Sanders' financial transaction tax proposal - do the numbers make sense? [View all]

[hill2016]

A financial transaction tax is very appealing to his supporters. It's the proverbial money tree: it can raise huge amounts of money and it can do so very painlessly (only harms the evil hedge funds and banks instead of normal people like you and me). Plays right to his image of striking against the fat cats at Wall Street and evil high frequency traders.

Only problem is how much money can it really raise? I would welcome anyone to challenge my analysis without resorting to name-calling.

According to his website, http://www.sanders.senate.gov/download/collegeforallsummary/?inline=file it could raise "hundreds of billions of dollars a year".

Let's analyze this thoughtfully.

(1) Firstly, let's agree on the principle that in order for people to be willing to pay the tax, they must be making much more than the amount of the tax in profits. Let's assume that people are willing to put up with a 60% effective tax on their profits. I'm not even considering the fact that profits are also taxed through corporate taxes or short-term capital gains taxes, in addition to state/local taxes.

(2) Secondly, let's try to look at some hard upper limits on the total earnings from the public financial sector. Bear in mind that a lot of these earnings have nothing to do with high frequency trading but other banking activity e.g. credit cards, asset management, interest from loans, investment banking, etc. Also bear in mind that increasingly a lot of prop trading has been driven out of banks by the Volker rule.

https://www.fdic.gov/bank/analytical/quarterly/
FDIC-insured institutions had net income of $40b in Q1. Let's assume $160b over a year. This includes small community banks and large money center banks.

http://graphics.wsj.com/quarterly-bank-earnings/
Looking at the top six banks, they earn about $25b in net income in a quarter or $100b a year.

http://equity-research.com/list-of-top-200-investment-banks-and-boutiques/
Looking at just the investment banks the US firms in the top 10 list earn about $60b in net income a year.

The entire S&P 500 earns about $1 trillion+ in earnings a year.

So perhaps a very generous upper bound on the total net income of the public financial industry is about $300b. As mentioned before, most of this would be non trading related activity (normal consumer, commercial and investment banking stuff). Most banks are getting rid of their prop desk.

If you recall JP Morgan's London Whale (which is the kind of prop trading we are talking about), they lost $7b for the bank, which was a big deal for them.


(3) Thirdly, on to the evil hedge funds. Again let's try to establish some upper bounds on their total profits (I'm using profits here to mean performance instead of actual incentive fees).

The hedge fund industry is about < $3 trillion. Average performance is about 10% a year. Let's say the total performance of the hedge fund industry is $300b a year. There are going to be some managers who are successful and those who fail. There are going to be some managers with very low returns and some people with very high returns. Also we are assuming all this is generated in US markets (as opposed to overseas markets).

Now this performance doesn't just go to the pockets of the hedge fund managers. At the end of the day, this performance belongs to the investors, who are going to be mainly pension plans, foundations, endowments, etc. Remember one goal is to hurting "normal" people. So we need to give them an exemption from this tax.

Also, a lot of this performance isn't generated by high frequency trading.


(4) So in conclusion,
1. The entire US banking sector earns on the order of $300b a year, the vast majority of which is normal banking stuff (consumer, commercial, and investment banking) instead of prop trading.

2. The entire hedge fund industry's performance is about $300b a year, which belongs to their clients. Most of this performance isn't generated by high frequency trading and we want to exempt the right kind of investors (pensions, foundations, endowments).

5. Finally, the last piece of the parcel is that we you raise tax on an activity, you generally reduce such activity.

So, how does Bernie raise "hundreds of billions" from his financial transactions tax?