Transaction Tax: General Overview

Publication Date: December 2004

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

Type:

Abstract:

In recent years a number of alternative taxation mechanisms have been proposed to augment or replace income taxes and other traditional revenue sources. This report describes the economics of one of the proposals -- a broad-based transaction tax or fee. On February 3, 2004, Representative Fattah introduced H.R. 3759 ("Transform America Transaction Fee of 2004") that required a study of replacing current federal taxes with a broad-based transaction fee. This report provides relevant background information on transaction taxes or fees in general and discusses some of their more notable economic aspects.

A broad-based transaction fee or tax is triggered by any transaction and is imposed either as a percentage of a transaction's full value, or as a flat fee. Most items are resold several times during the production process, and every such transaction would be taxed. This pyramiding effect makes the tax different from other consumption-based taxes, such as sales and use taxes or value-added taxes.

Historically, transaction taxes have been applied to a limited number of transactions, such as trades in various financial instruments. While they were used in the United States and abroad, they were never a major revenue source.

A transaction tax or fee may generate additional revenues for the federal government or substitute for existing ones. In doing so, it may reduce or eliminate existing distortions in the economic system, but introduce distortions of its own. For example, a transaction tax burden would fall more heavily on industries that involve large numbers of transactions. Its introduction might induce firms to vertically integrate production, which may not be beneficial from a social standpoint. Imposing the transaction tax in the financial market could possibly cause a significant loss of trading volume to competing overseas markets.

On the other hand, the transaction tax or fee might eliminate a great deal of complexity from the taxation system. It could be easier to administer and result in lower compliance and other related social costs. It may also prevent excessive speculative trading in financial instruments. In addition, it would be a means to tax underground economic activities.

Several tentative revenue estimates included in this report illustrate the revenuegenerating potential of a broad based tax. For example, a 0.5% tax on stock transfers would yield no more than $65.6 billion a year, and a 0.00006% tax on foreign exchange transactions would bring in just $4.3 billion. In order to replace all federal receipts with the transaction tax revenues, the rate would have to be set at about 4.3% per transaction, possibly more. This estimate does not account for new federal programs envisioned by H.R. 3759.

This report provides general background information, but it does not evaluate any specific legislative proposal. The report will not be updated.