Bernie Sanders’s tax plan to make college free for all Americans could end up losing rather generating revenue and lead to lower long-term economic growth.
In May, Sanders proposed introducing a financial transactions tax (FTT) to make college free for all Americans. FTT supporters argue that a 0.1 percent tax on all financial transactions would raise vast amounts of money and would discourage destructive behavior in the financial industry.
But what looks like a cost-free attack on Wall Street to pay for exploding college bills has three glaring problems that would make the tax an insidious cost to the economy.
Sanders’s FTT may end up raising much less than projected
First, it is highly unlikely that FTT will raise anything near the amount of money that Sanders hopes – around $50 billion.
The aims of reducing the number of financial transactions and raising revenue on those same transactions are clearly in conflict with each other. If the tax reduces the number of trades, then there are fewer trades to be taxed, and so there will be less revenue.
More fundamentally, a 2011 peer-reviewed paper by Tim Worstall, a fellow at the Adam Smith Institute, showed the tax will lead to government gathering less rather than more revenue. While taxing the transactions may raise money in the short term, the overall revenue generated by all other taxes will decrease. Worstall chalks the net decrease up to the hit the overall economy would take from such a tax.
Using the example of the same tax considered by the European Union, Worstall observes that a 0.1 percent charge on financial transactions would’ve caused GDP to shrink by 1.76 percent in the long-run, but the revenue yielded by the tax would amount to just 0.1 percent of GDP.
If Sanders is looking to raise money, Worstall recommends looking at taxing final consumption rather than transactions. The non-partisan Tax Foundation also argues that “the reduced trade volume would result in fewer people making money from the stock market and could push down capital gains tax revenue.”
These examples are far from theoretical. Sweden and France both experimented with FTTs in 1984 and 2002 respectively. Back in 2011, Sweden’s finance minister warned the EU not to go down the path of FTTs saying it wouldn’t raise substantial amounts of money and would drive financial services overseas.
Taxing high frequency trading may actually increase volatility
High-frequency trading and market volatility are other problems Sander’s tax plan aims to alleviate. HFT is is an automated trading platform which uses powerful computers to conduct transactions at phenomenally high speeds.
Critics say this kind of trading is risky and increases volatility. But the evidence supporting this claim is disputed. HFT also has significant benefits by improving market efficiency.
Firms that use the technique can give investors who wish to buy and sell stocks more accurate prices due solely to their speed. If the amount is reduced, investors and the wider economy will suffer because they’ll be operating on less than accurate information.
The claim that transaction tax would reduce volatility by cutting down on excessive speculation also runs into trouble. According to Worstall, increasing the costs of financial transactions has actually been linked to more volatility rather than less.
“This suggests that a transaction tax would increase, not decrease volatility. Since an FTT would decrease the size of the financial markets, prices would jump around rather more than they do at present – completely the opposite of what certain supporters of the FTT conclude,” says Worstall.
FTT wouldn’t have prevented 2008
Finally, what Sanders and his Democratic supporters fail to realize is that an attack on the financial sector with such a blunt instrument as transaction tax would do very little if anything to prevent another financial crisis.
As Worstall observes, “FTT would have had no effect whatsoever on the financial crash that actually happened in 2007/8, nor on the current problems of the eurozone.” The financial markets that would be most affected by FTT, such as foreign exchange, were not the markets that suffered a meltdown in 2008.
Well-intentioned though it may be the contradictory objectives, historical failures and harmful impact of FTTs should give Sanders pause for thought when he promises to make college free on the backs of Wall Street fat cats.
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