutual funds, ETF’s, 401k plans or pension plans. More than 65 million US households own stocks, according to the Investment Company Institute, including more than 100 million participants in 401(k) plans which primarily use mutual funds and ETFs to help save for retirement. And according to the Urban Institute, more than 20 million state and local government employees participate in a public pension plan. All of these hard-working Americans will wind up bearing the cost of any financial transaction tax as a tax on their savings and retirement nest eggs.
As the former president and CEO of TD Ameritrade I can assure you that today’s retail investor has never had it better with lower costs, expanded investment choices and more powerful technology. Today a retail investor can buy a stock with a low or even no trading commission and have that trade executed in milliseconds. Yet, Sen. Bernie Sanders, chairman of the Senate Banking Committee, has proposed a financial transaction tax proposal of .5% on all trades.
Most countries that have implemented a financial transaction tax have found out the hard way that the tax did not raise anywhere near the amount its proponents claimed it would given the ease with which investors are able to move to different products or offshore trading venues. Sweden imposed a 1% financial transaction tax in 1984. Within six years of its implementation, 50% of Swedish stock trading volume had moved to other countries and the market dropped 5.3%. That’s what smart people do in efficient markets. Sweden abolished the tax in 1991, and share prices rebounded by 9.7%.
A financial transaction tax may be a great soundbite for politicians — hitting Wall Street to help pay for current economic deficits. But it will increase the cost of capital for American companies and it will wind up as a tax on Main Street investors — hard-working Americans who are saving for their retirement. It may be good politics, but it is not good policy.