There has been increasing discussion in the global financial markets about imposing a transaction tax on all stock, bond, futures, options, foreign exchange, and derivatives trades. Several leading European political figures in countries including France and Germany have proposed some form of tax with money going toward either the UN Millenium Fund (to aide developing nations with poverty, hunger, disease, etc) or to be kept within the countries in which it is collected. The idea is not a new one but this is the first time I’ve seen any momentum (albeit slight) and given the global financial stress still hanging over the markets it’s probably an opportune time to begin discussions anew. I support this idea in general but the proposals on the table are poorly thought out and have no chance of being passed. They are a good place to start and there are good reasons to pursue this idea.

So what’s this all about? Simple – you buy a car for $20,000 you pay a sales tax; you buy 200 shares of IBM for $20,000 you pay no tax. A financial transaction tax (FTT) or “Tobin Tax” (named for a guy who suggested it in the 70’s) would introduce a relatively small tax on ALL trades done in the financial markets. The proposals range anywhere from a .25% FTT to a .005% FTT meaning a tax on your IBM trade from as high as $50 to as low as $1. Those who suggest a number of $50 really need to get their heads out of the sand – a tax at that level would seriously undermine global financial markets. At the lower end there is room to establish tax tiers based on market participation that would make economic sense without unduly disrupting markets by taxing critical liquidity providers out of business. I will elaborate on this idea later.

As always, there are pros and cons. The pros, at least those argued by supporters, are a reduction in irresponsible and socially useless speculation, a global banking industry taking greater responsibility for the financial recklessness that led to the market meltdown, and, if the funds are put toward developing countries, a source of revenue in an otherwise tight global economic climate. The cons, argued strongly by banking and business lobbies, are a reduction in trading volumes and liquidity, loss of jobs and a decline in Wall Street profits further exacerbating the economic crisis, harm to shareholders from lower earnings expectations, and a risk to global financial markets from a loss of investor confidence in general. In addition, the cons argue the tax would be easy to evade by moving operations offshore thereby leaving the negative effects intact without the benefits of higher tax revenues. Who’s right?

Well, they’re both right, naturally. When the tax is the highest the “benefits” are the greatest but the downside risks are unacceptable. At lower tax levels the benefits are smaller but the risks are smaller too. The question that needs to be answered is, what is the purpose of this tax? If we’re looking to punish the financial market and speculators then the FTT is a very poor choice of tools – it’s like carpet bombing in the age of smart bombs. Speculation is not inherently evil. Trading desks at major banks including Citibank, Bank of America, and Goldman Sachs facilitate tens of thousands of financial transactions each day for global customers. These desks make tens of millions of dollars from taking on and managing the risk their customers are looking to reduce through hedging. If we’re not happy with the profit these banks are making then we can easily introduce a 50% windfall profits tax on short-term capital gains from trading at any company whose primary source of income derives from financial markets. That will never happen but it’s certainly more effective and targets the major complaints without inflicting harmful taxes on the innocent market participants. I’m completely opposed to such a tax but it’s a smart bomb.

If the purpose of introducing a FTT, however, is to simply tap a new source of revenue, in a progressive manner, and to address national debt concerns without doing irreparable harm to global capital markets, then introduction of a very low FTT makes sense with one caveat – it must be introduced simultaneously in all major financial markets around the world. Without cooperation trading will quickly move to exchanges located in countries without such taxes and the balance will tilt toward the negative impacts of such a tax in other countries. International cooperation is a must and that makes the imposition of such a tax extremely unlikely. But at a time when all countries are suffering from the global economic slowdown any source of additional revenue should be welcome so now is the time to act.

A proposal for a .005% FTT has been floated jointly by the French and German foreign ministers who estimate revenues at nearly $50 billion per year. I cannot say how they arrived at their numbers but by my rough calculations they are extremely low. Nevertheless, my greatest concern with their approach is the straight line application of the FTT to all transactions regardless of the participant. This makes no sense and risks seriously destabilizing markets. I hope that if/when this idea is examined in a serious light the architects will consider that you cannot tax extremely active trading desks, floor specialists, and market makers, who spend all day providing desperately needed liquidity to the markets that enable our mutual funds, corporations, pension funds, etc to manage their portfolios effectively (hopefully!), at the same FTT rate as the customers themselves. We want everyone impacted to the point where they may say “ouch” but not to the point where they are forced out of business. You and I would probably not be thrilled but we wouldn’t lose any sleep if we had to pay a $20 tax when we invested $20,000 in the stock market. But for the stock specialist, paying even $1 each time they traded $20,000 worth of stock could put him out of business since he may do hundreds of such trades every day. It needs to make sense. There is a logical balance that can be found. We don’t want to throw out the moneychangers — just charge them rent.

The FTT is tricky but I see great potential without great sacrifice. Keep an eye on this one.

Tags: Financial Transaction Tax, FTT, Tobin tax

This entry was posted on Thursday, September 24th, 2009 at 4:30 pm and is filed under News/Politics. You can follow any responses to this entry through the RSS 2.0 feed.