Is a Financial Transactions Tax the Answer?

Dean Baker says a financial transactions tax has attractive properties:

Bloodletting on Wall Street, by Dean Baker: There were two noteworthy episodes last week in the ... the housing market meltdown. First, the New York Times ... found that the Wall Street banks had already written down ... almost half of their profits in their boom years from 2004 through the first half of 2007.

The other big item was that two Bear Stearns hedge fund managers were marched off to jail, charged with fraud and other related offences. ...

This raises many questions...

First, since so much of bank profits were illusory, the story about profits in the economy is somewhat different than we had thought. There really was no profit boom in this decade. ... This means that the upward redistribution that prevented most workers from getting much benefit from productivity growth over the last decade went exclusively to high-end workers, not corporate profits. ...

Wall Street's vanishing profit syndrome tells us much about the current ... relationship between stockholders and top executives.

Remember, the business ideology of the last quarter century... Everything must be done to maximise shareholder value. If this means massive layoffs or shutting factories that had supported a local economy for decades, so be it.

However, we have just seen the top managers of many major Wall Street banks take their shareholders for a huge ride. ...

[T]op executives have managed to wrest control of companies away from shareholders so that they can earn huge compensation packages regardless of their performance. This is an economy-wide problem. ...

However, the problem is worst on Wall Street. The compensation is higher and the performance is poorer. Furthermore, ... the failings of the Wall Street crew are likely to have greater economy-wide ramifications than ineptitude in most other sectors.

There are no easy remedies... Clearly we need a new regulatory structure... But with the Wall Street crew completely dominating the debate over regulation, we have little reason to hope for serious reform.

In the absence of a major regulator overhaul, there is one simple measure that would at least ensure that the public gets a cut of the action. A modest financial transactions tax could easily raise an amount equal to 1% of GDP, or $150bn a year at present. This is ... enough to finance a 10% across-the-board reduction in the income tax.

A tax of 0.25% on a stock trade or 0.02% on the purchase of credit default swap will have no measurable impact on productive financial transactions, but will likely put a serious dent in speculative activity. For this reason, it is a win-win-win proposition. It reduces speculation, it takes a big bite out of Wall Street revenue and profits and it raises a bucket of money. ...

I don't know. Not all speculation is bad, far from it - bubbles aren't that common - so I'm not sure stifling all speculation as opposed to a more targeted approach is best, or perhaps even better using an approach that reestablishes the authority of shareholders over management (see Dew-Becker and Gordon on this point, "we believe that better disclosure and better laws regarding corporate governance can help deal with high CEO pay").

Comments

[Fred]

A great way to send the financial industry over to London. A much better approach is to simply let a lot of investors and Wall Street types lose a lot of money so that they are scared straight for a while. As to the deflationary effects of such an implosion, that can be easily stopped by $2 trillion budget deficits plus a whopping big tariff to avoid demand leakage through a trade deficit.

[Tax]

"There really was no profit boom in this decade..."

Shareholders are being harmed by this system, so the solution is to put a tax on shareholders (stock trades). Actively managed mutual fund shareholders are toast if this tax comes to pass. It will drive the expense ratio up, at a time when profits are absent. The real return on the S&P this decade is negative. This $150 billion tax on mutual fund trades will create even greater real losses.

[Tax]

This proposal reminds me of the luxury tax that destroyed the small boat industry awhile back. 401ks are generally limited to bond funds and stock funds. Eliminate all the profit from the already poor performing stock funds, and 401ks become guaranteed vehicles of confiscation via inflation.

[Bruce Wilder]

Since the problem is overpaid executives and fund managers, bringing back the 70% and 95% income tax brackets would seem more directly to the point.

[Alan]

Why not simply increase personal income tax - back to the old days where marginal tax rates went as high as 92 cents in the dollar.

[Michael McKinlay]

A transaction tax is a great idea ...

It benefits investors over speculators and would help stabilize the markets. The revenue is greatly needed and would be garnered from those who most afford to pay it.

The transaction tax is a win \ win \ win solution.

[david]

I think I'm working with a different definition of speculation -- I think of it as the beauty pagent, and I don't see why "far from it" is an answer to "is all speculation bad?" Is most speculation good because it drives prices to their honest point? Cause that's not speculation by my definition, but I may be just whistling in the dark.

[BJ Feng]

Shareholders don't have enough control over management pay structures. It's getting better, but it's still difficult to remove crony directors. Activist blocs that try to get companies to adopt social programs that have nothing to do with the business at hand give pro-management groups an excuse to limit shareholder power.

