Taxing financial transactions is more strategic than taxing high wealth

by
Dean Baker
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from Dean Baker

Presidential candidate Joe Biden is considering to propose a financial transactions tax as part of his campaign for the Democratic nomination, according to a recent report from The Washington Post. This is big news for those of us who have long advocated such a tax.

Sen. Bernie Sanders has taken the lead on this issue among presidential candidates, including a financial transactions tax — also known as an FTT — as part of his plan for making college tuition free. Several other candidates also support a financial transactions tax, but if the Democratic Party’s leading centrist candidate endorses the tax, it would mark a new degree of acceptance within the mainstream of political debate.

Interestingly, Sen. Elizabeth Warren is not among those supporting a financial transactions tax. This is certainly not due to a reluctance to challenge the interests of the wealthy. Senator Warren has proposed an ambitious wealth tax that would tax wealth above $1 billion at the rate of 3 percent a year. While there are good reasons for wanting to tax the very rich, a financial transactions tax is almost certainly a better economic policy and would have much better political prospects.

We can see the economics of a financial transactions tax are superior when we consider the motivation for taxation by the federal government. The federal government doesn’t need taxes to spend money; it can just print it. It taxes to reduce consumption, in effect, to allow the economic space for spending.

To see this point, imagine that the federal government were to spend another $1 trillion next year on Green New Deal policies (a bit more than 20 percent of current federal spending), such as clean energy and mass transit subsidies. If there were no increase in taxes, we would expect to see a huge surge in demand in the economy, likely leading to inflation. (Assume that the Federal Reserve Board simply prints more money so that interest rates are little changed.)

Now suppose that the federal government handed another trillion dollars next year to Jeff Bezos, Bill Gates and other incredibly rich people. Again, let’s say there is no increase in taxes.

In this case, we almost certainly don’t have to worry about inflation. Jeff Bezos, Bill Gates and other multi-billionaires already have pretty much all the money they can possibly spend. This government handout will fatten stock portfolios but will have little effect on demand in the economy.

Now let’s flip this over and imagine that instead of handing money to our billionaires, we are taxing away their wealth at the rate of 3.0 percent annually. With Bezos, Gates and the rest still earning money on their assets, their wealth is likely to be little affected. The impact on the consumption of the very wealthy is likely to be minimal, meaning that we have created little room for additional government spending.

In fact, it’s possible the effect on demand goes the other way. Most billionaires like their money. The wealth tax gives them a strong incentive to hire accountants, lawyers and other people engaged in the tax avoidance/evasion industry. This is real spending that creates demand for goods and services, no matter how nefarious. It’s quite possible that a wealth tax will end up increasing demand in the economy.

By contrast, the way to avoid a financial transactions tax is to reduce trading. This means that we would see less demand for goods and services in the financial sector. Most estimates show that if we raise the cost of trading with a financial transactions tax, we will see a roughly proportionate decline in trading, meaning that the financial sector will bear pretty much the full cost of the tax. What people spend on the tax, they save on trading. This is what we want a tax to do: free up resources in the economy to allow the government to spend on other priorities.

The politics of any tax increase will always be difficult. The rich can be expected to use their political power to scare people into believing the world will end if they are forced to pay more taxes. But the wealth tax has a unique problem.The size of the narrow financial sector (securities and commodities trading) has exploded over the last four decades, going from roughly 0.5 percent of GDP to more than 2.0 percent of GDP. A financial transactions tax would partially reverse this rise. By my calculations, it could raise an amount roughly equal to 0.6 percent of GDP, which comes to $1.6 trillion over the next decade, with the money largely corresponding to a shrinkage of the financial sector.

Since the bulk of the money comes from a very small group of people, this small group of people has the option to announce that they will not pay the tax, by renouncing their citizenship. If that sounds strange to people, they have not been following the political behavior of the very rich in recent years. Can anyone say it’s worth $5 billion a year to Jeff Bezos to be a U.S. citizen?

Suppose 1,000 very rich people, representing $10 trillion in wealth, sent a letter to Congress proclaiming their plan to renounce their citizenship if lawmakers moved ahead with President Warren’s wealth tax? My guess is that Congress would not move forward (even if it otherwise were inclined to endorse such a measure). If Congress did move forward, and a substantial share of these billionaires carried through with their threat, the Warren administration would face a major embarrassment.

It’s great to see leading presidential contenders proposing measures to seriously address the rise in inequality over the last four decades. However, the implications of these policies have to be considered carefully. A financial transactions tax is likely to prove far more effective than a wealth tax.

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