January 31, 2016

For a Financial Transactions Tax

Prabhat Patnaik

SENATOR Bernie Sanders who is a “socialist” by his own admission and is campaigning with some success for nomination as the Democratic Party’s presidential candidate in the coming elections in the United States, has come out with a proposal for a Financial Transactions Tax, whose proceeds are to be used for making college education free for all students in public institutions. Since the campaign this time within the Democratic Party is focusing on control over Wall Street, Sanders’ proposal which directly affects Wall Street acquires great significance.

A Financial Transactions Tax is akin to a sales tax on “financial commodities”. It can cover a wide range of financial transactions, from banking services to foreign exchange transactions, to equity and derivatives transactions, to transactions in commodity “futures”. Of these, the tax on stock market transactions, as distinct from other transactions, including currency transactions on which the well-known economist James Tobin had suggested levying a tax some years ago for restricting speculative activity, is what is currently attracting attention because of its larger potential for revenue generation. And it is this which I shall be concerned with, in what follows.

As in the case of any sales tax, the tax rates on stock market financial transactions of course will vary across different assets; but it has been estimated that even if stock trades are taxed at a nominal 0.1 percent and derivative trades at an even more minuscule 0.01 percent, then, in the United States, the revenue generated will be $130 billion in one year and $1.5 trillion over a decade, which is a huge sum.

The idea of using financial transactions tax proceeds for welfare expenditure has been mooted for quite some time now. Some have even suggested a global financial transactions tax for meeting the health needs in underdeveloped countries; and others have argued the case for a universal global old-age pensions scheme paid for by a global financial transactions tax.

But a financial transactions tax is advocated not just because of its revenue potential. It is supposed also to curb wide fluctuations in the stock market, to cut out a whole range of short term trades, and thereby even to restrict the size of the financial sector, which is not only extremely bloated relative to the real economy in contemporary capitalist economies, but is even growing faster in comparison. Apparently, even the IMF now believes that a far-too-bloated financial sector acts as a drag on the growth rate of the real economy, and is favourably inclined towards curtailing its relative size; a financial transactions tax can be an instrument to achieve this end.




As is to be expected, such a tax-proposal has invariably aroused massive opposition from corporate-financial oligarchies all over the world. Even in India when an equity transactions tax was introduced, and that too at an absurdly modest rate, it still aroused such hostility that the rate had to be brought down even further. In the United States too, Bernie Sanders’ proposal has brought forth wide condemnation from the corporate spokespersons, who trot out absurd and baseless figures on how much the growth rate of the US economy would suffer if such a tax is imposed.

But leaving out such hyperbole, the crux of the argument of the opponents of the financial transactions tax is as follows: the revenue-based case for the tax, they hold, contradicts the “stabilising effect”-based case for the tax, ie, if the tax actually succeeded in curtailing speculation and imparting stability to the system, then it would not yield much revenue. This is because stability can be introduced only through a curtailment of the number of transactions that occur at present; but if there is such a curtailment in the number of transactions then the tax base correspondingly shrinks, and so does the tax revenue. It follows therefore that the benefits of the tax are much exaggerated by its proponents; and once this fact is recognised, and the modesty of even such benefits as are underscored by its proponents is appreciated, then such a tax ceases to be a worthwhile measure in view of its undoubtedly adverse effects on the capitalists’ inducement to invest (“animal spirits”).

This argument is similar to what one comes across even in the case of indirect taxes on commodities, namely that if the indirect tax rate is increased in the case of some particular commodity for discouraging its consumption, then it cannot simultaneously be advocated as a revenue-yielding measure.

This argument however is based on a logical fallacy. Suppose, as has been estimated for the United States, the price elasticity of demand for financial commodities is unity, which means that if the cost of financial transactions is doubled then the volume of transactions is halved, leaving the total value of transactions unchanged. Now, let us suppose that a Financial Transactions Tax doubles the cost of financial transactions, ie, while financial assets worth Rs 100 each were sold to the extent of 100 units earlier, with a total value of sales amounting to Rs 10,000, now the tax increases the cost of each asset to Rs 200, because of which the volume of assets transacted goes down to 50, with the value of total sales remaining at Rs 10,000 as before. In this new situation however there would still be Rs 5000 of tax revenue generated (ie, Rs 100 times 50), which means that there has been a substantial fall in the volume of transactions and yet an increase in the tax revenue collections.

The fallacy I have just talked about arises because of a confusion between the elasticity of demand with respect to the tax rate and the elasticity of demand with respect to the price of the financial commodity. Even when the latter is unity, the former is not. This is because the tax is only one component, and a minor one at that, of the total price. Hence even when a rise in price on account of the tax leads to an equi-proportionate fall in the quantity demanded, it leads to a less than equi-proportionate fall compared to the increase in the tax rate. This is why the magnitude of tax revenue increases with an increase in the tax rate.

The opposition of finance capital to a Financial Transactions Tax, it follows, is not based on any valid arguments: it arises for the same reasons as its opposition to the Currency Transactions Tax or the Tobin Tax, namely that it is interested in speculation while all these taxes are meant precisely to cut down speculation.

John Maynard Keynes the renowned British economist of the twentieth century had argued that the capitalist market is intrinsically incapable of distinguishing between “enterprise” and “speculation”, which he had defined respectively as buying an asset for “keeps” and buying an asset for sale tomorrow. It is this inability which according to him constituted the failure of the market; and he had advocated measures that would curb the impact of speculation on economic activity. The problem however is that finance capital is interested in speculation; and since anything that curbs the impact of speculation on the real economy ipso facto also curbs speculation per se, it opposes all such measures. This explains its hostility to the Financial Transactions Tax.




The potential for using this tax for welfare expenditure in India has already been discussed in an earlier article (People’s Democracy, November 1, 2015). To recapitulate the argument, the additional resources needed for a universal public health coverage plan in India, according to the report of an Expert Group set up by the erstwhile Planning Commission, is about 1.8 percent of the GDP. The value of daily transactions on the Indian stock market in the last few months has been around Rs 2 lakh crores. This means that a .37 percent tax on stock market transactions, which is even lower than the .5 percent tax suggested by James Tobin on currency transactions, will be quite enough to finance a publicly-funded universal health coverage scheme for India.

The opposition to this plan in India which will be immensely beneficial to the millions of poor in the country, as to the Sanders plan in the United States, comes from the corporate-financial oligarchy. This of course is to be expected, for if welfare-oriented reforms of such far-reaching magnitude could be effected “peacefully” under capitalism then the need for transcending the system would scarcely arise. This need arises precisely because the opposition of capitalists makes any such plan to convert the system into a form of “welfare capitalism” a mere pipe-dream, as the current imposition of “austerity” over large stretches of Europe at the expense of the existing welfare programmes is clearly demonstrating.

Nonetheless, the demand, such as that of Sanders, for a Financial Transactions Tax to pay for free public education, is of great importance.  If even a fraction of this demand is realised, then that is all to the good. And to the extent it is not realised, it still plays the role of a “transitional demand” in the Leninist sense, which makes people conscious of the precise reason why they continue to languish in misery, ignorance and ill-health, even in the midst of the remarkable affluence enjoyed by a few.