reframing the debate: a revenue, not a spending, problem
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Reframing the Debate: A Revenue, Not a Spending, Problem. Dr. William Barclay Chicago Political Economy Group Testimony to Illinois Legislative Pension Committee Hearing July 8, 2013. Dr. William Barclay - Background. Worked 22 years at Chicago exchanges - PowerPoint PPT PresentationTRANSCRIPT
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Reframing the Debate: A Revenue, Not a Spending, Problem
Dr. William BarclayChicago Political Economy Group
Testimony to Illinois Legislative Pension Committee HearingJuly 8, 2013
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Dr. William Barclay, CPEG 2
Worked 22 years at Chicago exchanges◦ MidAmerica Commodity Exchange, CBOT, CBOE and Chicago
Stock Exchange◦ Responsibilities included:
Product development Strategic planning Market research
◦ Worked with: Exchange staff Members (individual and institutions) Regulators: CFTC and SEC
◦ Occasional trader of derivative products Founding member Chicago Political Economy Group
(CPEG)
Dr. William Barclay - Background
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Financial Transaction Tax
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Dr. William Barclay, CPEG 4
What do Switzerland, Australia, Hong Kong and Singapore have in common?◦ They are all ranked in the top 5 countries on the
Heritage Foundation’s “Index of Economic Freedom.”◦ They also all have a financial transaction tax (FTT).
FTTs are, therefore:◦ Not an unusual tax.◦ Not a threat to successful financial markets.
Keynes, James Tobin and Larry Summers have all advocated FTTs – as did Pope Benedict XVI.
A Revenue Source
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Dr. William Barclay, CPEG 5
Country Rate Products CoveredAustria 0.15% Stocks and bondsAustralia 0.3% and 0.6% Stocks and bondsBrazil 5.2% Short term forex
tradesIndia 0.25% and 0.02% Stocks, options and
futuresTaiwan 0.3%, 0.1%, 0.1% Stocks, bonds and
futures11 European countries (France, Germany, Italy, Spain, etc.)
0.1% - Jan 2014 Stocks and some derivatives
FTTs Around the World
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Dr. William Barclay, CPEG 6
HR 1554 - An Illinois Financial Transaction Tax (FTT)
HR1554 sponsored by Rep. Mary Flowers would impose a Financial Transactions Tax on buyers and sellers equal to:◦ 0.01% of the underlying or notional value of contracts traded on
the CME(including the CBOT) and the CBOE – 1 cent per $100 of underlying value 2012 notional value on the CME alone was $805 trillion.
◦ The tax would be imposed on stock, futures, swap, credit default swap, and options contracts.
◦ It would not include transactions involving securities held in retirement or mutual fund accounts.
◦ The rate proposed in HR 1554 (1 basis point) is much less than commonly found among markets with FTTs.
Assuming even a 50% decline in trading, it would raise $30 – 40 billion annually.
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Dr. William Barclay, CPEG 7
An FTT on derivative contracts traded on Chicago derivative exchanges (CME* and CBOE)
Derivatives have both a buyer and a seller Both would pay the $1/contract FTT Even on the smallest contracts, this $1 is de minimus when
compared to the underlying or notional value of the contract ◦ E.g., Corn futures – roughly a $30,000 contract
A $1 FTT would be less than 0.0033% of contract value (1/3rd of a basis point)
◦ On larger contracts a dollar would represent even less, e.g., on the Eurodollar futures, a $1 fee on a $1,000,000 contract (0.00010% )
* CME owns the Chicago Board of Trade
A Very Modest CPEG Proposal: An Illinois FTT of $1/Contract
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Dr. William Barclay, CPEG 8
Chicago Board Options Exchange (CBOE):◦ Stock index options (on S&P 500, Dow, NASDAQ, etc);
Exclude options on individual stocks (size and competition) Chicago Mercantile Exchange (CME)
◦ Stock index futures and futures options (S&P 500, Dow, NASDAQ, etc.)
◦ Futures and futures options on interest rates products (T-bonds, T-Notes, Eurodollars, etc.)
