Syndicate content

Taxing financial transactions?

Asli Demirgüç-Kunt's picture

With federal budget deficits soaring all over the world, policy makers are looking at every opportunity to find new sources of revenue. After the bailouts of the financial sector and public backlash against announcements of large profits and bonuses by banks, a financial transactions tax appears to be a popular proposal both in the U.S. and abroad to "recoup" costs from the financial services industry. But is it really a good idea?

Following James Tobin’s original proposal, governments would place a small tax on financial transactions to discourage speculators (who trade frequently) without putting an undue burden on investors who buy for the long haul. Such a national transaction tax, at a rate of 0.1% to 0.25% of the value of the trade, would be levied on all financial transactions such as stock trades, but not on consumer transactions like credit cards. Advocates in the U.S. argue that it would raise $100 billion to $150 billion a year. Many economists – including prominent figures like Paul Krugman, Joseph Stiglitz, and Jeffrey Sachs – have backed the tax.

There's little disagreement that by picking up the bill of the bailout, taxpayers got a lousy deal in the financial meltdown. But is a levy on financial transactions likely to help pay for the cost and ensure that taxpayers are less likely to pay in the future? Unfortunately, in both cases the answer is likely 'no'.

One difficulty of taxing financial transactions is that funds can easily flow across borders and start trading elsewhere. For example Sweden tried a tax on stock and bond trades in 1980s, but abandoned it after Swedish investors circumvented the tax by trading abroad, resulting in a decline in domestic trading volumes. Implementing such a tax would require significant international coordination since all those who are taxed would seek to escape the tax by moving activity to another country. Despite the difficulties involved, coordinating such a tax might be feasible given recent worldwide action to restrict the movement of financial flows to tax havens and technological advances now available to tax authorities.

But even if the coordination problem could be overcome, another problem remains: the base of such a financial transaction tax is likely to be very elastic in response to the tax. In other words, even a very small tax may dramatically alter the way in which wholesale participants in financial markets behave. So even if it were possible to prevent flight to tax havens with the introduction of a transactions tax, the volume of transactions is likely to collapse, disappointing those who hoped to raise significant revenue through the tax. And since speculation is not easy to identify, such a tax will end up making it more costly to hedge risks as well.

Those advocating the tax as protection against future crises are not likely to find what they are looking for either. A transactions tax would have little effect in discouraging the activities of the credit default swap market or the market in securitized sub-prime mortgages, which have both been blamed for contributing to the recent crisis. It is also not obvious such a tax would reduce the volatility of asset prices; for example buyers in Britain's housing market have been required to pay a transaction tax on their purchases for years. We still need effective regulation and supervision to curb crises, taxes just can’t do that job.

Further Reading:

Patrick Honohan and Sean Yoder. 2011. "Financial Transactions Tax: Panacea, Threat, or Damp Squib?" World Bank Research Observer 26 (1): 138-161.

Comments

Submitted by Anonymous on
Taxes cannot replace regulation and supervision, but they can affect high volume trading which brings few benefits to the "real" economy A world wide tax of 0.1% would certainly stem some of the massive volumes of computer trading. That type of trading is purely done by large trading firms and banks, and it has been responsible for someof the most sickening, almost unexplained single day drops in market value. Computer trading presents significant risks to the markets and might in fact be partly cause for the volatility. I see no reason why that type of trading mainly executed by the large trading firms and banks could not be taxed. Stemming computer trading a bit in my view at least would have as many upsides than downsides, while in addition, it could generate significant revenues for governments who have almost all bailed out their financial sector to some extent. If indeed volumes should drop dramatically that would then also reduce the risk, a win-win in other words While hedging might become a bit more expensive, it might also have the beneficial effect of banks and traders taking a bit fewer risks. The current practice in computer trading is nothing else but gambling on both sides of the table, it has absolutely nothing to do with the health of the company that is being traded, the sector in which it may be operating, or the national economy as a whole. I see little benefit from it except for the froth it creates (and revenues for banks and trading firms). It seems only right that it be taxed since it in all likelihood the public purse will be sollicited again if (maybe when would be more appropriate) something goes wrong.

Submitted by Anonymous on
While there are some reasons why a failure to act collectively to impose a financial transactions tax might have some adverse consequences, it is pretty clear that imposing a transaction tax would improve the financial markets which are currently too highly affected by algorithmic and high frequency trading. Please take a look at the SEC's report on the flash crash of 2010, (http://www.sec.gov/news/studies/2010/marketevents-report.pdf) especially the pages on High Frequency Trading. The flash crash was caused by the interaction of a large trade overwhelming the market and algorithmic trading systems. A financial transaction tax would make the HFT un-economic -- while the tax would be minimal on any single trade, the algorithmic high speed 'arbitrage' trades would quickly go away since the taxes would be higher than the returns to the HFTs. "For the 6-business-day period of May 3 through May 10, these 17 HFT firms averaged 43.8% of total dollar volume on the public quoting markets. Their trading was divided between 51.5% liquidity-taking buys and sells (aggressive trading – generally taking bids and lifting offers) and 48.5% liquidity-providing buys and sells (passive trading – generally posting bids and offers)."

Submitted by Ryan on
Interested readers may also want to check out a recent article in the FT on the same topic, available here: http://blogs.ft.com/the-a-list/2011/09/29/a-tobin-tax-is-a-leap-in-the-wrong-direction/#axzz1ZLlzOFKz A short quote: "So the time is not ripe, but what of the principle? There is a Colbertian appeal to Tobin taxes. Why not take a tiny sliver off every financial trade? The golden goose will hardly notice and its hisses will be drowned out by the boos of the crowd baying for bankers’ blood. It seems likely to throw sand in the wheels of some potentially dangerous financial activity, notably high frequency trading, surely one of the dullest ways of making a living that mankind has so far devised. Yet you cannot take €50bn out of the economy without a significant economic impact. James Tobin distanced himself from those who wanted to adopt his tax as a disguised revenue raiser. Mr Barroso clearly sees it as an added tax, not a redistribution of the burden. And he has not offered a solution to the avoidance obstacle. If there is no parallel imposition in New York, the cost to Europe of displaced activity could be large."

Submitted by Hugues on
everybody seems to forget that Switzerland has such a tax, called stamp taxe but stamp or tobin call it whatever you want still as far as I know Switzerkand did not wait for international cooperation to set it and then has not lost it's status as an international financial center since it's been established. Why mention Sweden's stop and go and not other more successful experiences? ignorance or hidden agenda? both? by the way, like or not, extra taxes are on the way, yes they could slow growth, and maybe one day one will wonder if looking for growth at all prices, in particular trough leverage until it snaps, is the cause or the cure to our present difficulties.

Add new comment