That delay would provide the government and firms sufficient time to develop and implement the new reporting systems that would be necessary to collect the tax. The tax on financial transactions would reduce taxable business and individual income. The resulting reduction in income and payroll tax receipts would partially offset the revenues generated by the tax.
The estimate for the option reflects that income and payroll tax offset.
Impose a Tax on Financial Transactions | Congressional Budget Office
The estimate accounts for several effects that would reduce the revenues raised by the transaction tax. The option would lead to a loss in revenues in because the transaction tax would immediately lower the value of financial assets. That reduction in the value of financial assets would cause an ongoing reduction in capital gains. In addition, JCT's estimate reflects the expectation that financial transactions would be underreported until , when all reporting systems could be expected to be in place.
Revenues would be lower if the implementation of the option had to be phased in because of delays in developing the new reporting systems. The additional revenues generated by the option would depend significantly on the extent to which the number of transactions subject to the tax declined in response to the policy. The higher the tax rate was set, the greater the amount by which transactions would decline. For that reason, doubling the tax rate would not double the amount raised by the option.
Foreign currency denominated bank accounts
Similarly, cutting the tax rate in half would lead to less than a 50 percent decline in the amount of revenues raised. With even higher tax rates, revenues could actually fall, for two reasons. First, the higher the tax rate was set, the larger would be the indirect loss in revenues from the drop in asset values and, therefore, the loss in revenues from the taxation of capital gains.
Second, a higher tax rate would reduce the revenues generated by the financial transaction tax once the percentage by which the transactions decreased exceeded the percentage by which the tax rate increased.
A financial transaction tax would help ensure Wall Street works for Main Street
The estimate for the option is uncertain for two key reasons. The estimate relies on the Congressional Budget Office's projections of the economy and market activity over the next decade, which are inherently uncertain. A bigger source of uncertainty, however, is how much transactions would drop in response to a tax. If the response was smaller than expected, the tax would raise more revenues than estimated here.
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One argument in favor of a tax on financial transactions is that it would significantly reduce the amount of short-term speculation and computer-assisted high-frequency trading that currently takes place and direct the resources dedicated to those activities to more productive uses. Some high-frequency trading involves speculation that can destabilize markets, increase volatility, and lead to disruptive events, such as the October stock market crash and the more recent "flash crash" that occurred when the stock market temporarily plunged on May 6, Although neither of those events had significant effects on the general economy, the potential exists for negative spillovers from future events.
A disadvantage of the option is that the tax would discourage all short-term trading, not just speculation—including some transactions by well-informed traders that stabilize markets and help establish efficient prices that reflect more information about the fundamental value of assets.
Empirical evidence suggests that, on balance, a transaction tax could make asset prices less stable. In particular, a number of studies have concluded that higher transaction costs lead to more, rather than less, volatility in prices. However, much of that evidence is from studies conducted before the rise of high-frequency trading, which now accounts for a significant share of trading in the stock market.
The tax could also have a number of negative effects on the economy stemming from its effects on asset prices, the cost of capital for firms, and the frequency of trading.
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Traders and investors would seek to recoup the cost of trading by raising the return they required on financial assets, thereby lowering the prices of those assets. The tax would be small relative to the returns that investors with long-term horizons could earn, so the effect on asset prices would be partly mitigated if traders and investors reduced the frequency of their trading—but less frequent trading would lower liquidity and reduce the amount of information reflected in prices.
Consequently, investment could decline even though higher tax revenues would lower federal borrowing and thus increase the funds available for investment because of increases in the cost of issuing debt and equity securities that would be subject to the tax and potential negative effects on derivatives trading, which could make it more difficult to efficiently distribute risk in the economy. The cost to the Treasury of issuing federal debt could increase because of the increase in trading costs and the reduction in liquidity. Household wealth would decline with the reduction in asset prices, which would lower consumption.
It does nothing to help ordinary investors and can destabilize financial markets. How, then, does such a tiny tax raise so many billions? History suggests that trading volume would in fact decline somewhat as transactions became more expensive.
But is this a bad thing? There is, however, such a thing as too much liquidity, particularly when high-frequency traders get into the mix. With a transaction tax in place, the sheer magnitude of high-frequency trades and the tiny margins they pursue will become unprofitable.
The Currency Transaction Report Explained
The historical evidence on whether reduced liquidity resulting from a transaction tax raises or lowers market volatility — sharp, distortionary movements in prices — is inconclusive. But high-frequency trading has recently become a much larger share of the market, now over 50 percent in some of our busiest exchanges. So while we should proceed with caution, introducing such a tax is likely to reduce excessive liquidity. Would a transaction tax encourage trading to move offshore, in an era of electronically mobile capital? Still, a transaction tax would be more effective if it were adopted worldwide.
Fortunately, we may be headed in that direction. Eleven countries of the European Union agreed to implement such a tax, in , though pressure from opponents caused the introduction to be postponed until next year. According to the Tax Policy Center, 75 percent of the liability from the tax would fall on the top fifth of taxpayers, and 40 percent on the top 1 percent.