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What is a Financial Transaction Tax?

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  • Written By: Gregory Hanson
  • Edited By: Susan Barwick
  • Last Modified Date: 17 November 2016
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A financial transaction tax is a tax levied on certain types of financial transactions, but not on specific assets or organizations. These taxes are designed to raise revenue, of course, but are also often intended to modify the behavior of financial institutions and markets, typically to minimize excessive risk-taking and speculation, both behaviors that are widely seen as detrimental to the healthy functioning of markets. Financial transaction taxes have a very long history, but gained much more interest and appeal in the wake of the global financial crisis of 2008.

Taxes on the purchase or sale of equities, originally proposed by John Maynard Keynes, are intended to reduce speculation and limit the growth of dangerous bubbles in asset prices. These taxes, which impose a modest total tax, typically no more than 2% per transaction, are meant to limit the frequency with which investors buy or sell stocks. Even a modest tax, such as this, would render some types of rapid turn-around speculative trading unprofitable, and might reduce both market volatility and the percentage of speculators relative to the number of long-term investors. Experiments with these taxes have not shown conclusively whether they are effective at eliminating bubbles.

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Currency speculation is another major problem facing modern governments, and different versions of the financial transaction tax have been proposed as possible solutions to this danger. Currency speculators make money by rapidly moving to manipulate the value of a nation’s currency, entering and exiting positions in that currency with great speed. This practice, while potentially quite lucrative, can cause serious disruptions to the value of a nation’s currency and can, consequently, damage trade and other areas of national financial policy.

A financial transaction tax can be used to limit this sort of speculative activity. Paul Spahn proposed a financial transaction tax that would tax normal currency exchange at a very modest rate, a rate that would generate revenue, but not provide serious incentive to avoid currency exchange, as that would also damage the economic health of a country employing such a tax. If trade pushed a nation’s currency outside of a broad floating price band, however, a second, much higher tax rate would become active. This would effectively make it impossible to profit from currency speculation, as the much higher tax rate would consume all potential profits.

The global financial crisis of 2008 focused new attention on the possible utility of a financial transaction tax. There were practical aspects to this attention, having to do with the ability to reduce dangerous future speculation. There was also a widespread sense of outrage at the activity of the banking industry, particularly in the United Kingdom and the United States, and many politicians proposed these taxes as much as a way of recovering money from the bankers as of stabilizing the financial markets.

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