By Dean BakerCenter for Economic and Policy Research (CEPR)
July 26, 2000
There are many potential benefits from a modest tax on financial transactions, such as the buying and selling of shares of stock and blocks of foreign currencies. Such a tax would have the effect of reducing short-term speculation in these markets, thereby making them somewhat less volatile. It would also cut back some of the economic resources that are wasted in these transactions, since if the number of trades declines, the money spent on these trades would decline as well. In addition, it would make the tax code fairer, since most financial speculation is conducted either directly or indirectly by wealthy people. Just as poor and moderate income people pay taxes when they gamble at a casino or buy a state lottery ticket, a financial transactions tax would simply be applying a comparable tax to gambling in financial markets. Finally, a speculation tax could raise an enormous amount of revenue. A tax which was applied to all financial assets, which was equivalent to 0.25 percent on the purchase or sale of a share of stock and 0.10 percent on the purchase or sale of a bloc of currency, could raise close well over $100 billion a year in revenue.
This paper considers whether a unilateral speculation tax by the United States really is impossible. The fact that there will be evasion is not decisive: every tax is subject to some amount of evasion. The real question is whether the extent of the evasion will be so great as to make the tax pointless. This paper examines the experience with other types of taxes to provide some basis for projecting the degree to which traders will evade a speculation tax. It also discusses two other areas where the enforcement problems can be viewed as comparable: money laundering regulations, and copyright laws. The fact that the government continues to pursue these types of regulations suggests that the enforcement problems associated with a unilateral speculation tax are not insoluble.
Of course a unilateral tax by the United States is not the most desired outcome. If the United States is the only nation imposing a speculation tax, even in a best case scenario, there will be significant opportunities for evasion. Furthermore, one of the purposes of a speculation tax on currency transactions is to try to limit the instability in international currency markets. If the tax is restricted to the United States alone, it will have very little impact on the dynamics of these markets. Also, many proponents of speculation taxes envision some portion of the revenue being used to support international goals, such as promoting sustainable paths to development in poorer nations. Clearly this will not be accomplished by the unilateral imposition of a speculation tax, where presumably the revenue collected will be used for domestic purposes.
However, even if a unilateral speculation tax is not the best possible outcome, it is important to establish it as a possibility. There are real technical and political difficulties associated with creating an international tax system. These issues could make the effort the to achieve a single international tax structure quite complicated. Furthermore, international negotiations generally take place behind closed doors, outside of the public's view. If the negotiators themselves are not genuinely committed to the implementation of a speculation tax, it will be easy to find reasons to delay the process indefinitely.
If a major developed country such as the United States, or bloc, like the European Union, moved ahead unilaterally, it would be a big step forward toward achieving the goal of an international tax. In addition to imposing the tax on a large portion of the world's economy, such unilateral action would also change the political dynamics for major interest groups. Specifically, the financial sectors in the regions subject to the tax would suddenly have an enormous incentive to persuade their government to work towards the imposition of an international tax, since the unilateral tax would disadvantage them against foreign competition. It seems far more likely that this sort of process, rather than reaching a consensus internationally at the outset, would lead to an international tax on financial transactions.
Is the World Hostile to Financial Transactions Taxes?
The implicit assumption of many who reject the possibility of the United States imposing a speculation tax in isolation, is that many, or most, other nations are opposed to this tax, and that they would work to prevent the imposition of an international speculation tax. In fact, there is little reason to believe either that there is widespread opposition internationally, nor that such opposition could effectively resist a determined United States effort to promote a tax.
Table 1: Transaction Taxes Around the World
|France||0.6% < FFR 1 mil||0.6% < FFR 1 mil||present|
|0.3% > FFR 1 mil||0.3% > FFR 1 mil||(1972)|
|Hong Kong (c)||0.4% + various fees||0.4%||0.4%||1981-present (1994)|
|Indonesia||1,000 IDR||1,000 IDR||present|
|Japan||0.3%||0.16% or 0.03%||0.03%||1953-present (1989)|
|Philippines||0.5% + 90 PHP||present|
|Switzerland (e)||0.3%||0.3%||0||present (1993)|
|United Kingdom (f)||0.5%||0.5%||0||1891-1990|
Source: 1994 Handbook of World Stock and Commodity Exchanges (London: Blackwell Finance, 1994), Spicer and Oppenheim, Securities Markets Around the World (New York: John Wiley & Sons, 1988), Mya Saw Shin, Taxation of Stock Transfers in Various Foreign Countries (Law Library of Congress, 1989), OECD, Financial Market Trends (Paris: OECD, 1993)
a) Belgium also taxes securities quoted on the stock exchange. In order to have securities quoted on the exchange a tax of 0.042% of the value of the security quoted must be paid.
