New tax proposals are already being contemplated as a result of the Robinhood-GameStop controversy, according to an expert from Rice University’s Baker Institute for Public Policy.
Joyce Beebe, a fellow in public finance at the Baker Institute, explains what a financial transaction tax (FTT) is and what it could mean for investors in a new blog post.
“An FTT imposes a small levy on each financial transaction executed, essentially throwing ‘sand in the market’s gears’ to curb short-term, excessive trading,” she wrote.
Supporters of the FTT idea argue that because the tax has a massive base (based on the value of financial transactions), even a very low tax rate has the potential of raising a significant amount of revenue, according to Beebe.
“Evidence suggests that high-frequency trading has accounted for an increasingly larger portion of trades in recent years; however, the margin for each trade is usually quite small. Thus, a small FTT would be more than enough to stop most high-frequency trades,” she wrote.
Beebe notes that FTT advocates often call this a “Robin Hood tax,” though the namesake has nothing to do with the company at the heart of the controversy. It’s a reference to the tale about taking from the rich to give the poor.
“This is because the wealthy will bear most of the tax burden, and the tax revenue can be used on expenditures or programs that benefit lower-income households," Beebe wrote. "The progressive nature of the tax also makes an FTT favorable from a political perspective.”
However, opponents argue that the revenue potential and affected base isn’t as cut and dried.
“The debate about how much revenue an FTT can generate is unsettled. (Opponents) believe the tax could be avoided if not designed properly, and taxpayers will look for ways to substitute nontaxable transactions for taxable ones,” Beebe wrote.
“Critics also argue that an FTT may not be as progressive as claimed," she continued. "Because many middle-class taxpayers own stocks through retirement savings plans and mutual funds, they may indirectly bear a substantial portion of the tax burden through these holdings.”
Because an FTT increases transaction costs and lowers trading volume, Beebe explains that the tax would reduce speculative trading and the associated stock price volatility. But lowering the trading volume might affect the process of discovery, because it would take longer for new information to be priced into underlying assets.
“The slower price discovery process would prolong investors’ reaction times before the prices adjust to reflect the fundamentals, which could lead to more price volatility,” she wrote. “Empirical studies are also inconclusive as to whether an FTT increases or reduces asset price volatility.”
State-level FTT proposals have emerged in New York, New Jersey and Illinois over the years but they’ve faced significant objections from business communities.
“The New York Stock Exchange and the Nasdaq have threatened to move to Texas or Florida if these proposals become law. As expected, financial service firms also strongly opposed the FTT and have been advocating against the tax,” Beebe wrote.