Democrats have been talking a lot about different ways to tax the rich as of late, ranging from Sen. Elizabeth Warren’s wealth tax to a variety of proposals related to stock buybacks. Now Sen. Brian Schatz is floating another idea: a tax on stock trades.
On Tuesday, Schatz introduced legislation proposing a financial transaction tax. He shared details of the bill in an exclusive Vox interview recently. The idea entails enacting a small tax on stock market sales. The Hawaii Democrat claims the proposal could raise nearly $800 billion for the federal government over the course of a decade but, more importantly, would clamp down on speculation and other nefarious behaviors in the market. Sens. Chris Van Hollen (D-MD), Jeff Merkley (D-OR), and Kirsten Gillibrand (D-NY) are co-sponsors of the bill.
“Roughly half of the 8 billion daily trades now are high-frequency trades, and that is increasing volatility in the market; it is allowing a certain category of traders to essentially skim profit off the top,” Schatz told me. “And on a more basic level, it is turning the stock market into a true casino, in which you are making a bet that has very little to do with the fundamentals of a company.”
Wall Street may not be the enemy it was in the immediate aftermath of the financial crisis, but it is still subject to frequent criticism from the left. Schatz’s proposed tax would presumably impact all investors — including those with 401(k)s and pensions. But it would affect wealthy Americans the most, because an estimated 84 percent of the value of stocks is owned by the wealthiest 10 percent of households.
Especially in the wake of the 2017 Republican tax bill, which cut taxes for most Americans but overwhelmingly benefited corporations and the wealthy, a tax that would move in the other direction is an attractive idea.
“The government has a revenue problem, and as near as I can tell, this is among the most popular ideas to generate significant revenue,” Schatz said. His proposed legislation isn’t likely to go anywhere until at least 2021 — but for a Democratic Party looking to expand the social safety net in lots of different ways, it could become an attractive way to finance anything from Medicare-for-all to Cory Booker’s baby bonds to free college.
How Schatz’s bill would work: you make a trade, you pay a tax
Schatz’s bill would tax the sale of stocks, bonds, and derivatives at a 0.1 percent rate. Stocks and bonds you’ve heard of, but derivatives are a little more complicated — they’re basically contracts that are a bet on what will happen to an underlying asset, like a stock, currency, or commodity such as oil. That small 0.1 percent tax would be applied to any transaction that takes place in the US or that a person in the US makes.
There are some nuances. The tax would apply to the payment flows under derivatives, meaning the actual payment for the contract made between the two parties. It uses the definition of derivatives as laid out by the Modernization of Derivatives Tax Act of 2017. Initial public offerings and short-term debt of less than 100 days would be exempted.
Schatz’s proposal is similar to one the nonpartisan Joint Committee on Taxation evaluated in 2018. It determined such a tax would raise $777 billion over 10 years. It isn’t not clear how much the tax would affect market behaviors until put in place, but that number could vary significantly if Schatz’s proposal actually passed.
The JCT notes that such a tax would immediately lower the value of financial assets and that the amount of revenue generated would depend on how much financial transactions declined in reaction to the policy. In other words, we don’t know how much trading would drop as a result of the tax, and the more transactions drop, the less revenue there is to raise.
Schatz isn’t the first Democrat to zero in on this idea. Sen. Bernie Sanders ran on a similar idea — albeit with a higher rate — in the 2016 Democratic primary. He pitched it as a way to pay for free college. That proposal mirrored a bill put forth by former Rep. Keith Ellison (D-MN). Rep. Peter DeFazio (D-OR) and Van Hollen — now the senator from Maryland — have also proposed financial transaction taxes. DeFazio will lead the House version of Schatz’s legislation, and Van Hollen is No. 2 on the Senate bill.
The case for financial transaction taxes, briefly explained
Proponents of financial transaction taxes, often referred to by their acronym FTT, say their case is pretty simple: It’s a way to cut down on speculative behavior in the stock market and raise revenue to boot.
Nobel laureate Joseph Stiglitz, a longtime supporter of such taxes, wrote in 1989 that an FTT “is likely to increase the overall efficiency of the economy and may actually enhance the efficiency with which the stock market performs its most important roles.” A 2016 report from the liberal-leaning Economic Policy Institute determined that FTTs are a “crucial policy tool.” Jared Bernstein, the former chief economist to Vice President Joe Biden, in a 2015 op-ed said FTTs are a “smart, fair way to raise urgently needed revenues while reducing unnecessary trading that makes our markets more volatile.”