b) The Stamp Tax applies only to trades not carried out on the Helsinki Stock Exchange. Trades carried out on the exchange are not taxed. The tax on exchange trades was abolished in 1992.
c) The Stamp Duty and Levies amount to 0.4% of value traded. Fees of $15 HK are payable by seller on new transfer deed and $2 HK per board lot traded payable by shareholders.d) Portugal taxes all off exchange trading at 0.1% of value. The tax rates listed in the table are for trades on exchanges.
e) In April 1993 the Stamp Duty on many securities and types of trade was abolished. Current exemptions include: Eurobond and Euro-stock issues, money market and bond trades between foreign parties, trading inventories of Swiss securities dealers, and mutual fund certificates.
f) The tax rate was 2% until 1984 when it was reduced to 1%. It remained at 1% for two years until it was reduced in 1986 to the 0.5% level. The Tax was removed in 1990.
On the first point, speculation taxes are not new to the world. Every nation with a financial market has taxed such transactions at some point, and many still do today. Table 1 presents data on the transactions taxes imposed in most of the world's major financial markets. As can be seen, until recently every nation in the world imposed some tax on stock trades, and many imposed taxes on other financial transactions as well. In some cases, these taxes were quite substantial. In Denmark, Ireland, South Africa, and Sweden the taxes were 1.0 percentage point or higher. Until 1966 the United States had a federal tax on stock sales of 0.1 percent at issuance and 0.04 percent on transfers until 1966. At present, stock trades in the United States are taxed at the rate of 0.0034 percent. This revenue is used to support the Securities and Exchange Commission.
In recent years most nations have lowered their transactions taxes or eliminated them altogether. In the political debate that led to the tax reductions, one of the main arguments advanced by the financial industry was the threat from international competition in general, and competition from the United States in particular. Since foreign speculation taxes were largely lowered as a result of the threat from low cost markets in the United States, it is reasonable to believe that they could be raised if costs in the United States markets went up as a result of the imposition of a speculation tax.
It is also worth noting that there are very active political movements in many nations which support increasing existing speculation taxes or imposing new taxes. For example, in March of 1999, the Canadian Parliament overwhelmingly passed a resolution which called for the government to work for the imposition of an international tax on currency trading at international forums. More recently, growing support for a unilateral tax on currency trades resulted in a vote in the French Parliament, although the measure was defeated. One of the main concerns expressed by the opponents was the difficulty that a country like France would face in imposing such a tax unilaterally. Given the history of support for speculation taxes, and the existence of a significant political movement in various countries that favors such taxes, it can be expected that the imposition of speculation taxes in the United States will be readily supported and followed in much of the rest of the world.
An additional reason why the United States need not act alone is simply that it is a powerful enough nation to impose its will on the rest of the world. The willingness of the United States to act unilaterally in international affairs may not be an admirable trait, but nonetheless it is a reality. The United States has often been willing to stand virtually alone on many major issues, perhaps most blatantly in its current refusal to pay its debt to the United Nations, until the organization restructures in a manner acceptable to the United States. In another example of its willingness to act alone, the United States has refused to move forward on the climate change agreement that it signed onto in Kyoto, Japan in 1997. As a result of its unmatched economic and military power, it usually can force the rest of the world to accommodate its concerns. If the United States sought to use its power in international forums to promote a speculation tax, it is likely that it could succeed.
Few would argue that the United States should attempt to impose an international speculation tax, if it were really opposed by the vast majority of nations. Nonetheless, the argument of some opponents of the tax, that the United States stands helpless in this matter before the rest of the world, is implausible on its face. A determined effort by the United States to demand assistance in preventing tax evasion by U.S. corporations and U.S. nationals, would surely produce real results.
To sum up, there is every reason to believe that if the United States were to take the lead in promoting the international imposition of speculation taxes that it would find most of the nations of the world eager to line up behind it. However, in the event that there did prove to be substantial opposition in other nations, the United States could almost certainly use its power in international forums to ensure cooperation for enforcing a domestic speculation tax.
Would a Speculation Tax Cripple U.S. Financial Markets?
A unilateral speculation tax will raise the cost of doing business in U.S. financial markets relative to those elsewhere in the world. This will cause some amount of business to shift to markets elsewhere, insofar as corporations or individuals are able to evade the tax by doing so. The extent of this shift will depend both on the ability of traders to evade the tax by shifting their business elsewhere, and the resulting size of the cost savings. While there will undoubtedly be some loss of business due to the imposition of a tax, claims of opponents -- that any transactions tax will destroy U.S. financial markets -- defy economic logic and common sense.
