The idea of imposing a financial transactions tax on Wall Street trading has received a lot of attention from Congress, the press and economists in the years since the financial crisis. The basic proposal is that the government would impose a fee on the sale or purchase of certain financial assets like stocks, bonds or credit default swaps. Market participants would have to pay the tax at the time of the transaction. Proponents of the idea suggest that such a tax would generate substantial revenue and curb risk in the financial system.
The European Union has already approved such a tax in concept, although there have been delays in its actual implementation. In the U.S., however, the tax is highly controversial and generally associated with progressives. To date, Congress has yet to enact or even seriously consider a financial transactions tax.
What no one in the financial markets or the media seems to have noticed is that the federal courts, on their own and without approval from Congress, have already imposed a fee on the sale of bonds and similar instruments in bankruptcy. This decision could help pave the way to a financial transaction tax.
In September 2012, the Judicial Conference of the United States decided to impose a $25 fee for the sale or transfer of what is known as a "proof of claim." A proof of claim is a document filed with a bankruptcy court to collect on a bond or any debt from a bankrupt company. The fee went into effect in May 2013.
This fee functions in essentially the same way as a tax. The courts use electronic recordkeeping, so the actual costs of transferring a proof of claim and sending notice are minimal. The real purpose of the fee is to generate revenue for the benefit of the government, just like any other tax.
While the scale of this initiative is relatively small, it could set a precedent for taxing the sale of financial instruments. This is troubling for anyone concerned about the market distortions that might result from taxing financial transactions.
In the robust market known as claims trading, during a corporate bankruptcy the original creditor or bondholder will sell or transfer a proof of claim to an investor. The transaction provides immediate liquidity to the seller. The investor recognizes value by paying a deep discount and reaping a reward later on. Alternatively, an activist investor can exchange the bonds purchased in bankruptcy for equities in a newly reorganized business. In this way, strategic investors can build up a significant, perhaps controlling, ownership stake in companies exiting bankruptcy.
It is unclear what effect the fee may have on liquidity in bankruptcy cases. But given this uncertainty, the newly elected Congress should repeal the bankruptcy tax. Moreover, legislators should take steps to ensure that the federal judiciary cannot unilaterally impose market-distorting fees or taxes in the future.
John McMickle is the founder of JDM Public Strategies, a consulting firm that works in financial services and government relations. He served as the bankruptcy counsel to the U.S. Senate Judiciary Committee from 1994 to 2001. Follow him on Twitter @jdmpsllc.