TUSCALOOSA, Ala. — Taxing financial transactions is the latest bad idea to capture politicians' attention in Europe and the United States.
Originally proposed as a means of preventing volatility in financial markets, the tax is now popular among politicians in the United States and Europe for being a populist slap at bankers and financial firms, as well as the vast revenue they predict such a tax would generate.
Despite its superficial attractiveness, such a tax would be a bad idea for four reasons:
First, although it appears on the surface that the tax would fall on despised Wall Street firms, in fact it would largely fall on individuals, including the middle class. In particular, such a tax would cut returns to pension funds, reducing income to current and future retirees.
One British study found that the burden of Britain's stamp tax on securities — a form of financial transaction tax (FTT) — falls primarily on long-term, risk-averse investors rather than on speculators.
Studies by both the International Monetary Fund and a United Kingdom think-tank predict that most of an FTT would be passed on to consumers. This is not surprising. Even small increases in costs add up in long-term investments like pensions.
An FTT would also disproportionately hurt small firms attempting to raise capital; studies of last summer's French FTT found it has hurt them the most.
While appearing to be a "Robin Hood" tax on banks and financial firms, an FTT would prove to be a tax on retirees and small businesses. Not only is that unfair, but it is exactly the wrong thing to do in the midst of a recession.
Second, although proponents sometimes claim the tax will calm financial markets, the best evidence suggests an FTT will do the opposite.
A Bank of Canada study of previous FTTs found that they increase financial market volatility, reduce trading volumes and raise the cost of capital.
Even the European Commission, which advocates for an FTT, admits that it would have a negative impact on long-run growth.
A British Parliamentary study concluded that the loss in growth would be between five and 20 times the revenue a FTT would yield. An International Monetary Fund study found that even small FTTs reduce liquidity, slowing price discovery in financial markets. In the midst of a global liquidity crisis, further reducing liquidity would be stunningly stupid.
Third, although the tax appears small — most proposals are for a 0.1 percent tax — the total amount of the tax quickly adds up as transactions accumulate as the tax is levied on every step in a transaction. That seemingly insignificant 0.1 percent would actually be a whopping 25 percent annual cost for the overnight "repo" transactions that banks routinely use to finance themselves overnight.
Finally, if the U.S. adopted a FTT, we would give up a competitive advantage our financial industry is about to be handed by the EU's planned adoption of a FTT.
This will drive financial transactions outside those financial markets, boosting the U.S. market share.
When Sweden adopted an FTT in the 1980s, 60 percent of trading volume in the most actively traded Swedish shares moved to London's markets and the tax produced only 3 percent of the predicted revenue, less than the cost of collection.
Not surprisingly, Sweden repealed the tax in 1991. If the United States follows the EU lead, we will lose market share to London and Hong Kong, where governments are firmly opposed to FTTs.
Politicians love to peddle populist remedies. Like most such products sold by such hucksters, this particular snake oil is likely to make our economy sicker.
Andrew Morriss is a professor of business at the University of Alabama.