The first question that needs to be examined in considering the extent to which a speculation tax will cause flight from U.S. financial markets is: who would stand to gain from switching, if the law were successfully enforced? A well designed tax should follow the model of the Danish stock transactions tax, which applied to the foreign trades of Danish nationals and Danish corporations. This meant that Danish citizens or corporations could not benefit by shifting their trades to other markets, if they complied with the law. A speculation tax unilaterally imposed in the United States should follow the same principle. It should apply to all trades by U.S. nationals or corporations anywhere in the world. This would mean that, insofar as they adhered to the law, U.S. nationals and corporations would not be able to gain by shifting their financial transactions beyond the border.
If this law is successfully enforced, then the only business that could be lost to the U.S. financial industry is that of foreign nationals and corporations. There is no reliable data on the percentage of trading on U.S. exchanges that is attributable to foreign nationals or corporations, but as a first approximation it is reasonable to assume that it is roughly proportional to foreign ownership of U.S. financial assets. At the end of 1998, approximately 8.0 percent of the value of the equities on the U.S. stock exchange was held by foreigners. If the tax were fully enforced on U.S. nationals and corporations, regardless of where their trades took place, this 8.0 percent of trades would be the business that could potentially be lost due to the tax.
Of course, a modest increase in the cost of financial transactions due to the imposition of a tax would not lead all foreign traders to flee U.S. markets. At present, there are substantial differences in transactions costs between markets, with costs in the United States among the world's lowest. Even with the imposition of a 0.25 percentage point tax on a stock trade, and comparable taxes on other transactions, the cost of trading on U.S. markets would still be low relative to the costs in many other markets (Smith 1989). The higher costs would cause some foreign nationals and firms to trade elsewhere, but most would probably still view the United States market as a relatively attractive place to invest funds. The huge size and relative security of the U.S. financial markets would still make them attractive, even if the cost of trading increases somewhat. The U.S. market is also attractive because of the ready availability of complementary services, e.g. legal and accounting services (Noyelle, 1989). This means that even without international coordination or cooperation there is a limit to the extent to which foreign nationals and corporations would want to shift their business to escape a speculation tax. Even if one quarter of the foreign transactions moved elsewhere as the result of this tax, this would only lead to a reduction in trading volume in the U.S. exchanges of approximately 2.0 percent. This is equal to about one and half month's growth in trading at the 17 percent annual growth rate on the New York Stock Exchange over the last decade (NYSE 2000, p 91).
Enforcement Issues The biggest obstacle to the successful imposition of speculation tax is the threat of evasion by U.S. nationals and U.S. corporations. Many opponents of the tax assume that the opportunities for evasion will be so great: that few individuals or corporations will comply with the law. This means that the tax would have little impact on the volume of trades and that the revenue collected would be minimal. The assumption that evasion would be widespread or near universal defies economic logic and the experience with other types of regulations imposed by the government.
The basic logic determining the extent of evasion will be the trade-off between the expected gains compared with the expected penalty associated with being detected. The latter would depend on both the probability of being caught and the penalties that would be imposed for defying the law. The arithmetic suggests that the gains from evading the tax are fairly limited. The gains are by definition somewhat less than the size of the actual tax, since there will always be some costs to using the alternative trading mechanism that allows for evasion. This means that, at most, the gain on a trade of a share of stock would be somewhat less than 0.25 percent of the share price, and less than 0.10 percent on a bloc of currency.
By comparison, the costs of evasion could be quite large. In Britain, the tax on stock trades is associated with a stamp that conveyed legal ownership of the stock. A person without the stamp could not claim ownership of the stock and therefore would find it difficult or impossible to resell their stock. In this case, the potential loss is 100 percent of the value of the asset, considerably more than the gain from evading the tax. The potential cost of evasion could be made considerably higher with the imposition of fines or prison sentences for large-scale untaxed trades.
Whether such penalties would be effective in limiting the extent of evasion is largely a speculative question at this point, but there are some precedents which suggest that evasion could be kept under control. The first reason to believe that it will be possible to collect this tax, even on the foreign trades of U.S. nationals or corporations, is the fact the United States is currently able to collect a significant amount of income tax revenue from their foreign income. In 1994, U.S. corporations paid over $1 billion in income taxes on their foreign earnings. They reported paying more than $25 billion in income taxes to foreign governments, which can be deducted, dollar for dollar against their domestic income tax liability. Individuals also reported more than $15 billion in foreign-source income to the I.R.S. in 1991. While this data does not indicate the extent to which U.S. corporations or individuals fail to report foreign-source income, it does show that they feel the need to report a substantial amount of foreign income to the I.R.S. In this case, the enforcement mechanisms are sufficiently serious, and the prospective penalties large enough, to ensure that many corporations and individuals comply at least in part with the law.
