reframing the debate: a revenue, not a spending, problem

Dr. William BarclayChicago Political Economy Group

Testimony to Illinois Legislative Pension Committee HearingJuly 8, 2013

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)

2Dr. William Barclay, CPEG 7/8/2013

Financial Transaction Financial Transaction TaxTax

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.


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


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.


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


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.)


$6.1

$4.6$5.2


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).


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.


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.


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 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 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.


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


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.17Dr. William Barclay, CPEG 7/8/2013

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.


“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


Raising Revenue from Those Who Can Afford It

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.


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.


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.


A Summary of Dr. Ron Baiman’s July 3, 2013, Testimony

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


Allocate the $880 million to a dedicated fund.

Use the same IDOR return and investment assumptions that underlie the $95 billion “pension shortfall.”

Use IDOR’s same 33 year period. Net present value of these 6 tax loopholes:

$70.5 billion


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.


reframing the debate: a revenue, not a spending, problem

Documents

futures options sp

options contracts

corn futures

eurodollar futures

stock index options

etcexclude options

contract value

derivative contracts