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Last week Senator Bernie Sanders and Representative Barbara Lee are introducing bills in the Senate and House for a financial transaction tax (FTT). Their proposed tax is similar to, albeit somewhat higher than, the FTT proposed by Senator Brian Schatz earlier this year. The Sanders-Lee proposal would impose a 0.5 percent tax on stock transactions, with lower rates on transfers of other financial assets. Senator Schatz’s bill would impose a 0.1 percent tax on trades of all financial assets.

At this point, it is not worth highlighting the differences between the bills. Both would raise far more than half a trillion dollars over the next decade, almost entirely at the expense of the financial industry and hedge fund-types. In the case of the Schatz tax, the Congressional Budget Office estimated revenue of almost $80 billion a year, a bit less than 2.0 percent of the budget. The Sanders-Lee tax would likely raise in the neighborhood of $120–$150 billion a year, in the neighborhood of 3.0 percent of the federal budget.

While the financial industry will make great efforts to convince people that this money is coming out of the middle-class’ 401(k)s and workers’ pensions, that’s not likely to be true. This can be seen with some simple arithmetic.

Take a person with $100,000 with a 401(k). Suppose 20 percent of it turns over each year, meaning that the manager of the account sells $20,000 worth of stock and replaces it with $20,000 worth of different stocks. In this case, if we assume the entire 0.5 percent specified in the Sanders-Lee bill is passed on to investors, then this person will pay $100 a year in tax on their 401(k).

While no one wants to pay more in taxes, this hardly seems like a horrible burden. After all, the financial industry typically charges fees on 401(k)s in excess of 1.0 percent annually ($1,000 a year, in this case), and often as much as 1.5 percent or even 2.0 percent.

The actual financial transaction tax burden to this 401(k) holder will be considerably less than this $100 for two reasons. First, not all of the tax will be passed on to investors. The industry will have to bear part of the burden in lower fees. If they can pass on 90 percent, the burden on this 401(k) holder falls to $90 on their $100,000 in assets. If the industry can only pass on 80 percent, then the burden falls to $80, or 0.08 percent of the value of the holder’s 401(k).

Even this amount overstates the actual impact. One outcome of the tax is that stocks will be traded less frequently. That is an intended result. There is considerable research on how the cost of trades affects the volume of trading. Most of the research finds it to be roughly proportional, meaning that a 10 percent increase in the cost of trading results in a 10 percent decline in the volume of trading.

In this case, the cost of the tax to this 401(k) holder would be entirely offset by the savings from trading less. Let’s say that it cost this person 0.5 percent a trade before the tax is imposed. In that case, the tax will have doubled their trading cost. The expected result is a 50 percent reduction in trading volume. Instead of trading $20,000 of stock a year, they will only trade $10,000.

The savings from reduced trading are equal to, or quite possibly larger than, the tax paid by this 401(k) holder. Before the tax is put into effect, the holder is paying $100 in trading costs on $20,000 in trades each year. After the tax is in place the holder is paying $100 (including the tax) on $10,000 in trades. The holder is now paying more for each trade, with the 0.5 percent tax added in, but is paying no more in total for trades each year. The financial industry effectively eats the full cost of the tax.

This raises the question: is this 401(k) holder hurt by trading less? The answer, in general, is going to be no. Every trade has a winner and a loser, a buyer that paid too much for a stock, or a seller got too little. On average, these are offsetting. While every investment manager claims to be above average, this is not true.

For most of us, trades will just be a wash. This was the great insight of Jack Bogle, the founder of Vanguard, who died earlier this year. Bogle argued that since most people are not going to gain by trading they should save their money and just buy a low-cost index fund. Many people do follow this advice (Vanguard has over $4 trillion in assets). But for those who don’t follow Bogle’s advice, a financial transaction tax will help to eliminate lots of wasteful trading. .

To be clear, there is value to having a liquid market where people can sell stock or other financial assets when they need to. But we had highly liquid financial markets two decades ago when trading volume was roughly half its current levels. In other words, we don’t have to worry that FTTs along the lines proposed by these two bills will prevent the financial markets from functioning.

There will be some traders who do lose from these bills. The losers are the high-frequency traders who can trade billions or even tens of billions of dollars in a single day, relying on beating the market by a fraction of second to get small profits on each trade.

A small tax taking away the bulk of these traders’ profits hardly seems like a bad thing, since these traders are some of the richest people in the country. Furthermore, their profits from high-frequency trading come at the expense of other investors who are half a second slower in completing a trade. Their loss is everyone else’s gain.

In short, an FTT is one of those rare taxes in which everything goes pretty much the right way. Ordinary investors will be largely unharmed by the tax. It reduces the resources devoted to wasteful trades in the financial industry. It whacks some of the richest people in the country who now profit at the expense of ordinary investors. And, it raises lots of money for the government.

What’s not to like?

This first appeared on CERP.