A tax on securities trading to fund government spending would likely bring in less revenue than intended and drive up costs in other financial markets, according to a new study from research firm Greenwich Associates.
Financial transaction taxes, or FTTs, have existed in some form for centuries in Europe and parts of the U.S., and the idea of enacting a broader FTT in the U.S. is often raised during election years. An FTT would charge a fraction of a percentage of the value of a trade, with proposals from Democratic candidates during the 2019 presidential primary campaign ranging from 0.1% to 0.2% on stock, bond and derivative trades. Proponents say such a tax could be used to offset expensive government programs, such as the economic stimulus packages passed in response to the COVID-19 crisis.
But while an FTT could raise revenue for the government, Greenwich Associates found in surveying financial professionals and studying the results of FTTs currently in use in Europe that a tax would likely diminish liquidity, weaken trading activity and have negative unintended consequences in credit markets such as home lending. By discouraging higher trading volumes, FTTs levied on each conducted trade also tend to raise less tax revenue than intended, Greenwich Associates wrote.
"Many countries have imposed FTTs, adjusted the rates over several years and then finally repealed them when the impacts became clear — whether due to failure to achieve anticipated revenue, loss of volume to other markets or trading methods, or some combination thereof," wrote Shane Swanson, a member of Greenwich Associates' market structure and technology group and the study's author.
In France, for example, an FTT of 0.2% was implemented in 2012 on stock purchases of specific French companies and levied an extra fee on high-frequency trading, excluding market makers, which typically fulfill retail trades. Studies following the tax showed that volumes fell and bid-ask spreads increased, and revenue from the tax was as much as 50% lower than projected.
Broker/dealers and market makers would likely respond to higher spreads by passing along the cost in the form of a fee for their clients, including retail investors who have recently benefited from a new status quo of free trading on major retail brokerage platforms.
In a survey of 58 respondents from brokers, wealth managers, institutional asset managers, banks and other institutions, Greenwich Associates found that 69% would reduce or significantly reduce the amount of trading they do.
Less trading activity in credit markets could also raise the cost of mortgages and public financing, according to the study.