What is a Financial Transaction Tax? How Much Could It Cost You?
As the 2020 presidential election approaches, a financial transaction tax (FTT) is coming back into focus for investors. What, exactly, is an FTT? And how could it impact Main Street and Wall Street?
An FTT is a tax, usually a fraction of a percent, on the sale and/or purchase of a security, such as a stock or bond. Supporters of an FTT say it would be a substantial revenue source that could generate billions of dollars annually. But, as taxes do, it would raise the transaction cost, and not just for banks and professional traders, but Main Street investors as well.
An FTT would affect the millions of Americans who are exposed to the capital markets through mutual funds inside and outside of employer-sponsored retirement plans, which include 401(k) plans and IRAs. An estimated 56.2 million households, or 44.5% of all U.S. households, owned mutual funds as of mid-2017, according to Investment Company Institute, a leading global association of regulated funds, including mutual funds, exchange-traded funds, closed-end funds and unit investment trusts.
The CBO in 2018 said that a 0.1% tax would increase revenues by $777 billion from 2019 through 2028, and would also reduce business and individual income. The organization argued that a tax on financial transactions would limit the amount of short-term speculation and computer-assisted high-frequency trading. The CBO, however, did acknowledge that a big source of uncertainty around an FTT is how much transactions would drop as a result of the tax.
Meanwhile, Vanguard, one of the world’s largest asset managers, warned in late 2019 that an FTT would hinder millions of families saving for retirement.
“An FTT generates a substantial drag on investment returns as the tax cascades and compounds over time. The real-world implications for investors, including those investing in retirement accounts, are sobering,” the firm said.
In-depth analysis by Vanguard revealed that a 10-basis-point (0.1%) tax would require the everyday investor to work roughly two-and-a-half years longer before retiring.
“The tax would make saving for college more difficult as well,” the Vanguard report said. For instance, “Families could take on debt to make up the difference, with a $7,800 student loan. Or, parents would need to save roughly an additional $250 per year, per child, to achieve the same balance in a college savings account.”
The costs of an FTT could accumulate quickly because the tax could be enforced multiple times on an investment. Depending on how an FTT proposal is structured, shareholders of mutual funds and ETFs could face double taxation if the “tax is collected both on trades in fund shares and on stock trades that mutual funds routinely engage in to invest shareholder cash, meet shareholder redemptions, and adjust fund portfolios,” ICI noted.
Furthermore, the U.S. has enacted many FTTs and subsequently repealed them after they had fallen short of expectations.
“In 1914, the U.S. imposed an FTT and in 1932 it was doubled, sending the stock market to its lowest point in the Great Depression,” the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness (CCMC) said in a statement. “The FTT was then repealed in 1964 because of instead of raising revenue, the FTT restricted investment to a small portion of the population and led the American capital markets to underperform.”
In fact, the CCMC found that the CBO’s 2018 option for a 0.1% FTT would actually lead to a first-year loss in revenue of $43.9 billion due to reduced capital gains tax revenue from declining asset prices.
“Presidents Kennedy and Johnson wisely repealed the tax and ushered in a new era where 50% of Americans are now invested in our capital markets,” said U.S. Chamber Center for Capital Markets Competitiveness Executive Vice President Tom Quaadman. “An FTT will increase the cost of capital, decrease investment, harm businesses and Americans who are saving and investing.”
To learn more, please visit ICI’s FTT website.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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