Yet another money grab by liberals? When will it stop? Speculation is punished by loses, as we are witnessing in the financial sector. These companies won't be speculating anytime soon, just as the dot.com bust enforced caution. Yet for the left, it seems that any type of loses are just not allowed. What gives? There have been booms and busts for all of recorded human history, modern booms and busts are much more sanguine, not worse. Let those who stretched take their loses and lumps, the memory of the pain is all that's needed.

[James]

Stop the subsidies.

Roll back the Bush tax cuts.

The big trading houses will use the 'dark pool' exchanges to avoid the transaction tax.

[don]

Executive pay is a big problem, and taxpayers are picking up much of the tab. The risks it encourages are lop-sided. How could we make Cayne or O'Neal pay for the losses their strategies imposed? Is Thain any smarter? What does he know that would make him worth his compensation? There just doesn't seem to be any way to prevent the 'lop' without some very serious regulation.
Speculation may have a bad side, but bad speculators pay the price. The transaction tax will merely move trading offshore, as Fred notes. Speculation and trading are not activities that should be discouraged. If we thin markets down, there may be very high prices to be paid when the next problem hits markets. The income tax on very high incomes is a better idea, but the tax would need to be structurted to avoid a similar problem (expatriation of highly-paid executives and traders.) Better yet, tax something that more clearly should be discouraged, like gasoline consumption.

[libertas]

Even a small transaction tax would slow down the wild computer-driven trading that distorts the stock market, without significant impact on investors. Badly needed.

[Sean]

Right said Fred.

[Stephen Heyer]

Bruce Wilder: “Since the problem is overpaid executives and fund managers, bringing back the 70% and 95% income tax brackets would seem more directly to the point.”

Excellent point, but Bruce is pushing uphill against vastly powerful, entrenched interests who have largely captured the political process and media.

Not gunna happen short of a near revolution and the peasants are far too brain-washed and cowered for that to be a threat.

[Stephen Heyer]

BJ Feng: “Yet another money grab by liberals? When will it stop? Speculation is punished by loses, as we are witnessing in the financial sector.”

Sorry, rubbish.

When top executives can loot enough in a single year to set themselves up for life (and buy off a bunch of politicians) there is no punishment! In fact, the economically sensible thing to do is set things up so that you get a few years clear looting, then depart with your fortune.

The loss is entirely transferred to shareholders, employers and innocent bystanders.

[BJ Feng]

Yes, the problem is that great years are rewarded, but so are terrible years. Retirement packages aren't needed, for extraordinary service, a gold watch and the bonuses of years past should be enough. Certain companies like Oracle give ridiculous bonuses (Larry Ellison), but fortunately such theft seems to be on the decline. Any severance bonus should have to be approved by shareholders, and I don't mind requiring all incentive packages to be approved as well. That would eliminate the goalpost moving we see today.

Another tier of 39.6% for capital gains over $10 million indexed for inflation I could support, but the income tax tier brackets should be raised as well to help out the middle and upper middle classes (raise the minimum income needed to get you into the top tax brackets).

The transaction tax is a very poor proposal, there are much better ones available.

[Cyrille]

A 0.25% transaction tax would do next to no harm to shareholders.
It's to frenetic share traders that it would do something.

As a shareholder, I'd sure want that to be in place. Everywhere.

[a]

Well, I'm not sure a transaction tax will take a big hunk out of profits from Wall Street in any direct fashion. That is, a 25 bips tax on stock transactions will not mean 25 bips less in revenue for the firm handling the transaction.

What is will do is raise the effective bid-ask spread, thereby decreasing the opportunities for arbitrage and the number of transactions, thus decreasing profit at IBs.

That's if the system is watertight. But I imagine it won't be, and the system will be avoided, either by trading in London (it doesn't matter where electronic exchanges are physically located) or by trading on derivative stock-lookalikes, which I presume wouldn't be taxed.

[hari]

US Treasury should do as they do here, in EU, all such transactions carry a VAT (tax).

Make the playing field more transparent for speculators.

[Sam]

Hari. The EU does not apply a VAT to financial transactions. The financial sector is VAT exempt (principally because they haven't worked out how to tax it). This means that they can't recover VAT on their inputs (so the treasury gets something) but don't charge VAT on their outputs.

[reason]

Sam - are you sure. I suspect that there is VAT on Services provided (i.e. on brokers commission), but buying and selling securities doesn't have any Value Added, so it can't have any Value Added Tax.

[save_the_rustbelt]

"Why not simply increase personal income tax - back to the old days where marginal tax rates went as high as 92 cents in the dollar."

Well maybe not, because the financial markets would move to Hong Kong. Wall Street would be reduced to a large computer center for trades made by expat financial executives.

Slowing down speculation is a good idea, but the method to do so must not cramp the markets unduly.

