The presidential primary may be over – but that doesn’t mean that the ideological battle between Bernie Sanders and Joe Biden is.

Progressives and liberals are still competing for control of the Democratic Party’s platform. And with that in mind, studying Bernie’s positions is still worthwhile.

One proposal from the Vermont senator which has received much less media attention than Medicare for All or the Green New Deal is his “tax on Wall street speculation,” known among economists as a financial transaction tax (FTT).

Bernie reintroduced this position (which he had previously run on in 2016) in a 2019 episode of The Joe Rogan Experience. He touted a 0.5% tax on all stock trades as a way to curb short term speculation and raise money for student debt cancellation.

To be sure, reforming the investment-related parts of the tax code to discourage speculation is a worthwhile objective, as is raising revenue for social programs. Even executives at large investment firms – like BlackRock CEO Larry Fink – have bemoaned short term-focused investor behavior as an unhealthy, price-distorting force in stock markets.

But according to history – and based on a brief look at the makeup of the financial services industry – Bernie’s FTT proposal wouldn’t do a particularly good job at either of those things.

Financial Transaction Taxes Hurt Middle-Income Investors

Bernie’s proposal ostensibly targets high-frequency trading firms – but that doesn’t mean that middle-class savers and investors would be protected from its effects. In fact, they might effectively end up paying most of the tax through their mutual funds.

These baskets of stocks are some of the most popular investments in America. 44% of households own at least one. And although they’re often held in tax-advantaged accounts like IRAs, 401(k)s and 529 plans, they themselves are not tax-advantaged assets.

Mutual funds generally buy and sell securities many times a day. In particular, index funds – a mainstay of relatively low-income 401(k) and IRA investors – must execute dozens or hundreds of trades a day in order to keep their prices in line with their underlying indices.

That means that they’d heavily incur Bernie’s FTT – and they’d inevitably pass it on to shareholders in the form of lower returns or higher expense ratios.

Based on a Morningstar analysis of the plan’s impact on ETFs and mutual funds, the drag on returns produced by a 0.5% FTT on stocks would be equivalent to increasing the expense ratio of the average passively-managed fund by more than 30%, and almost doubling the expense ratio of the average actively-managed fund.

Source: Author

Due to the nature of compound interest, this seemingly small difference in returns can snowball into tens of thousands of lost dollars over the course of a typical 40-year investment horizon.

That’s worrying when you consider how unprepared Americans already are for retirement.

According to the Employee Benefit Research Institute (EBRI)’s 2018 Retirement Confidence Survey, a majority of American workers – 54% in fact – have less than $50,000 saved for retirement.

Source: EBRI

Most will end up needing at least $1 million for healthcare, housing, and other old-age expenses, and will struggle to come up with it by the time they hit their 60s.

Thus, Bernie’s FTT could seriously impair many American workers’ paths to retirement by shaving tens of thousands of dollars off their returns within defined-contribution plans.

But the tax’s impact on workers’ retirement prospects is just one of the arguments against it. Late 20th-century history is another.

Why Sweden Repealed Its Financial Transaction Tax

One of the most economically progressive countries in the world experimented with a Bernie-style FTT in the 1980s – only to abandon it less than a decade later.

Sweden introduced a 0.5% tax on the purchase or sale of equity securities in 1984. It doubled the rate in 1986, but then abolished it in 1990.

The effects of the tax – and the reasons for its abolition – were threefold.

First, it depressed financial market activity to an extreme degree. A European Commission working paper on the effects of the tax found that Sweden’s options trading market disappeared entirely in the years following its enactment, and 60% of stock trading volume moved to the United Kingdom.

Second, it failed to limit volatility at all, as demonstrated in a 1993 study by Steven R. Umlauf published in the Journal of Financial Economics.

But third – and perhaps most importantly – the Swedish FTT actually decreased total tax revenue.

Umlauf found that so much trading volume left Sweden in the years between 1984 and 1987 that capital gains taxrevenue was so severely impacted to the point of cancelling out any revenue gains from the FTT.

An Alternative to FTT

Capital gains taxes, while we’re on the subject, provide another mechanism to control short–term speculation.

In fact, a thoroughly researched proposal from the not-so-distant past uses a system of capital gains tax raises to increase revenue and decrease speculation while avoiding the pitfalls of Bernie’s plan.

Hillary Clinton’s 2016 tax plan involved a series of capital gains tax increases designed to create a stepped system.

Investors would pay the maximum rate on sales of securities they had held less than one year, a slightly lower rate on sales of securities they had held between 1 and 2 years, and so on until they arrived at the lowest rate after 6 years, as shown by the orange line in the figure below.

Source: Tax Policy Center

According to an analysis by the Tax Policy Center, this tax would be effective in raising revenue and incentivizing investors to hold securities for as long as is advisable – two goals that the FTT fails to achieve.

The Tax Policy Center projects that the Clinton plan would bring in $84 billion over the course of the decade, would increase average capital gains tax expenditure by at least 10% for the top 0.1% of filers and would immediately decrease short term selling activity.

Since the proposal works through the existing capital gains tax system, lower-income investors within 401(k)s, IRAs, 529 plans and other tax-advantaged accounts would be completely unaffected (as they pay no capital gains tax within those accounts), unlike under a FTT.

In short, Clinton’s stepped capital gains tax system accomplishes all of the goals of Bernie’s plan with none of the adverse effects on retirement prospects, stock markets or tax revenues.

Has Biden adopted it for his 2020 platform? Not quite – but it is theoretically compatible with his plan.

Implications for Biden, Bernie and the Future

The presumptive Democratic nominee’s tax plan increases capital gains tax rates to the ordinary income rate for filers with income above $1 million – a much broader hike which would raise much more money than either of the plans we’ve previously discussed.

An analysis of Biden’s plan by the Tax Policy Center projects that the capital gains provision alone would bring in $448 billion over the next decade. However, there’s nothing about this proposal which controls speculation; it affects short-term and long-term investors equally.

That problem could be solved easily by merging his plan with Hillary’s stepped capital gains plan, adding a nonrefundable tax credit to Biden’s capital gains system which increases in value for each year an investor has owned a security they’ve sold that year, up to a maximum of 17% of the sale price. (This figure is calculated by subtracting the current top income tax bracket from the current lowest capital gains tax bracket).

This addition would slightly reduce revenue, but it would provide the full anti-speculation benefit of Clinton’s plan – strongly encouraging buy-and-hold investing – while also raising much more money than Clinton’s plan itself.

Benjamin Graham, the father of modern value investing, once said, “The individual investor should act consistently as an investor and not as a speculator.” Even Wall Street itself agrees with progressives that short-term speculation and high-frequency trading are unreliable investment strategies.

But a “tax on Wall Street speculation,” simple as it may seem, creates more problems than it solves. Some simple modifications to the existing capital gains system could do the job much better.