Financial Transaction Tax

A financial transaction tax is a charge levied on the purchase or sale of a security in the financial market. These securities include bonds, stocks, and other financial products. The tax is proportionally charged and progressively taxed. Those who trade more are taxed more.

FTT is a revenue source for the government. It can potentially boost the available welfare services. However, it can also reduce individual and business income. In the stock market, this could limit speculation for the short term and increase computer-assisted high-frequency trading.

A financial transaction tax is levied on selling and buying securities from the financial markets. It is also applicable to the transfer of securities, financial instruments, and derivatives. The tax is levied proportionally and progressively. In other words, it is based on the proportion of the value involved: the higher the value, the greater the tax. This increases the cost of trades for investors and raises overall trading expenses. Consequently, it reduces the rate of returns and may discourage frequent speculative trading.

FTT was primarily introduced to curb excessive risk-taking in trading, which can lead to financial market failures. By increasing government revenue, it also aims to reduce the frequency of short-term speculative trading. This can reduce the money being diverted to profit-seeking activities, which could otherwise be used to develop human capital. The funds could be used for welfare activities or activities that have social value.  Proposed financial transaction tax differs by country. 

The tax primarily affects the wealthy and is thus considered justified. The funds collected can benefit low-income individuals and provide financial bailouts if needed in the future. Additionally, it can help reduce taxes and public debt and offer the opportunity to reallocate resources to other welfare programs. 

The U.S. acknowledged the concept of FTT in the 19th century. New York City and the state had tax imposition on transfers of stock between 1905 and 1981. In 1914, the U.S. taxed sales of stock at the rate of 2 basis points at par value. It doubled the rates in 192 during the great depression to raise revenue. However, it was phased out in 1965. 

Its theoretical basis dates back to 1936 during the Keynes era, who saw it as a means to curb short-term speculation in financial markets.  The idea was prevalent throughout the 1960s and reintroduced in the 1970s by Tobin and various other people, such as Summers and Summers and Stiglitz in the 1980s. At present, the Securities and Exchange Commission, or the SEC, funds its operations through tax levied on small transactions. 

The countries that support FTT are:

• Argentina
• Belgium
• Brazil
• British Virgin Islands (BVI)
• Costa Rica
• China
• Cyprus
• Dominican Republic
• Egypt
• Ethiopia
• Finland
• France
• Gabon
• Germany
• Hong Kong 
• India
• Ireland
• Italy
• Kenya
• Kuwait
• Lebanon
• Malaysia
• Malta
• Nigeria
• Pakistan
• Panama 
• Peru
• Philippines
• Poland
• Puerto Rico
• Romania
• Senegal
• Singapore
• South Africa
• South Korea 
• Switzerland
• Taiwan 
• Thailand
• Trinidad & Tobago
• Ukraine 
• United Kingdom
• United States
• Venezuela

Let us look at some examples to understand the concept better.

Example #1

Imagine Dan is a trader and a French citizen. He buys 100 shares of a company priced at 100 euros, which gets him a total of 10,000 euros. In the year 2023, the French financial transaction tax rate declared by the government was 0.3%. This simply means that for every trade done by Dan, a French financial transaction tax rate of 0.3% will be applicable. 

Suppose he plans to buy shares but lacks sufficient funds, deciding instead to purchase the lot in two transactions of 50 shares each for 100 euros. He will be taxed 30 euros on each transaction, totaling 60 euros. This tax amount represents half the cost of one share. This is a significant amount for trading and hence curbs his urge to trade for short-term speculation. 

Example #2

The article published by the World Economic Forum presents arguments for FTT, provided that there is a nuanced approach. It argues that a well-designed FTT is needed to address negative financial activity that induces zero societal benefit. It also exposes a country's economy to risks. 

The published article states that high-frequency trading, which is said to be restricted by FTT, does not provide meaningful liquidity. It also dismisses the point that it affects pensioners by stating that market crashes would be much more damaging. It further argues that the proposed financial transaction tax, according to rules by different countries, can bring the right balance.

Some of the benefits of the FTT are listed below: 

• It increases government revenue that could benefit poor people through welfare activities funded through the revenue. 
• It enhances the diversion of funds to profits and diverts them to socially beneficial activities and the development of human capital. This also reduces the induction of inflation. 
• It curbs speculative trading and hence prevents people from losing their hard-earned money.
• It has the potential of being a simple system that can be administered easily by authorities and is easy for taxpayers to comply with.
• It is designed to minimize the potential tax avoidances and efficiency losses. 
• It can reduce volatility and produce efficiency gains.

Despite its potential benefits, the FTT has several drawbacks that should be considered. 

• It also curbs productive trading along with speculative trading, which would reduce liquidity in the market.
• It raises the cost of capital.
• Discourages investment due to imposed taxes. 
• It could increase asset price volatility. 
• While it is a restriction for the rich, it could impact retirement savings for retirees and middle-class workers. 
• The results have been mixed, and implications have been complex in the countries that have implemented them. Its success depends on the financial sector's size, structure, and operation of the financial markets. 
• It has the potential to harm individual investors, cause market distortions, and reduce the efficiency of markets. This could impair the market's liquidity by reducing market volumes and distorting price discovery.