A Matter of Perspective

Added Costs From a Financial Transaction Tax Would Be Minuscule Compared to Fees Investors Already Pay

By Taylor Lincoln and Andrew Perez

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Introduction

Proponents of creating a tiny levy, or financial transaction tax (FTT), on transactions involving stocks and other financial products, have justified the proposal on at least three bases:

  1. The tax would be fair. Most transactions in which goods are sold are subject to a sales tax. Why shouldn’t the same be true for transactions that occur in what is likely the most lucrative sector of the economy? Such a tax would have the added benefit of being progressive, meaning it would fall more heavily on people of greater means. Historically, fewer than one-fifth of households with incomes in the lower 60 percent of the national income spectrum have owned any stock in taxable accounts, according to the Center for Budget and Policy Priorities.
  2. The tax would likely make the markets less risky. Proposed FTTs of 0.01 to 0.03 percent would likely dampen the volume of so-called high-frequency trading, which is a strategy in which computers buy and sell massive volumes of stocks and other financial instruments in millisecond intervals. A relatively new phenomenon, high- frequency trading was estimated in 2012 to account for up to 60 percent of all stock transactions and has been blamed for leaving the markets susceptible to dramatic, irrational swings.3 Such trading is of dubious social value and is arguably predatory because its practitioners exploit technological advantages and tricks (such as posting fake orders to discover prices others are willing to pay) to squeeze minuscule profits out of each trade. These profits come at the expense of ordinary investors. A well-structured FTT would sap much of the profit-making potential out of high-frequency trading without significantly affecting other investors.

    The Congressional Budget Office in 2011 appeared to agree. “One argument in favor of a tax on financial transactions is that it might reduce the amount of short-term speculation and computer-assisted high-frequency trading, and direct the resources now dedicated to those activities to more productive uses,” the CBO wrote in 2011.“Excessive speculation can destabilize markets and lead to disruptive events, such as the October 1987 stock market crash and the more recent ‘flash crash’ that occurred when the stock market temporarily plunged on May 6, 2010.”

  3. 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. 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.8This 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.
  • If the investor were to purchase $85,000 in mutual fund shares at once, a 0.03 percent financial transaction tax would require the investor to pay an extra $25, in addition to the $24.48 in recurring costs outlined above. But if the mutual fund in which the investor purchased shares had fees adhering to the industry average, the investor also would also have to pay $850 in front-end load fees at the point of purchase. Thus, an FTT would raise this investor’s first-year costs by just 2.5 percent.

A similar disparity would emerge for investors who buy and sell their own stocks.

An investor with $85,000 in stock who turns over one-fourth of his or her portfolio every year would pay $12.24 to comply with a 0.03 percent FTT. In contrast, that investor would already be paying $163.92 annually in commissions and other costs. The FTT would increase the investor’s total costs by about 7.5 percent.

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.