The financial transaction tax: Panacea, pathogen, or just a bitter pill?

Nuts and Bolts

The National Futures Association (NFA) supports itself in part by charging a small “assessment fee” of $.04 per round-turn on futures trades, and the agency’s existence helps keep the futures industry both honest and alive. That, essentially, is the argument that proponents of FTTs are making as well, and there is no shortage of tax proposals or of academic exploration into what will happen under this tax or that one, and much of it is quite specific.

The bulk of the arguments have been summarized best in two International Monetary Fund (IMF) publications. The first, “A Fair and Substantial Contribution by the Financial Sector,” is a report published in June 2010 at the request of the G-20. The second, “Taxing Financial Transactions: Issues and Evidence,” is a working paper published in March 2011 and authored by IMF economist Thornton Matheson.

Both papers point out that financial-sector bail-outs have cost taxpayers dearly, and will even once all the money is paid back. They also point out that the bailouts were highest where the markets were most “free.” In the UK, for example, the bailout debt stood at 6.1% of GDP at the end of 2009. In Germany, the figure was 4.8%, and in the United States it was 3.6%. As of January 2012, U.S. financial institutions bailed out under the Troubled Asset Relief Program (TARP) still owed the U.S. government more than $133 billion.

The papers first ask whether a major overhaul of the banking system is politically feasible and conclude that it’s not. They then move forward on the assumption that the current behemoth will one day run amok again, and the consequences will spill out to the economy as a whole, making another bailout inevitable. A tax, they conclude, should be looked at as part deterrent and part down-payment on the next debacle. They then take stock of all the various propositions on the table – from taxes on transactions to taxes on risky investments to taxes on liabilities.

The Obama Administration, for example, proposed a Financial Crisis Responsibility (FCR) fee, which would be a 0.15% tax on the liabilities of firms that received money under TARP. The FCR would be assessed on all companies until the last TARP money is paid back. The administration proposed the fee more than two years ago, however, and it hasn’t even been widely debated.

In the end, both papers advocate starting with sledge-hammers and working toward scalpels – specifically, with across-the-board taxes that evolve as regulators come to understand the specific sectors, companies and even individuals involved.

Fullerton advocates starting with a 0.25% tax on stock trades and a 0.02% on derivatives, but with exemptions for the first $100,000 of trades made by any individual each year, as well as pension funds and IRAs. This, he says, can be adjusted over time as regulators learn what works, what doesn’t and why.

“One thing I’m confident of is that none of the authors of any of these academic papers have any clue as to what’s going to happen,” he says. “Even the people who do high-frequency trading will have a hard time telling you what will happen, so how can some economist sitting in an office somewhere do the same?”

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