Dr. William Barclay
Chicago Political Economy Group
Testimony to Illinois Legislative Pension Committee Hearing
July 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)
Dr. William Barclay, CPEG
7/8/2013
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Financial Transaction Tax

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).
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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.
Dr. William Barclay, CPEG
7/8/2013
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Country
Rate
Products Covered
Austria
0.15%
Stocks and bonds
Australia
0.3% and 0.6%
Stocks and bonds
Brazil
5.2%
Short term forex
trades
India
0.25% and 0.02%
Stocks, options and
futures
Taiwan
0.3%, 0.1%, 0.1%
Stocks, bonds and
futures
11 European
countries (France,
Germany, Italy, Spain,
etc.)
0.1% - Jan 2014
Stocks and some
derivatives
Dr. William Barclay, CPEG
7/8/2013
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
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.
Dr. William Barclay, CPEG
7/8/2013
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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
Dr. William Barclay, CPEG
7/8/2013
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
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.)
Dr. William Barclay, CPEG
7/8/2013
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$6.1
$4.6
$5.2
Dr. William Barclay, CPEG
7/8/2013
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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).
Dr. William Barclay, CPEG
7/8/2013
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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.
Dr. William Barclay, CPEG
7/8/2013
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
Consider 3 very active futures contracts:
Corn:

E-Mini S&P 500:

10 Year T-Note:
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A $1/contract FTT is less than the minimum tick.

◦ Each contract is for 5000 bushels
◦ Smallest price change (minimum tick) is $0.0025 =
$12.50
◦ Each contract is $50 x the index (about $81,000 today)
◦ Minimum tick (smallest price change) is .25 index points
= $12.50
◦ Each contract of for $100,000 face value
◦ Minimum tick is 1/64 of a point = $15.625
Dr. William Barclay, CPEG
7/8/2013
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
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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?
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
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.
Dr. William Barclay, CPEG
7/8/2013
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
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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.
Dr. William Barclay, CPEG
7/8/2013
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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.
Dr. William Barclay, CPEG
7/8/2013
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
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, brokerdealers
◦ High-income individuals
◦ Day traders
Dr. William Barclay, CPEG
7/8/2013
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
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.
Dr. William Barclay, CPEG
7/8/2013
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
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.
Dr. William Barclay, CPEG
7/8/2013
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“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
Dr. William Barclay, CPEG
7/8/2013
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Raising Revenue from Those Who Can Afford It
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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.
Dr. William Barclay, CPEG
7/8/2013
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
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.
Dr. William Barclay, CPEG
7/8/2013
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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.
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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.
Dr. William Barclay, CPEG
7/8/2013
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A Summary of Dr. Ron Baiman’s
July 3, 2013, Testimony

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CME’s tax reduction - $85 million
Foreign dividend exclusion - $386 million
Domestic production credit - $200 million
◦ IL would join 22 other states in decoupling
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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
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Retailer’s discount - $109 million
◦ Flows largely to out-of-state retail chains such as
WalMart
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TOTAL: $880 million/year in lost tax revenue
Dr. William Barclay, CPEG
7/8/2013
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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
Dr. William Barclay, CPEG
7/8/2013
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
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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.

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An FTT is a particularly attractive path.
It is time to act.
Dr. William Barclay, CPEG
7/8/2013
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Dr. William Barclay, CPEG
7/8/2013
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