Sand in the Gears

Buy a cup of coffee in Manhattan, and the sales tax is 8.875 percent. Buy a share of Exxon on the New York Stock Exchange, and the tax rate is just a hair more than zero. Like other double standards that benefit high finance, the zero tax rate on financial transactions both reveals and reinforces Wall Street's massive power and privilege.

But now a growing movement is coalescing around the idea of a financial--speculation tax, as an opportunity to confront Wall Street politically, shrink the bloated financial sector, diminish dangerous speculation, and raise significant sums of money to meet priority needs. The movement is drawing support among consumer, labor, and financial-reform groups associated with Americans for Financial Reform and also among climate-change and global-health campaigners, who hope a speculation tax can generate revenues for targeted purposes. The idea is attracting interest among congressional leaders and has the affirmative support of British Prime Minister Gordon Brown, French President Nicolas Sarkozy, and other European leaders.

There are numerous possible variants of a financial-transaction tax. Nobel economist James Tobin famously proposed a tax on currency transactions, and some advocates focus on currency trades. Even Larry Summers, as a young economist, wrote a scholarly paper supporting a Tobin tax as salutary "sand in the gears" -- and that was before the explosion of derivatives trading. Today's leading proposals envision a sales tax applied to stocks, derivatives, and other financial instruments, scaled to prevent investors from circumventing the tax simply by switching from, say, stocks to derivatives.


A speculation tax has several distinct benefits. First, it can slow down the ever faster pace of buying and selling financial instruments. Far too many of Wall Street's transactions take the form of short-term trades intended to aggregate tiny margins. This insider business does little to promote efficient allocation of capital -- Wall Street's purported service to the real economy. But it creates major risks because it uses very high leverage that endangers individual financial institutions and our whole financial system.

Vanguard founder John Bogle says he "loves" the speculation tax because it will curb the worst trading excesses. Bogle campaigns against high-turnover, speculative trading as an investor-consumer rip-off. Altogether, he points out, investors by definition can only do as well as the overall market return. The aggregate impact of frequent trading by mutual funds doesn't change this, but it does provide the rationale for high fund fees -- the "croupiers'" cut, Bogle says. A speculation tax would encourage longer-term investing and give investors more incentive to urge for better management.

Second, by reducing trading volume, a speculation tax can also help shrink the bloated financial sector generally. Finance is an "intermediate good" -- something that is supposed to help produce the goods and services we ultimately care about, not just be an end in itself. Dean Baker of the Washington, D.C.?based Center for Economic and Policy Research asks how we would react if trucking had tripled in size relative to the economy over the last three decades, as finance has by some measures. An oversized financial sector is not just an economic problem, of course; a bigger Wall Street is able to exert more political power.

Third, a speculation tax can raise serious money. Assuming a quarter-percent tax on stock trades, and a commensurate rate tax on other instruments, Baker and Robert Pollin of the University of Massachusetts, Amherst, estimate that a speculation tax could raise more than $100 billion a year.

Despite Wall Street's intense opposition to a speculation tax, such a measure remains politically viable because of its revenue-raising potential. A diverse set of interests are hoping to tap some of the revenue from a speculation tax. The AFL-CIO hopes a speculation tax can finance job creation and infrastructure investment. Climate campaigners want a speculation tax that could generate monies to transfer to developing countries to assist their transition to a post-carbon economy and help them adapt to a changed climate; the World Bank estimates developing-country energy-transition costs at hundreds of billions a year. Global-health and anti-poverty advocates are seeking tens of billions annually to provide basic health care in poor countries and meet the modest targets of the United Nations Millennium Development Goals, which aim to cut severe poverty in half by 2015.

Fourth, and making the tax even more attractive, it is extremely progressive. The rich own most stocks and bonds -- with the top 1 percent holding 40 percent of the nation's financial assets, and the top decile controlling roughly 80 percent -- and they would pay most of the tax. A speculation levy is eminently feasible. A tax of less than two-thousandths of a penny on stock trades presently funds the Securities and Exchange Commission.

Opponents and skeptics of the speculation tax offer two primary arguments. First, they contend, if done only domestically, the tax would drive financial business overseas. But this is Wall Street's standard response to any national regulatory moves and is no more plausible in this instance than others. A stock tax in the United Kingdom has not driven business from the London Stock Exchange, which has grown rapidly over the last decade. Prior to the financial crash, Wall Street firms complained untruthfully that the Sarbanes-Oxley accounting standards -- the extremely modest reform resulting from the last financial crash -- were driving new stock offerings to the UK. And while Wall Street traders may disapprove of a speculation tax, listed companies or offerors may look more kindly on a modest tax aiming to reduce turnover.

While international agreement should not be a prerequisite for action on a speculation tax, a global approach would certainly be a good thing. Given European support, U.S. embrace of a speculation tax would likely result in an international accord.

Opponents' second main argument is that a speculation tax will in fact prove harmful to small investors who rely on mutual funds. Investors in high-turnover mutual funds will suffer high costs, argues George Sauter, managing director and chief investment officer at Vanguard Group (yes, the same Vanguard founded by John Bogle), with significant impact on returns over time due to compounding. Not only will the tax impose costs, he argues, but eliminating high-volume traders from the market will raise bid-ask spreads and thus impose additional costs on mutual funds.


These claims are not groundless, but they are overblown. The direct impact of the tax on small investors can be avoided by providing an exemption for retirement accounts and under some threshold in trades, as the leading congressional proposals do. Dean Baker concedes that a rise in the bid-ask spread will occur but contends it will be far smaller than Sauter suggests. And increased transaction costs, to the extent they occur, will have a beneficial effect for smaller investors: It will encourage them to switch to investment in broad index funds and to pursue longer-term investments generally. Also, importantly, increased costs per trade will be offset by reduced trading volume.

In Congress, Rep. Peter DeFazio of Oregon has introduced the Let Wall Street Pay for the Restoration of Main Street Act, which would impose a .25 percent tax on buying and selling a stock and a corresponding amount on other financial transactions. DeFazio's bill has 29 co-sponsors. On the Senate side, Sen. Tom Harkin of Iowa has introduced a similar measure, The Wall Street Fair Share Act, with three co-sponsors. But the interest on the Hill goes far beyond the numbers co-sponsoring the proposals. Nancy Pelosi has spoken positively of the idea, and other Congress members consistently raise it as a potential funding source for jobs and transportation initiatives.

In the United Kingdom, the idea of a speculation tax has caught the public's imagination thanks to a cleverly branded "Robin Hood" campaign and a humorous Internet video featuring actor Bill Nighy. U.S. campaigners hope that importing the verve of the Robin Hood campaign will enable the speculation tax to break through the clutter of confusion around seemingly technical and arcane financial-reform proposals. With public anger at Wall Street still boiling hot, and massive domestic and global needs remaining unfunded, this is the right political moment to win a speculation tax.