Financial Transactions Tax Won’t Affect Pension Funds
NYPAN supports BOTH the original Stock Transfer Tax AND the Wall Street Tax created by Invest in Our NY.
Proposals for financial transactions taxes (FTT) have gained considerable support in recent years. There have been several bills introduced in Congress calling for an FTT. All the major candidates for the 2020 Democratic presidential nomination came out in support of an FTT. The idea of raising substantial revenue (the Congressional Budget Office estimated a 0.1 percent tax could raise almost $800 billion over a decade), while reducing wasteful trading in the financial sector, has considerable economic and political appeal (Congressional Budget Office).
As an FTT has become more politically plausible, some managers of pension funds, both public and private, have expressed concern about its possible impact on their finances. This report will show an FTT would have a minimal impact on the solvency of pension funds. At the most basic level, the size of the proposed taxes is small relative to annual returns or even compared to the other administrative costs that pension funds incur.
Furthermore, we would expect the pension funds would trade less in response to the increase in the cost of trading stemming from tax. Most estimates show that the decline in trading volume due to the tax would roughly offset the increase in trading costs (Matheson). This means, for example, that if the tax raised trading costs by 30 percent, the expected trading volume would decline by roughly 30 percent. In the end, the total amount that pension funds spent on trading, even including the tax, would be little changed.
This paper examines two issues related to pension funds and FTTs. First, data from several of the largest public pension funds shows that a substantial share of pension fund assets is invested in countries that already impose FTTs, including the United Kingdom, France, Italy, China, and India. Pension funds would not voluntarily expose themselves to these taxes if they were a big factor in reducing investment returns. The fact that the pension funds for which we could find data willingly invested a substantial portion of their assets in countries with FTTs indicates that they do not see it as a major negative for investment returns.
The other issue the paper examines is the current returns received by pension funds. As noted above, we would expect that pension funds would reduce their trading volume in response to the imposition of an FTT, roughly offsetting the cost of the tax. In principle, lower trading volumes should have little impact on returns since trading is largely a zero-sum game. Every trade has a winner and a loser, which should average out for most investors, who will end up half the time in each group. Increased trading volume can only improve returns on average if it leads to better outcomes for the economy as a whole, which is not a plausible story in the US economy at present.
Of course, there are some investors who are net winners from their trades. If these investors traded less then it could mean that they would receive lower returns. The second half of this paper considers this possibility by examining the returns of these funds over the last five years. If they substantially exceeded major market indexes, there would be an argument that pension funds have successful trading strategies that could be harmed by a reduction in trading volume. As it turns out, their returns do not exceed returns from the S&P 500 over this period.
These two points should help to reduce concerns that pension funds may have over the risks they would face from an FTT. First, they already seem quite comfortable in investing markets where they face FTTs, so by their actions, they do not seem to view FTTs as being too harmful to investment returns. Second, they do not seem to have any extraordinarily successful trading strategy that would be harmed if they reduced trading volume in response to an FTT.