Impose a Tax on Financial Transactions

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Revenues -53.6 13.3 62.9 85.0 92.6 95.9 98.7 101.3 104.1 106.9 200.3 707.3

Source: Staff of the Joint Committee on Taxation.

This option would take effect in January 2018.

The United States is home to large financial markets, with hundreds of billions of dollars in stocks and bonds—collectively referred to as securities—traded on a typical business day. The total dollar value, or market capitalization, of U.S. stocks was roughly $23 trillion in March 2016, and about $265 billion in shares is traded on a typical day. The value of outstanding bond market debt was about $40 trillion at the end of 2015, and average trading volume in debt, concentrated mostly in Treasury securities, amounts to over $700 billion on a typical day. In addition, large volumes of derivatives—contracts that derive their value from another security or commodity and include options, forwards, futures, and swaps—are traded on U.S. financial markets every business day. None of those transactions are taxed in the United States, although most taxpayers who sell securities for more than they paid for them owe tax on their gains.

This option would impose a tax on the purchase of most securities and on transactions involving derivatives. For purchases of stocks, bonds, and other debt obligations, the tax generally would be 0.10 percent of the value of the security. For purchases of derivatives contracts, the tax would be 0.10 percent of all payments actually made under the terms of the contract, including the price paid when the contract was written, any periodic payments, and any amount to be paid when the contract expires. Trading costs for institutional investors tend to be very low—in many cases less than 0.10 percent of the value of the securities traded—so this option would generate a notable increase in trading costs for those investors.

The tax would not apply to the initial issuance of stock or debt securities, transactions in debt obligations with fixed maturities of no more than 100 days, or currency transactions (although transactions involving currency derivatives would be taxed). The tax would be imposed on transactions that occurred within the United States and on transactions that took place outside of the country, as long as any party to an offshore transaction was a U.S. taxpayer (whether a corporation, partnership, citizen, or resident). The tax would apply to transactions occurring after December 31, 2017. This option would be effective a year later than nearly all of the other revenue options analyzed in this report to provide the government and firms sufficient time to develop and implement the new reporting systems that would be necessary to accurately collect the tax.

The tax would increase revenues by $707 billion from 2017 through 2026, according to estimates by the staff of the Joint Committee on Taxation (JCT). The option would result in a revenue loss in 2017 because the transaction tax would lower the value of financial assets and thus lower capital gains. JCT assumes that, until 2020, when all reporting systems are expected to be in place, financial transactions will be underreported. Revenues would be lower if implementation of the option was phased in because of delays in developing the new reporting systems. (Because a financial transaction tax would reduce the tax base of income and payroll taxes, it would lead to reductions in revenues from those sources. The estimates shown here reflect those reductions.) The additional revenues generated by the option would depend significantly on the extent to which transactions subject to the tax fell in response to the policy.

One argument in favor of a tax on financial transactions is that it would significantly reduce the amount of short-term speculation and computer-assisted high-frequency trading that currently takes place and direct the resources dedicated to those activities to more productive uses. 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. Although neither of those events had significant effects on the general economy, the potential exists for negative spillovers from future events.

A disadvantage of the option is that the tax would discourage all short-term trading, not just speculation—including some transactions by well-informed traders and transactions that stabilize markets. Empirical evidence suggests that, on balance, a transaction tax could make asset prices less stable: In particular, a number of studies have concluded that higher transaction costs lead to more, rather than less, volatility in prices. (However, much of that evidence is from studies conducted before the rise of high-frequency trading programs, which now account for a significant share of trading in the stock market.)

The tax could also have a number of negative effects on the economy stemming from its effects on asset prices and the frequency of trading. Traders and investors would seek to recoup the cost of trading by raising the return they require on financial assets, thereby lowering the value of those assets. However, because the tax would be small relative to the returns that investors with long-term horizons could earn, the effect on asset prices would be partly mitigated when traders and investors reduced the frequency of their trading, which would have a trade-off in terms of lowering liquidity and reducing the amount of information reflected in prices. Consequently, investment could decline (leaving aside the positive effects of higher tax revenues lowering federal borrowing and thus increasing the funds available for investment) because of the following: the increase in the cost of issuing debt and equity securities that would be subject to the tax and the potential negative effects on derivatives trading that could make it more difficult to efficiently distribute risk in the economy. The cost to the Treasury of issuing federal debt would increase (again, leaving aside the effects of deficit reduction) because of the increase in trading costs and the reduction in liquidity. Household wealth would decline with the reduction in asset prices, which would lower consumption.

In addition, traders would have an incentive to reduce the tax they must pay either by developing alternative instruments not subject to the tax or by moving their trading out of the country (although offshore trades by U.S. taxpayers would be taxed). Such effects would be mitigated if other countries enacted financial transaction taxes; currently, many members of the European Union are considering implementing such a tax.