The gargantuan stupidity of the financial transactions tax
I am accosted by a gentleman called Jim Lardner who wants me to tell you all my thoughts on the financial transactions tax currently being debated. So I shall: it's a gargantuanly stupid idea on a par with fucking for virginity. This isn't what Mr. Lardner wants me to say of course but he did indeed ask:
I hope you’ll consider running an editorial or opinion piece making the case for a Wall Street speculation tax, aka a financial transaction tax. That case is getting steadily stronger. Such a tax would be a way to get the financial sector to bear more of its rightful share of the tax burden while also nudging the industry away from high-frequency trading and ultra-short-term speculation toward banking practices with a clearer value to the society at large.
His email goes on to point me to the paper that his organisation, Public Citizen, has just cobbled together to support their insistence that it's only the Big Bad People on Wall Street who will end up coughing up this tax. Given that my one and only peer reviewed paper ever was actually upon this subject I might not have been the right person for him to ask if we're honest. An early version, before review, of that paper can be seen here if anyone's interested. It was also the evidence I gave to the House of Lords on the subject. In very brief form, it wasn't high speed trading, nor any of the markets where that occurs, which led to the crash*. Reducing speculation increases price volatility, the tax itself will not in fact raise any net revenues and yet will have a cost to both the workers in the form of lower wages and pensioners in lower pensions. All in all not a series of recommendations for any tax at all.
But to be more specific about this particular set of arguments being proffered. We are told in the paper itself that:
The tax would raise revenue. An FTT of 0.03 percent would raise $352 billion over nine years, the bipartisan Joint Committee on Taxation estimated in 2011.6 The Congressional Budget Office estimates that a 0.01 FTT would generate $180 billion over the nine years beginning in 2015.7
Opponents of an FTT have predicted that it would drive up costs for ordinary investors.8 This paper will illustrate that any costs added by an FTT would be minuscule in relation to the costs that already burden ordinary investors.
Calculations in this paper show that a person with $85,000 invested in a mutual fund with average fees and asset turnover rates is paying $1,144 every year in disclosed and hidden costs. A financial transaction of 0.03 percent would cost an average mutual fund $24.48 a year to buy and sell stocks on behalf of this hypothetical investor. Assuming these costs were passed on to the investor, the new fees would only increase the investor’s annual costs by 2.1 percent.
So an FTT would indeed drive up costs for individual investors making the critics correct on this very point then? And it's worth noting that they're doing a usual trick. We see the revenue figures as a gross figure for 9 years, while we're given the cost figures for one individual for one year. And we're shown the cost figures only for those in mutual funds (how many is that? 100 million?) rather than the costs to consumers from all applications of the tax. But then comes the great switch:
Aside from costs that can be easily quantified, critics of an FTT have claimed that the tax would reduce market liquidity, which refers to the ease with which assets can be bought and sold. Therefore, these critics contend, an FTT would raise transaction costs for investors.10 This paper does not address these claims, other than to observe that the only form of trading that would be substantively affected by an FTT is high-frequency trading, which did not exist until last decade.
Sigh. The argument is now that it's not going to cost people very much because we've decided not to count that cost which is going to be the largest for people.
To understand this point accept that current spreads (ie, the difference between buy and sell prices) in most markets these days are around 1 basis point (bps, or 0.01%). This is significantly lower than it was a few decades ago or even a decade ago. The reason is that that high frequency trading has meant a collapse in the difference between the two prices. The proposers of the FTT are indeed correct that a tax of 0.01 (or 0.03) %, or 1 to 3 bps, will limit a large amount of that HFT. But this will also mean the evaporation of that liquidity. And as it's that liquidity that has collapsed the spread then the absence of it will widen the spreads again.
In fact, we can show that the spreads must widen to be larger than the tax itself being applied. If there's a tax of 3 bps on a trade then no one's going to trade at a spread of less than 3 bps. Why would you trade for a margin less than the tax you have to pay? Yes, this is part of the point of the tax, to deter frequent trading: but look what it does to the price of those infrequent trades that are the only type left being done. They have to, by definition, pay a spread equal to or greater than the tax that is being charged. Thus all of the revenue from the tax (and as I point out in that paper, this will be less than the revenue lost from other taxes as a result of the introduction of the FTT) will have its burden, and more, upon end investors. This paper obscures that finding by resolutely refusing to actually look at one of the major costs of an FTT.
I'm not averse to the idea that more revenue might be plucked from the wallets of Wall Street. I've actually backed one idea, what we in London call the Bank Levy, as being an extremely good idea. But transactions taxes are simply a bad idea for they have the sorts of effects I've detailed above. There are other good taxes that could be applied: sales taxes on financial deals perhaps. But this particular idea of an FTT is a gargantuanly stupid one.
- What did lead to the crash was the mortgage market. Something which is not a highly liquid and often traded market. And at heart the problem was that banks, highly leveraged banks, held onto tranches of the loans they had originated. If all of those securitised loans had been sold onto end investors then there simply would not have been banks falling over. The Dodd Frank solution is that all banks must now, by law, hold onto 5% of the securitised loans that they originate. Thus making mandatory the mistake that led to the crash.
[Image via Wikimedia]