The idea of imposing a small tax on financial transactions is gaining popularity around the world. It’s even got a catchy nickname: the Robin Hood tax.
The motivations to impose a financial transactions tax are one part Occupy Wall Street and one part Willy Sutton. Some see it as a way of penalize bankers, or at least correcting excesses of “speculators.”
Others are attracted to imposing a tax on financial transactions because, as Sutton used to say when asked why he robbed banks, “that’s where the money is.”
Let’s hope this idea never makes it into actual public policy. The Robin Hood tax is so deeply flawed that it is unlikely to raise much revenue or fix the financial system.
The idea of a financial transaction tax is not new. It goes back at least to economist John Maynard Keynes, who argued for a securities transaction tax in his General Theory of Employment Interest and Money. Keynes thought the tax would reduce financial speculation, which he saw as destabilizing markets and economies.
Another version of the idea was proposed by another economist, James Tobin, who wanted to impose a tax on currency exchanges in order to damp volatility in international exchange rates. Tobin mistakenly believed that much of the volatility was caused by speculators.
In truth, most foreign currency trading is conducted by businesses to hedge against exposure to changes in exchange rates. Periods of increased volatility in exchange rates tend to be caused by government policy — and the reactions of market participants attempting to hedge risk — rather than the activity of pure speculators.
More recently, the idea was revived in the wake of the financial crisis. People like New York Times columnist Paul Krugman urged a financial transaction cost in order to curb the activities of speculators and financial “hyper activity.” Krugman described much of the activity of financial markets as “socially useless.”
The latest push for a financial transaction tax comes from politicians who see it as a way to raise revenues. Last month Congressman Peter DeFazio of Oregon and Senator Tom Harkin of Iowa, both Democrats, proposed a financial transaction tax that would impose a $3 tax for every $10,000 in transactions.
Other proposals, including those from the nurses’ union, call for a tax of $50 per $10,000. The European Commission in Brussels has said it would like to put a $10 per $10,000 financial transaction in place. French President Nicolas Sarkozy and German Chancellor Angela Merkel have endorsed the idea.
But these taxes are unlikely to raise anywhere near as much money as the politicians believe — and may increase systemic risk for global finance.
The total nominal volume of financial transactions around the globe is 73.5 times higher than nominal world GDP. This immense sum is one of the things that draws politicians like bears to a trout stream. All that money swimming past; they want to put their claws into it.
But notice one implication of the size of financial transaction to total GDP. Much of this is necessarily beyond the reach of taxes. If a tax were imposed that attempted to collect every dollar of financial transactions, it would be impossible. Remember, more is transacted than is produced. What’s more, the financial transactions would just cease to happen altogether at a 100 percent tax rate.
Financial transactions are very likely highly elastic to changes in taxes. Many transactions, in fact, are driven to minimize current tax implications. If you change the tax code to increase taxes, the participants in financial markets will change their behavior, but not necessarily in ways that benefit society.
One example of socially malignant adjustments to a financial transaction tax could be in the concentration of risk in market makers. If conducting transactions is taxed, market makers will seek to conduct fewer transactions. In order to continue to service their customer transactions, however, they will have to retain larger positions in assets their customers are likely to buy. This means they will build up more risk internally and be more susceptible to failure in the event of a sudden market downturn.
Financial transactions will also tend to become more synthetic, more like the kind of half-imaginary collateralized debt obligations constructed just before the collapse of the mortgage market. Because the construction of a synthetic CDO does not involve actually purchasing mortgage assets — merely indexing a new financial asset to an existing group of mortgage assets — it would receive favorable tax treatment. So the wizards of Wall Street would sell synthetic everything — synthetic equities, bonds, futures, options, commodities. This would make financial markets less transparent and financial institutions more vulnerable to failure.
Because larger institutions are better able to handle increased tax overhead as well as find ways around conducting transactions by internalizing trading, it’s very likely the financial transaction tax would lead to increased consolidation in the financial sector. So the Too Big To Fail banks will get bigger as they swallow up the banks that still operate on a human scale.
Another problem is there is an issue of international fairness when it comes to financial transaction taxes. Let’s say we get around the very real problem of trading through tax havens — somehow, although no one has figured out how this would be possible. So now we have financial transaction taxes everywhere trading occurs.
But it turns out that financial transactions are very concentrated.
Most of the taxes would be charged on trading done in Hong Kong, London, Frankfurt and New York. Unless a supranational tax authority were created, the governments of Hong Kong, the UK, Germany and the United States would reap most of the revenue from these transactions.
But the taxpayers would not be confined to people and institutions based on those countries. Italian companies seeking to hedge their currency risk, for example, would find themselves taxed by the UK and Germany. Does Italy really think transferring wealth to the UK and Germany is a good idea?
In short, the Robin Hood tax probably wouldn’t result in much revenue, and most of it would go to the world’s wealthiest countries despite some of it coming from the most distressed. It would lead to increased consolidation, increased risk taking and increased systemic risk in the financial sector.
Robin Hood, you may recall, met his end when he went to his cousin for medical treatment. She doesn’t just bleed him — not an uncommon treatment at the time. She overbleeds him, and Robin Hood dies.
So maybe this is a Robin Hood tax after all, something that will kill the thing it promises to fix.
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