[Robinia]

There are relatively few real bounds to the increasing number and speed of financial transactions, nor of the outmigration of financial services to the lowest-cost location. In the theoretical construction of this, the volume of transactions possible at the cheapest (tax-free) price can be assumed to be run on photovoltaic computers operating at the speed of light on ships in international waters, connected to investors via satellite. The race to the bottom will ultimately, I suppose, bring us to that (or perhaps the financial services/market locations will be in the Cayman Islands or Luxembourg).

A tax on transactions would be the way that you would impose a bit of friction on this. But, it would have to be a world-wide tax, or evasion would set in. The risk in the ever-escalating speed and volume of transactions is that increased sensitivity to emerging trend-- necessary for investors to cope as the speed and volume increases dramatically-- results in a feedback loop that increases volatility and turbulence, to the great detriment of investors with limited capital. Eventually, you would postulate that markets would operate at warp speed, but only a very few players would have funds to invest.

To my way of thinking, the best way of controlling this is not to postulate an uber-lord (government) that applies friction, brakes (taxes) to keep the speed down. It is, rather, to encourage investors to seek something beyond just maximum percentage return. As soon as a triple-bottom-line approach is applied by an investor, the need to balance more than one end-variable (money return) slows the pace. I don't think it is impossible to get investors to be interested in the social and environmental effects of their investing. It is actually far less boring than financial market trends operating at high speed. There just are not well-developed intermediary institutions using this approach. As far as governmental involvement... perhaps not all capital gains should be taxed identically? Ah, but, that would be industrial policy. Which, in a world of global climate change, does not really seem like it should be unspeakable.

[Already Overtaxed]

How exactly is this transaction tax going to raise revenue when you will drive away most of the transactions that occur on wallstreet? If you drive out the "speculators" then all you accomplish is trading moving offshore, which means all the short term cap gains these "speculators" made go overseas and not to the US. The volume in the stock market will plummet which means you'll put the CBOE and CME out of business along with several brokerage houses. The bid/ask spreads on stocks will be HUGE meaning there will be no real price discovery since there will be very little volume. The expense ratio on mutual funds will be astronomical......

So can somebody who actually understands how the stock market works explain to me how this is actually a good idea?

[No FTT]

The author is spewing this nonsense all over the net. There were only 15 countries with a transaction tax and most of them recently have lowered or done away with it. The transaction tax was used in the US between 1914 and 1966, during the worst financial collapse possible. Great idea, Baker. Bring back something that does not work. How about a $0.25 tax on every word you write?

[Massimo GIANNINI]

Let's read again about Tobin Tax here as I also proposed it. I believe that to the extent that markets have not efficiently allocated resources and managed risks there is scope to cut marginal speculative investments with a tax similar to the one Tobin proposed. It could be pushed at G20 level. We can work out the details. Let's not listen just to one Nobel Prize or few economists depending on personal political agenda.

[I_Am_Main_Street]

I am absolutely shocked and outraged by this proposed tax on the poor that live on Main Street. I have read several blogs and articles on this transaction tax. Revenge against Wall Street my foot. Everyone knows that the rich are a minority and cannot possibly pay most of the taxes. Only the poor will pay this tax or certainly most of it.

Very clever way of the elites to propose this tax and make it look like revenge against Wall Street when Main Street will be paying nearly all of this tax for the wrong that Wall Street bankers have done. And it sounds like much of Main Street is actually falling for it. Bravo.

I am certain that I will not have enough to retire on. I work my fingers to the bone to save up scraps of money. With what little I have, I purchase a bit of stock or a mutual fund, and I need every cent invested and working for me. Without the compounding because of paying this tax upfront, this tax will cost me at least many tens of thousands over a lifetime. A miniscule 0.25 percent upfront tax my foot. Without the compounding factor, I will earn several percentage points less by the time I am too sick and old to work.

I cannot believe that I am being singled out to pay for something that I did not remotely have anything to do with. I am one of the poor. I am not Wall Street. I am not the banker that made all of those foolish, risky loans. I did not accept the responsibility of taking a huge risk and then default on my mortgage. We the non-elites own most of the stock market, not Wall Street and the rich, as they are the minority. Half of all households own stock. As much as $200 billion in supposed tax revenue divided by 50 million households means we are expected to each pay an average of $4,000 each year? Why do so many of the elites hate Main Street so much? Is it because the poor are gullible and fall for such proposed lies and schemes?

Wall Street banks and the mortgage defaulters are being bailed out, are going unpunished for their recklessness, get to keep millions in bonuses, and actually are receiving special tax treatment, but poor people like me will be the ones to pay for what they have done.

It sounds like those that are guilty of these crimes are those that are just too happy proposing this tax and are shirking their responsibility for the wrong that they have done. They obviously have a substantial pension to look forward to or are already wealthy, trust fund babies. Good for them.