◦ Futures and futures options on currencies (Euro, UK pound, yen, etc.).
◦ Futures and futures options on commodities (corn, wheat, soybeans, hogs, cattle, etc.)
What Instruments Would Have an FTT?
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Dr. William Barclay, CPEG 9
2008 2009 2010 2011 2012$0.00$1.00$2.00$3.00$4.00$5.00$6.00$7.00
Total Revenue
Total Revenue
US $
Bill
ions $6.6 $6.1
How Much Revenue Could a $1/contract FFT Raise?
$6.1
$4.6$5.2
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Dr. William Barclay, CPEG 10
The most common one is: “The exchanges will move out of state.”
Another common one is: “Traders will take their business elsewhere.”
Yet another one is: “The tax could be easily evaded and/or costly to collect.”
Let’s consider each in turn by looking at the economic arithmetic of an FTT (the incentives involved).
All Taxes Face Counter Arguments
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Dr. William Barclay, CPEG 11
The relevant question: Have exchanges moved when FTTs were implemented?
No – this has not occurred. Why? The tax is not paid by the exchange. There
is no economic incentive for the exchange to move.◦ An FTT is levied on the act of trading.
The exchange simply functions as the collection agency for an FTT.
The Economic Arithmetic of an FTT: Exchanges
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Dr. William Barclay, CPEG 12
Consider 3 very active futures contracts: Corn:
◦ Each contract is for 5000 bushels◦ Smallest price change (minimum tick) is $0.0025 = $12.50
E-Mini S&P 500:◦ Each contract is $50 x the index (about $81,000 today)◦ Minimum tick (smallest price change) is .25 index points =
$12.50 10 Year T-Note:
◦ Each contract of for $100,000 face value◦ Minimum tick is 1/64 of a point = $15.625
A $1/contract FTT is less than the minimum tick.
The Economic Arithmetic of an FTT for Traders: I
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Dr. William Barclay, CPEG 13
Consider this economic arithmetic from the perspective of a trader (hedger, e.g., farmer, portfolio manager) or a speculator:
If the $1/contract FTT was levied, the trader would give up a fraction of the smallest first and last price change:
◦ $1 of $6.25, $12.50 or $15.625 ($25 on the big S&P 500 Index futures)
◦ What kind of trading strategy or trader is looking for price changes less than the smallest amount a contract can change in value?
Another way of thinking about this: The $1/contract FTT is significantly less than the difference between the bid and ask prices for these contracts.
The economic incentive for a trader to move is very limited.
The Economic Arithmetic of an FTT for Traders: II
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Dr. William Barclay, CPEG 14
The relevant question: To where would traders go? Some products trade under exclusive licenses.
◦ These include almost all stock index products. Derivative exchange competition is not primarily
product based. ◦ Very few identical products are listed on different
derivative exchanges. ◦ This may reflect 1980s/early 1990s competition in FX
and petroleum products. Consistent outcome: one exchange won all the volume.
It also reflects the problem of liquidity creation in derivatives trading.
The Economic Arithmetic of an FTT for Traders: III
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Dr. William Barclay, CPEG 15
The argument that an FTT would be easy to evade/costly to administer also has little merit.
Clearing houses match and clear all trades (CME’s Clearing House and OCC for CBOE).
The CH already serves as a collection agency for transaction fees.
The CH could easily collect an FTT. Thus an FTT is very low cost to administer
and difficult to evade.
Administering an FTT
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Dr. William Barclay, CPEG 16
The FFT is on the act of trading – like a sales tax for buying clothes, food, a car, etc.◦ It is on both buying and selling the derivative.
The FFT is a very progressive tax because of who trades and thus who would pay the tax :◦ Institutions such as banks, hedge funds, broker-
dealers◦ High-income individuals◦ Day traders
Who Would Pay the FTT?
