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September 26, 2008
Speculation and Taxation: Time for a Transaction Tax?
Joseph J. Thorndike

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Joseph J. Thorndike is a contributing editor with Tax Analysts. E-mail:

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High gas prices have prompted a search for scapegoats on Capitol Hill. Oil companies were the first to take the heat, as lawmakers cast a disapproving look at the record high earnings posted by Chevron, Exxon Mobil, and other malefactors of great profit. But the legislative upshot -- a tax on windfall profits -- hasn't gotten very far, despite support from Sen. Barack Obama, D-Ill. So maybe it's time for a new scapegoat.

What about speculators? Last week the House Energy and Commerce Committee invited a few oil market experts to do a little speculation of their own, asking them to assess Wall Street's role in driving oil prices to record territory. They happily obliged, suggesting that a crackdown on some types of investment activity might bring prices down by 50 percent.

But how, exactly, should lawmakers curb speculation? In recent weeks, members of Congress have floated several ideas, including higher margin requirements, enhanced disclosure by investment banks, and bigger budgets for federal commodity regulators.

But most regulatory measures depend on making some sort of distinction between speculative and nonspeculative investment. And that sort of distinction has eluded American lawmakers for decades, frustrating their episodic efforts to limit speculation in various financial markets.

So what to do? Economist Dean Baker, codirector of the Center for Economic and Policy Research, has an answer. "Treat speculation like casino gambling," he wrote in a recent post to his popular blog, "Beat the Press" -- "just tax it." Baker suggested that a broad-based financial transaction tax might help curb commodity speculation while also raising a nice chunk of change for the Treasury (

More specifically, Baker supports "a set of modest taxes on financial transactions" -- perhaps 0.2 percent on commodity futures trades and 0.25 percent on stock trades. In a 2002 paper, he and two colleagues suggested that such taxes might raise $150 billion a year ( And as a bonus, they added, the taxes would probably "take a big bite out of the hides of speculators."

Baker's idea has pedigree and precedent. Harvard economist Lawrence Summers suggested something similar in the late 1980s, when lawmakers and academics were still trying to make sense of the 1987 stock market swoon. Nobel laureate James Tobin endorsed a levy on currency transactions (an idea that still has broad support among the antiglobalization crowd, not to mention currency speculator extraordinaire George Soros). Even John Maynard Keynes suggested that some sort of transaction tax might reduce the "predominance of speculation over enterprise" so characteristic of American society.

Around the world, several countries have imposed taxes on financial transactions. The United Kingdom, in particular, taxes stock transfers at 0.25 percent. If imposed in the United States, Baker has contended, "this sort of tax would make almost no difference to a typical middle class shareholder" while putting "a serious crimp in the money shuffling business that has wreaked so much havoc on the U.S. economy." (See _the_right/.)

For readers with a historical bent, it's worth recalling that the federal government -- as well as several states -- has repeatedly imposed a tax on the sale or transfer of securities. The first stock transfer tax can be traced to the early Republic, and it reappeared during the Civil War and the Spanish-American War. In 1914, faced with yet another military conflict, Congress again turned to the stock transfer tax. But this time the levy remained on the books for more than 50 years.

The Revenue Act of 1914 levied a tax of 2 cents per $100 of par value on all sales or transfers of stock. The tax was designed principally to raise revenue, not regulate markets. But that didn't stop advocates from predicting that it would also curb speculation.

The tax survived World War I and went on to raise considerable revenue in the bull market of the 1920s. In 1928 Democratic congressional leaders tried to reduce it, suggesting that current rates were unnecessary and excessive. But progressive leaders in both parties rejected the move, complaining that it would encourage speculation. They found surprising but crucial support in the person of Sen. Reed Smoot, a fiscal conservative who supported the transfer tax as a revenue measure. Ultimately, according to historian Cedric B. Cowing, nonfinancial business interests rallied to the cause, preferring the transaction tax to more onerous revenue alternatives.

In 1932, as lawmakers were casting about for ways to raise new revenue in the face of a Depression-spawned deficit, they slated the stock transfer tax for a big increase. Wall Street leaders complained that any hike would be ruinous, and they deployed a variety of arguments to bolster their case. Stock purchases were not speculation, they insisted. And even if they were, it was Ok, because speculation was good for the economy and the nation. And in any case, it was impossible to tell the difference between investment and speculation, so better to leave well enough alone.

Lawmakers were unconvinced, and the Revenue Act of 1932 more than doubled the rates. But Treasury experts remained lukewarm. In general, the tax probably made the revenue system more progressive, concluded economist Carl Shoup in a key 1934 study. But it didn't raise a lot of money, and it probably couldn't be made to produce much more. "Except as a check on speculative activity the tax probably has little to justify it," he wrote. Worse yet, it did a poor job of curbing speculation. "At present rates it probably does not check the kind of speculative activity -- the reckless, foolish activity -- deplored by those who would like to use the tax for this end," he wrote.

Nevertheless, the stock transfer tax remained on the books for another 32 years, disappearing only in 1966 when lawmakers repealed it as part of a broader effort to streamline the tax system. Few observers mourned its passing.

The idea remained dormant until the late 1980s, when both Democrats and Republicans began to ponder its potential. The stock market crash in 1987 had revived interest in the antispeculative potential of financial transaction taxes. Prominent economists published a flurry of papers on the topic, giving it intellectual currency for a few years.

Even more important, however, a federal budget crunch sent politicians in both parties scrambling for new revenue. Speaker of the House Jim Wright offered his support for some sort of financial transaction tax, chiefly as a revenue tool. Even the Treasury Department was reportedly considering it, which at least one observer found amusing. "A securities transfer tax, deliberately designed to create friction in the wheels of commerce, is a strange bird to be hatched by a Republican administration," wrote Washington Post columnist Michael Kinsley in 1990.

Indeed it was. But antispeculation sentiment runs strong in Washington, at least every once in a while. And when juxtaposed with a revenue crunch, it can be a powerful force for innovation. That might be an idea worth watching.