A second example is the experience with money laundering regulations. More than a decade ago, the United States began t put in place a set of rules requiring banks to monitor the behavior of their customers and to report suspicious activities to law enforcement officials. While the United States was the lead actor in this initiative, it worked through several ad hoc inter ational bodies to gain cooperation from other nations. These regulations make fairly extensive demands on banks, requiring them to verify the identity of their customers and to monitor large cash transactions. These demands go against the immediate inter sts of the banks affected, since they both involve some cost, and will to some extent reduce their business, since customers engag d in money laundering will presumably take their business to institutions that don't comply with the regulations. Nonetheless, the Administration reports that the regulations have been successful in reducing the volume of illegal money laundering and ha e led to many arrests. In fact, Treasury Secretary Lawrence H. Summers has recently proposed new regulations that would cut off contacts between international financial clearing houses and foreign banks that do not comply with U.S. rules on money laundering (U.S. Department of Treasury, 2000).
The situation with money laundering regulations is particularly instructive since the regulatory apparatus being put in place is very comparable to what would be needed to enforce financial transactions taxes of various types. There would be a need for financial institutions to monitor trades and withhold the tax required under the law. Institutions that allowed trading to proceed without being subject to the tax would have to be isolated from the rest of the financial system in a manner similar to the treatment of banks that don't comply with money laundering regulations. The presumption of the Clinton Administration, and other supporters of money laundering regulation, is that the costs of being isolated from the world's financial infrastructure are likely to far outweigh any possible profits from money laundering. The equation is also affected by the fact that being out of compliance with these regulations would be a signal that the bank is engaging in illegal activity, and likely to open it up to criminal investigation as well.
The basic arithmetic of the sums at the stake suggest that financial transactions taxes should be much more enforceable that restrictions on money laundering. In the case of money laundering, the stakes will be quite large, since the huge amount of cash gained through illegal activities will be of relatively little use, if it cannot be in somewhere brought into the financial system and effectively hidden. By comparison, the potential gain to be split between the speculator and the financial intermediary is the amount of the tax. If the tax rate is relatively low (e.g. a 0.1 percent tax on currency trades), an intermediary would be paying a high cost in terms of its isolation from the financial system, and taking a large risk in terms of criminal penalties, for what would have to be a relatively modest potential gain. The volume of trades that would make tax sheltering very profitable, is so large that it would be almost impossible not to detect.
The third example which suggests that a speculation tax could be enforceable is the success of government regulations on copyrights. Copyrights on items like music, movies, and software are government enforced monopolies provided to the holder of the copyright. The experience with copyrights is noteworthy, because the potential gains from evasion are several orders of magnitude larger than the gains associated with evading a tax on speculation. While evasion of the proposed speculation tax would provide gains that are far less than 1 percent of the price of asset being traded, evasion of copyrights can provide gains that are fully 100 percent of the value of item. For example, in the case of computer software or recorded music, items can often be obtained in violation of the copyright at essentially no cost to the consumer. Furthermore, the Internet allows almost infinite opportunities for evasion.
This last point is noteworthy, because the financial industry has strong pressures for concentration and centralization that do not exist in the realm of recorded music and visual material or software. A party engaged in financial transactions takes a very large risk by dealing with a bank or other financial institution that operates outside of the main financial system. The bank's assets will not be guaranteed by any government, which means that the trader must be confident that its basic finances are sound. Furthermore, the trader must take the risk that its transactions are dealt with fairly, that it is accurately quoted the market prices, that its trades are executed as quickly as possible, and that the bank itself will honor its commitments. These factors all present very large risks to any trader that chooses to deal with a rogue bank.
There is no comparable pressure for centralization in the case of the transfer of material subject to copyright protecti n. Digital versions of recorded music or movies are identical. (Software manufacturers can make proof of authorized purchase a condit on of provided assistance.) Apart from the legal risk, there is little obvious advantage in making the purchase from a icensed distributor.
While the software, movie, and recording industry all recognize the evasion of copyrights as a serious problem that cuts into their profits, the fact remains that these industries continue to earn tens of billions of dollars of profits each year on their copyrighted material. Few have suggested that the problems of enforcement are so great as to make copyright regulations pointless. In fact, the direction of recent legislation has actually been to expand the scope of copyright protection, as the length of copyrights has been extended from fifty years past the death of the copyright holder to one hundred years.
