Robin Hood, nearing European victories, still struggling to awaken in the U.S.
Because per-share profit is generally small, even a modest FTT would cut into, or even eliminate, that profit. The practice would thereby become less attractive to investment banks, independent high-frequency trading firms, and hedge funds.
Some critics of high-frequency trading say these superfast transactions — which scarcely existed 20 years ago — amount to gambling. They point to events on May 6, 2010 as an example of the risk to market stability that high-frequency trading poses.
Late in that trading day, the Dow Jones Industrial Index dropped almost 600 points in just five minutes. (By the end of the trading day, the index had recovered the 600 points it had lost.) The event came to be known as the “Flash Crash.” It was triggered by a large sell initiated by a mutual fund. High-frequency computer programs sensed the movement and flooded the market with trades. Human traders realized something was awry but didn’t know what, so they just stopped trading. They effectively turned off their computers.
During the Flash Crash — which lasted mere minutes — some companies’ share prices fluctuated wildly. Accenture, for example, came down from $41 per share to one penny, only to rebound within a few seconds to approximately $40 per share. Procter & Gamble fell from $60 per share to about $39 in the span of 3.5 minutes. And one minute later the stock had sprung back to just over $60. By day’s end the market recovered, but other “mini” flash crashes (see here and here) have followed, notably in the currency and commodities markets.
“A very lightly regulated casino,” was how Rep. DeFazio described the current U.S. financial market. “It has very little to do with raising capital to support productive enterprise,” he said. “Instead it has just become a place where certifiably smart people with degrees from MIT develop algorithms to game the market, [creating] tremendous volatility — to hell with long-term impacts.”
Dean Baker, economist and co-director of the liberal Center for Economic and Policy Research, said there isn’t sufficient evidence that an FTT on its own would stop high-frequency speculation, although he thinks the volume of high-frequency trading would be slowed. Instead, he emphasized an FTT’s ability to shift investors’ priorities.
Baker argued that today’s financial markets absorb capital and talent that would otherwise be deployed in other areas. If high-frequency trading were to decrease, “you free up labor, you free up capital,” he said. The current financial market “pulls away resources from the productive economy. It hurts industries that have a high dependence on external funding,” such as new companies looking to grow and innovate. Those firms can have a hard time finding investors, Baker said, because “capital is being diverted to the financial sector.”
The revenue-generating potential of an FTT
Aside from its impacts on financial markets and investment patterns, an FTT would, according to its proponents, generate much-needed government revenue at a time when both state and federal budgets are under duress. The Harkin-Defazio bill is projected to raise $352 billion over a nine-year period. Another plan — this one put forward by Robert Pollin, professor of economics and co-director of the Political Economy Research Institute at the University of Massachusetts-Amherst, and the Institute’s associate director, U. Mass. associate research professor James Heintz — claims to be able to raise a comparable amount of money in a single year. The Pollin-Heintz plan would feature rates that vary by type of finanical instrument, imposing the higher rate on stocks transactions (see bottom box).
Differing rate structures; differing levels of revenue
The amount of money an FTT could generate depends, of course, on what is taxed and at what rate.
The Harkin-DeFazio bill calls for a flat 0.03 percent tax on stocks, bonds, and derivatives. According to a press release from Harkin’s and DeFazio’s offices, the Joint Committee on Taxation has calculated that the measure would generate revenue of $352 billion from 2013 to 2021.
Robert Pollin and James Heintz, economists at the University of Massachusetts-Amherst, have formulated a very different FTT. Their plan proposes tiered rates of 0.5 percent for stock transactions, 0.15 for those involving bonds, and 0.005 for those involving derivatives.
Similarly, Dean Baker of the Center for Economic and Policy Research has proposed an FTT that would tax stock transactions at a 0.5 percent rate, and both bond and derivative transactions at a 0.01 percent rate.
Some critics dismiss an FTT’s revenue-raising potential. They point out that if an FTT successfully discourages high-frequency trading, then there will be fewer transactions to tax. Pollin, Heintz, and Baker all agree that an FTT will discourage some trading, particularly high-frequency trading.
Nevertheless, Pollin and Heintz contemplated a 50 percent drop in overall volume when estimating that their FTT would generate $352 billion annually.
When Baker calculated a 50 percent drop from the current trading volume level (the scope and price of derivatives transactions is anything but transparent, so different analysts posit different current transactional volume and cost), he estimated that his proposed rates would yield $177 billion annually.