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Dr. William Barclay, CPEG 17
What is good tax policy: ◦A good tax should be a small amount for
any single event. ◦A good tax should fall on those able to
bear the tax. ◦A good tax should tax activity that we
want to limit or discourage. Lord Adair Turner – much of what goes on
in finance is “socially useless” activity.◦A good tax should further economic or
social justice.
FFT: A Tax for the People, Not on the People
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Dr. William Barclay, CPEG 18
A $1/contract FTT meets the criteria for a good tax:◦ The FFT rate is very low compared to the value of a
contract. Total notional value of trading on the CME in 2012 was
$806 trillion.◦ The FFT would fall primarily on high income
individuals and wealthy institutions.◦ The FFT would probably discourage some “socially
useless” short term trading.◦ An FFT taxes the sector that caused the financial
crisis that led to the Great Recession.
An FTT is Good Tax Policy
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Dr. William Barclay, CPEG 19
“When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”
- John Maynard Keynes
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A Graduated Income Tax
Raising Revenue from Those Who Can Afford It
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Dr. William Barclay, CPEG 21
Some claim Illinois is a high tax state. That depends on where your household falls in the income
continuum. Consider all major taxes: income, property and sales taxes.
◦ IL bottom quintile households pay taxes at the 2nd highest rate in the US.
◦ Middle income quintile households pay taxes at the 5th highest rate in the US.
◦ However, top 1% income households pay taxes at the only the 30th highest rate in the US.
◦ The next 4% of households by income pay taxes at only the 15th highest rate in the US.
A graduated income tax would help remedy this unfair distribution of taxation.
Taxes in Illinois
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Dr. William Barclay, CPEG 22
A Graduated Individual Income Tax (GIT) for Illinois CTBA’s GIT proposal would:
◦ Raise $2.4 - $3.4 revenue annually.◦ Cut overall state income tax burden for 94% of
all taxpayers. Taxpayers with under $150,000 in annual base
income would receive a tax cut. Effective rates would be 0% for incomes below
$9,000 and slowly increase to roughly 6%.◦ Keep the effective state income tax rate for
millionaires. ◦ Stimulate the growth of at least 36,000 jobs in
the state’s private sector through enhanced public and consumer spending.
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Dr. William Barclay, CPEG 23
Comparing Illinois to Other States 34 of the 41 states with individual income
taxes have graduated rates. Iowa’s GIT applied to Illinois would raise
42% more revenue than the roughly $15 B raised from Illinois’ current temporary 5% flat rate◦ It would still cut rates for most filers.
KY, MO, and WI all have GIT’s that raise 11% to 24 % more revenue and cut tax rates for most filers.
If Illinois had Oregon’s GIT, the state would almost double its IIT revenue.
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Raising Revenue by Closing Tax Loopholes
A Summary of Dr. Ron Baiman’s July 3, 2013, Testimony
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Dr. William Barclay, CPEG 25
CME’s tax reduction - $85 million Foreign dividend exclusion - $386 million Domestic production credit - $200 million
◦ IL would join 22 other states in decoupling On line hotel room purchases - $25 million Offshore oil drilling - $75 million
◦ Many other states tax the income share that can be apportioned to their state
Retailer’s discount - $109 million◦ Flows largely to out-of-state retail chains such as WalMart
TOTAL: $880 million/year in lost tax revenue
Six Large IL Tax Loopholes
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Dr. William Barclay, CPEG 26
Allocate the $880 million to a dedicated fund.
Use the same CFGA* return and investment assumptions that underlie the $95 billion “pension shortfall.”
Use CFGA same 33 year period. Net present value of these 6 tax loopholes:
$70.5 billion*Commission on Government Forecasting and Accountability
IL Tax Loopholes vs. Pension Funding Gap
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Dr. William Barclay, CPEG 27
Illinois has potential revenue sources. Illinois can enact legislation that would:
◦ Solve the “pension funding crisis.”◦ Not take away from teachers, state employees,
and others their earned benefits.◦ Pass constitutional scrutiny.
An FTT is a particularly attractive path. It is time to act.
A Summing Up
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Dr. William Barclay, CPEG 287/8/2013