FTT supporters often home in on high-frequency traders, a type of algorithmic trading on computers to buy and sell equities in fractions of a second. They take advantage of tiny differences in prices that regular investors moving at normal speeds can’t access. It’s the kind of stuff described in Michael Lewis’s 2014 book Flash Boys.
A tax on financial transactions would cut down on the type of speculation and “rent-seeking” that high-frequency traders engage in and potentially cut down on the destabilization some say they cause in the market. And it could kill off the practice altogether, which is why the industry opposes it. “This for sure would kill off this kind of profiteering,” Steve Rosenthal, a fellow at the Tax Policy Center, told me.
“All we’re trying to do here is get high-frequency trading under control, and it is currently out of control,” Schatz said.
FTTs probably aren’t as good as fans say they are. They’re not as bad as detractors argue, either.
The thing about financial transaction taxes is that depending on whom you talk to, you get a lot of different answers about whether they’re good or bad. Proponents of them often overestimate how effective they are in raising revenue and talk about them like a Robin Hood tax that takes money from the rich and gives it back to the poor. Opponents of financial transaction taxes warn that they’ll produce huge distortions in the market or perhaps kill it altogether and significantly reduce liquidity.
The truth is probably somewhere in the middle: Financial transaction taxes are an option to raise some revenue, but often not as much as those proposing them say, because they also put a damper in trading activity. (Schatz in our interview acknowledged that revenue estimates are definitely subject to change.) And FTTs do reduce trading and may make some changes to behaviors in the market, but as mentioned, not all of those behaviors are necessarily good in the first place.
“Basically, you’ve got one more distorting way of raising revenue, and it probably mostly falls on high-income people. Our fiscal situation is such that we need to figure out ways to raise more money,” Len Burman, co-founder of the Tax Policy Center, told me. “It’s not ideal, but every tax entails economic costs.”
Burman and others at the Tax Policy Center in 2016 produced a report examining the ramifications of a financial transaction tax. They determined that having the financial sector pay for some of the benefits it receives is “very tempting,” but the case isn’t clear-cut: An FTT could reduce volatility but it could also increase it, and while it might weed out some less than desirable activity, it could also take out good activity along the way.
“FTTs don’t raise as much as their advocates say, but they also don’t cause the distortions that are as bad as the lobbyists against them argue,” Kenneth Rogoff, a Harvard public policy professor and former chief economist at the International Monetary Fund, told me.
Rosenthal, from TPC, quoted Jean-Baptiste, Louis XIV’s finance minister, in trying to explain the conundrum surrounding FTTs: “The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the smallest possible amount of hissing.”
In other words, designing a financial transactions tax such as Schatz’s requires a balancing act of imposing a large enough of tax so that it’s possible to gain revenue without quashing that activity altogether.
We probably won’t know how this would work unless we tried it
The US isn’t the first country to contemplate a tax on financial trades — in fact, a number of countries already have. Schatz rattled off multiple examples, including Australia, Belgium, France, Italy, South Korea, Switzerland, and the UK.
In places where FTTs have been implemented, the results have been mixed.
In the UK, for example, a 0.5 percent “stamp tax” is charged when someone buys stock market shares, and the UK market is fine. France in 2012 introduced a tax on financial transactions, and a study from the European Commission found that trading volumes declined slightly, but share prices and volatility weren’t meaningfully harmed. France and Germany have begun to push for a European Union-wide FTT.
On the other hand, Sweden in the 1980s introduced a financial transactions tax, and it had a major detrimental effect: Trade volume plummeted. Tax Foundation economist Kyle Pomerleau explained that it had an “obvious massive loophole,” which was that Swedish traders could migrate to the London Stock Exchange to avoid the tax, which they did until it was eventually abolished.
Schatz’s team hopes they’ve designed the FTT they’re setting out in a way that would model the more successful examples and avoid the mistakes of the others. Whenever you put new rules or taxes on the stock market, traders try to find a way around it, and they think they’ve put the right guardrails in place in the way they’re approaching derivatives and in making sure all traders in the US are subject to the tax, even if they’re buying and selling in foreign markets.
Rogoff, from Harvard, said that at low levels of taxation, like what Schatz is putting forth, the effects of an FTT “wouldn’t be anything catastrophic.” But he warned that the government shouldn’t start writing checks based on what it thinks revenue from a tax will be. “It is certainly something that should be examined,” he said. “But don’t start spending the money based on projections.”
Schatz himself acknowledged revenue is a factor in this, but it’s not the central point. “High-frequency trading is a real risk to the system, and it screws regular people; that’s the main reason to do this,” he said. “If in the process of solving that problem we happen to generate revenue for public services, that’s an important benefit, but that’s not the main reason to pass this into law.”
Update: This story has been updated with the official introduction of the bill.