The fact that most policy makers and economists continue to believe that copyrights are a viable form of property suggests that a speculation tax would be enforceable. The potential gains from evading copyrights dwarf the potential gains from evading a speculation tax. Since the lost profits due to copyright clearly are manageable for the industries affected, the lost tax revenue due to evasion should not be so large as to make a speculation tax futile.
Most supporters of speculation taxes would like to see them imposed globally through an international agreement. However, it may be necessary to first establish such taxes in one of the world's major trading blocs before it can be implemented world-wide. The evidence suggests that the problems associated with the unilateral implementation of speculation taxes in either the United States or a major trading bloc like the European Union are manageable. As with all taxes, there will be opportunities for evasion. These opportunities would clearly be less if the tax were applied globally.
However, the success of the United States government in enforcing its income tax laws on income generated in foreign nations suggests that it is possible to get foreign cooperation in the application of U.S. tax laws to the foreign activities of U.S. nationals and corporations. The apparent effectiveness of regulations on money laundering are especially encouraging for the prospect of enforcing financial transactions taxes. The demands on financial institutions under these regulations are comparable to the demands that would be imposed with the imposition of financial transactions taxes. The incentives for evasion are much greater in the case of money laundering. The fact that government officials claim that money laundering regulations have been largely effective suggests that financial transactions taxes could also be successfully imposed.
Furthermore, the fact the government can still effectively protect copyright laws, where there are much greater incentives for evasion than in the case of the proposed speculation tax, suggests that a speculation tax can still be enforceable in the Internet age. There clearly will be problems associated with the implementation of a speculation tax. But these are likely to be the sort that can be fixed by fine-tuning after the fact. They do not appear to present insurmountable obstacles.
Board of Governors of the Federal Reserve Board, 2000. Flow of Fund Accounts, 4th quarter 1999. Washington, DC. Federal Reserve Board.
Economic Report of the President, 2000. President's Council of Economic Advisors. Washington, D.C.: U.S. Government Printing Office.
Helleiner, E. 2000. "The Politics of Global Financial Reregulation: Lessons From the Fight Against Money Laundering," Unpublished Manuscript, Department of Political Studies, Trent University, Peterborough, Ontario, CA.
Noyelle, T. 1989. "New York's Competitiveness," in Thierry Noyelle ed., New York's Financial Markets. New York: Westview.
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Schmidt, R. 1999. "A Feasible Foreign Exchange Transactions Tax," Ontario, CA: North-South Institute.
Schmidt, R. 2000. "Efficient Capital Controls," Unpublished Manuscript, International Development Research Centre, Government of Canada.
Smith, R. 1989. "International Stock Market Transactions," in Thierry Noyelle ed., New York's Financial Markets. New York: Westview.
United States Department of Treasury, 2000. The National Money Laundering Strategy for 2000. Washington, D.C.: U.S. Department of Treasury.
 Helleiner (2000) argues that exactly this sort of dynamic helped to promote the Basle Accord on risk standards and international enforcement of regulations to prevent money laundering. In both situations, once the rules were applied to banks in the United States, these banks became major proponents of their application world-wide.
 Imposing a speculation tax on financial transactions could violate a temporary WTO provision that prohibits the imposition of new taxes on electronic commerce. If it were ruled to be, then the United States would have to consider the impact of the penalty imposed.
 Table B105 of the Economic Report of the President (2000) puts the foreign ownership of U.S. stocks at the end of 1998 at $1121.1 billion. The Federal Reserve Board estimated the equity value of U.S. corporations at that point as $13,703.4 billion (Flow of Funds table L.213).
 There is also the question of foreign corporations that choose to have their stocks or other assets traded on U.S. exchanges, since a speculation tax will make these firms less willing to have their shares traded on U.S. exchanges in the future, and could cause some firms to delist their stock from U.S. markets. While trading the stock of foreign firms in U.S. markets is increasingly common, the assets of foreign corporation still account for only a tiny portion of the assets traded on U.S. exchanges. For purposes of this discussion, they can be safely ignored.
 If the alternative trading mechanism were as convenient and inexpensive as a legal trade on U.S. financial markets, then it would already be the preferred method of trade, even without the tax. Also, traders will inevitably bear some portion of the tax, so the cost of the trade will rise by somewhat less than the amount of the tax.
 This data can be found in Nutter, 1998.
 The process through which these regulations came to be enforced is described in some detail in Helleiner 2000.
 Schmidt (2000 and 1999) provide detailed proposals for how a tax on currency transactions could be administered.