Bernie Sanders' Bold Idea to Make Wall Street Pay

Why a financial transactions tax is good policy.

Last week, Bernie Sanders, the Senator from Vermont and only announced challenger to Hillary Clinton for the Democratic nomination, took a strong stand for everyday people. He proposed a financial transactions tax (FTT), effectively a Wall Street sales tax, and to use the revenue to make public colleges tuition free.

While making college affordable to low and middle income families is important, the proposal for an FTT is a real game changer. There is no single policy that would have anywhere near as much impact in reforming the financial sector. An FTT would effectively impose a sales tax on stocks and other financial assets, so that speculators have to pay a tax on their trades, just like people who buy shoes or clothes.

There are three points people should understand about an FTT. The first is that it can raise an enormous amount of money. An FTT could be imposed at different rates. Sanders proposed following the rate structure in a bill put forward by Minneapolis Congressman Keith Ellison. Eleven countries in the European Union are working to implement a set of FTTs that would tax stock trades at a rate of 0.1 percent and trades of most derivative instruments at the rate of 0.01 percent.

Extrapolating from a recent analysis of the European proposal, a comparable tax in the United States would raise more than $130 billion a year or more than $1.5 trillion over the next decade. This is real money; it dwarfs the sums that have dominated most budget debates in recent years. For example, the Republicans had been trying to push through cuts to the food stamp program of $40 billion over the course of a decade. The sum that can be raised by this FTT proposal is more than 30 times as large. The revenue from an FTT could go far toward rebuilding the infrastructure, improving the health care system, or paying for college tuition, as suggested by Senator Sanders.

The second point is that Wall Street will bear almost the entire cost of the tax. The financial industry is surely already paying for studies showing the tax will wipe out the 401(k)s held by middle income families. This is nonsense. Not only is the size of the tax small for anyone not flipping stock on a daily basis, research indicates that most investors will largely offset the cost of the tax by trading less.

Most research shows that trading volume falls roughly in proportion to the increase in transaction costs. This means that if an FTT doubles the cost of trading then the volume of trading will fall by roughly 50 percent, leaving total trading costs unchanged. Investors will pay twice as much on each trade, but have half as many trades. Since investors don't on average make money on trades (one side might win, but the other loses), this is a wash for the investor.

While most middle income people don't directly trade the money in their retirement accounts, they do have people who manage these funds. The research means that the fund managers will reduce their trading, so that the total costs of transactions that are passed on to the investor remain roughly constant. This means that the financial industry will bear almost the entire cost of the tax in the form of reduced trading volume.

This gets to the last point: a smaller financial industry is a more efficient financial industry. The purpose of the financial industry is to allocate money from savers to companies that want to finance new investment. As the industry has exploded in size over the last four decades there is no reason to believe that it has gotten better in serving this basic function. In fact, the stock bubble at the end of the 1990s and the housing bubble in the last decade might suggest that it has gotten worse.

A study from the Bank of International Settlements and more recent research from the International Monetary Fund find that a bloated financial sector slows growth. An oversized financial sector pulls resources away from more productive sectors of the economy. People who could be engaged in biological research or developing clean technologies are instead employed on Wall Street designing computer programs to beat other traders by a microsecond to garner profits at their expense. An FTT will make much of this activity unprofitable, encouraging people to turn to more productive work.

In short, an FTT is a great way to raise large amounts of money to meet important public needs. It will come almost entirely at the expense of the financial industry and should strengthen the economy. We now have one presidential candidate who is prepared to support a strong FTT. Are there others?

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

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