Question:
I stumbled across a link regarding a Financial Settlement Tax (not FTT) from Scott Smith who is running a presidential campaign. The idea is to tax financial payments estimated to be $4515 trillion per annum in the US:“The Bank for International Settlements in Basel, Switzerland, known as the BIS, publishes an annual report known as the Red Book, which reports on the volume of payments for most of the major nations in the world. The Federal Reserve keeps track of payments in the United States and provides the data to the BIS for publication in the Red Book. The Committee on Payments and Market Infrastructures at the BIS oversees the publication of the Red Book. International Financial Settlement payments are recorded and published and 1/10 of 1% could be deducted and transparently reported on the Internet.”
My questions are below:
1) Roughly what percentage of settlements would disappear with a 0.1% tax? My guess is there’s a significant percentage of very low margin trades that would end with such a tax.
2) Since you can’t take nearly 30% from the economy without someone noticing, what distortion(s) would be introduced in the market?
Answer:
1) There is no way to tell even approximately without a well calibrated model. As you suggested, very small profit margin trades will no longer be conducted. However, there are other, potentially much more important routes. First, many small transactions (e.g., groceries) will go back to cash and some employers will start paying their employees in cash. Second, many financial transactions previously conducted within the U.S. borders would instead be conducted abroad: an "off-shore" wealth-management industry would emerge to address the needs of U.S. clients and avoid the tax. Third, the U.S. financial system would lose part of its attractiveness as an intermediary to foreigners: e.g., foreign banks may stop using New York City-based banks as correspondent banks and switch to London-based banks. Also, foreign companies may no longer find it as attractive to do IPOs in the United States. In addition, it is unclear how the rest of the world would respond to a dramatic change in the U.S. tax regime. However, it is unlikely the Unites States will be able to coordinate with every other country on the switch.
2) If I understand Mr. Smith’s plan correctly, his idea is that while the FST "removes" this fraction of the money supply, the same fraction is injected by the Federal Reserve through directly financing government expenditures. (At present, the Federal Reserve is prohibited from lending to the government directly.) Thus, I don’t have the same exact concern you indicated about the plan. My concerns are a bit different. First, since the FST is not a tax in a literal sense (i.e., not a tax collected by the U.S. Treasury) and keeping track of FST amounts in real time can be costly, how would the government and Federal Reserve know how much to inject? Mistakes could result in inflation or deflation. Second, in this tax scheme, fiscal and monetary policy become inseparable. This implies less flexibility to conduct economic policy. Also, I don’t see anything in the scheme that prevents the government from forcing the Federal Reserve to "monetize" deficit after deficit, ultimately leading to a hyperinflation.
