A poor excuse to rob from the rich

2nd February, 2013

A financial transaction tax would at best be irrelevant to financial stability

‘The eurozone’s biggest economies would raise €30bn-€35bn from their planned levy on financial transactions, according to an expansive European Commission proposal that ensnares trades executed in London, New York or Hong Kong.’
Financial Times, January 30

That’s going to spoil your day. You’re always grumbling about new taxes.

Well, it’s no fun paying taxes. But of course, it is very nice having schools, a police force and a health service. So the question is whether this is a good tax or not.

The Robin Hood Tax campaign claims such taxes could raise hundreds of billions of pounds, fight poverty and won’t affect the ordinary public.

Really? If you believe that I have a very nice bridge you may be interested in buying.

Sarcasm is unbecoming, especially in an economist. I expect you’re going to tell me that the tax will be simply avoided?

Well, of course the tax will be somewhat avoided. All taxes are somewhat avoided. There’s even evidence sharp reductions in inheritance tax temporarily reduce the death rate, as people wait for the tax to fall before they expire. Zero tax avoidance, then, is an unfair benchmark to apply to any tax. Incompetently designed transaction taxes are easy to avoid – the poster-child of how not to do this is Sweden, for much of the 1980s. Several European countries – notably Germany – have scrapped their financial transaction taxes. But it is possible to collect revenues through determined FTTs – and ironically, given British opposition to this proposal, the world’s most successful FTT is perhaps the UK’s stamp duty reserve tax, a transaction levy on trading shares. It’s still called that because back in the day people used to stamp things.

And the stamp duty has clearly failed to extinguish share trading in the City.

But it has helped fuel the market for derivatives contracts, which don’t attract the same tax. And banks are exempt from stamp duty, even if they’re trading for their own profit. As a result, most trading in London is exempt, and the International Monetary Fund argued that by promoting trade in share-substitutes, the tax increases “financial leverage and risk”. But it’s certainly true that it is possible to levy an FTT and raise some revenue without causing the tax base to evaporate completely. But I am wondering why anyone would want to.

To reduce volatility in the financial system and to make bankers pay for the mess they’ve caused. And to end poverty.

I support your goal, but it would reflect better on development charities if they argued aid costs money but is worth it. As for reducing volatility in the financial system, that’s not clear. Let’s assume that an FTT neither drove transactions overseas nor created side-markets; it would then reduce the volume of transactions.

And thereby reduce volatility.

How? It will reduce liquidity, which in most theoretical models and most empirical studies increases short-term volatility. Admittedly that’s probably manageable. It will encourage longer-term holding of shares, which in principle increases short-term pressures on companies: locked-in investors must worry about dividends today because they can’t sell their shares purely on the basis of a company’s long-term prospects. With a small tax the effect will be tiny, but it’s still an effect in the wrong direction. The FTT should reduce flash trading by computers, which might be a good thing, although flash trading is not a European vice now. But flash trading needs direct regulatory attention – the problem at the moment seems to be quote-stuffing, in which no transaction takes place at all.

Did you not notice the gigantic financial crisis?

The crisis was the result of complex mortgage-backed assets, insurance companies writing suicidal credit default swaps and highly leveraged banks – and nothing to do with short-term share trading. The exception is the overnight repurchase market, which suffered the equivalent of bank runs and involves short-term trading. But the repo market is excluded from the new European Commission proposal. So the FTT is at best irrelevant to financial stability.

But surely you’re not saying we shouldn’t tax banks and bankers?

Of course we should. I’m with the IMF on this: the FTT is feasible but we have better options, including value added tax on financial services or taxing balance-sheet debt to reduce leverage. To invert an old saying, the FTT is the best possible tax on banks – apart from all the other ones that have been tried.

Also published at ft.com.

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