Senator Bernie Sanders (I-Vt.) and Rep. Pramila Jayapal (D-Wash.) have called for a financial transactions tax (FTT) on the sale of stock and bonds to fund their ambitious College for All Act. Sanders justifies the tax as reimbursement from Wall Street following the 2008 financial crisis. The reality, however, is that an FTT is a tax on all investors, not Wall Street.
The exchanges and brokers that process stock trades will naturally pass the cost of the tax through to investors, including investors in mutual funds and 401K plans as well as pension plan beneficiaries. Our state and local governments will have to raise their taxes to make up for the losses imposed by an FTT on their pension plans. Indeed, the tax would end up being a transfer from badly underfunded state and local pension funds to the federal government — one estimate by D.C.-based education and advocacy organization, Modern Markets Initiative indicates that it could cost as much as $2.3 billion annually to just 10 state pension funds.
Even more insidious is how the effects of the tax compound over time. An investor doesn’t just pay the tax once, but year after year on their savings. The money that is taxed away in the early years is money that can’t grow into retirement security. This is especially harmful to people working hard to save for retirement, forcing them to work much longer. A worker who saves $500 per month over a 45 year working career and earns 5 percent on their money would see their retirement accumulation drop by over $90,000 — a 9 percent drop.
Some view an FTT as a way to reduce “excess” trading and dampen volatility in financial markets. In fact, the experience in the U.S. and other countries is just the opposite, that an FTT has little effect on volatility and may even increase it.
Attempting to punish Wall Street with an FTT is like trying to punish the oil industry by raising the gas tax. While a higher gas tax will reduce demand for gas, it will be passed through to ordinary motorists — not big oil companies. An FTT would reduce some trading — and the jobs that go with it — as well as drive some trading offshore to other countries. When Sweden, for example, imposed an FTT, half of its stock market trading volume moved offshore to London.
It’s no secret that the U.S. is running an unsustainable deficit. The government has to raise enormous sums of money not only to cover the existing deficit, but also to make needed investments in infrastructure, education, scientific research and public health. The taxes that result should be designed to equitably and efficiently raise the needed revenue while minimizing distortions to the economy. An FTT is too inefficient and creates too many distortions. Other countries that have launched FTTs have found that they generate far less tax revenue than the proponents promised.
There are better ways to raise revenue than by taxing retirees through a reinstatement of the discredited FTT. First, we should properly fund the IRS so that it can collect the taxes already on the books. After years of budget cuts, the IRS is hard pressed to collect all of the taxes due. A beefed-up IRS will reduce the tax gap by collecting a reported $140 billion annually, mostly from the fat cats with complex tax avoidance schemes.
We need to think holistically about the entire tax system, and not focus on one tax in a misguided attempt to punish an industry some don’t like. We need to optimize the interaction of income, sales, capital gains, and estate taxes. As marijuana becomes more legal, it should be taxed like alcohol and tobacco, which could raise $28 billion a year, according to D.C.-based think tank Tax Foundation. A tax on carbon pollution will incentivize moving away from fossil fuels. This will also reduce dependence on oil and enhance national security, raising over $200 billion annually in revenue in the process.
The government needs to thoughtfully evaluate how it can pay for its proposed spending plans. A distortive FTT which robs savers is not the answer.
James J. Angel, Ph.D., CFP®, CFA is a finance professor at Georgetown University’s McDonough School of Business.