What Is a Financial-Transaction Tax and Why Do We Need It?

There is a tax on the 1 percent that Washington should be considering: A financial-transaction tax—better known as a financial speculation tax (FST).

A financial-speculation tax has been discussed, from time to time intensely, ever since the financial crisis of 2008 riveted attention on the  markets that drove the economy to the edge of a Great Depression-quality abyss. One motivation was to make the perpetrators pay, as the public focused on bonuses at levels befitting Croesus and callous disregard for the responsibility borne by the banks for the great recession. But the financial transaction tax is also good policy. Under the concept, financial transactions—purchases and sales of equity shares and bonds and the execution of derivatives—are taxed based, at least in part, on the size of the transactions. As a revenue source, it has great potential: An FST could easily raise over $150 billion a year, according to some estimates, depending on the details of the tax and trading volumes in a post tax environment.

The FST could rein in some of the worst excesses of financial markets that too often operate like casinos. By increasing the costs of placing trades, the tax would moderate trading actively generally, but it would most strongly deter short-term trades rather than longer term investments. Importantly, for example, an FST could reduce the profitability of high-frequency trading, whereby computerized trading system enter and exit trading markets many times during the day—a practice that regulators worry gives an unfair advantage to some firms and increases market volatility.

Adopting an FST does not involve a leap of faith. From 1914 to 1966, the U.S. imposed a small tax on all stock trades, and Congress more than doubled the tax in 1932 to raise revenues during the Great Depression. The Securities Exchange Commission still exacts a fee equal to .00257 percent of each equity transaction traded on an exchange that funds the agency off-budget. In the UK, the government imposes a “stamp tax” equal to 0.5 percent of each equity transaction. About twenty-nine other countries also impose some form of an FST. In these jurisdictions, markets have survived and even thrived, even though trading in other jurisdictions without an FST is available. Most notably, financial markets in the UK have grown considerably since the early 1990s even with an FST in place.