The Tobin tax is back in fashion. Would it help?
We staggered back into NYC early this morning, cross-country road-trip completed. I'll write something soon about the important things I learned sitting in a small-to-mid-sized SUV (we had a Mercury Mariner, then traded it in at the Moline Hertz for a Hyundai Santa Fe) for up to 14 hours a day. But for now, the first headline to catch my attention after I awoke had to do with Adair Turner, the head of the UK's main financial regulator, proposing a global tax on financial transactions. The former Merrill Lynch vice chairman did this in a Q&A with Prospect Magazine that non-subscribers can only read the first few paragraphs of. The FT summed up the juicy bits:
Lord Turner appears worried about a return to “business as usual” in the banking sector, suggesting that new taxes may be necessary to curb excessive profits and pay in the financial sector.
“If you want to stop excessive pay in a swollen financial sector you have to reduce the size of that sector or apply special taxes to its pre-remuneration profit,” he says.
Lord Turner says higher capital requirements will be the FSA's main tool to eliminate excessive activity and profit, but that a tax on transactions on a global level may be an additional option.
This idea of a financial transaction tax is generally credited to the late Yale economist James Tobin, but it actually goes back farther than that. John Maynard Keynes suggested in his General Theory, U.S. Sen. Carter Glass pushed it in 1929, and it surely must have been in the air before then as well. More recently, Larry Summers briefly got interested in transaction taxes in the 1980s. And the Swedes actually implemented such a tax in 1984 but gave up in 1990 because it didn't raise much money and drove transactions abroad.
As somebody who doesn't believe that the nearly half-century-long trend toward lower transaction costs more-frequent trading and has left financial markets significantly more rational or efficient, I'm not unsympathetic to these efforts. But I really can't see how a global transactions tax would have prevented or even substantially altered the trajectory of the financial crisis of the past couple of years. The problem wasn't too-frequent trading, it was too-gullible (or too-greedy) buying of debt securities.
I think Adair Turner agrees with this—he says higher capital requirements are his top priority, after all. But then why even bring up the transaction tax? Maybe because he knew it would generate lots of headlines in the UK and European press.
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I have never managed to understand how anyone in his/her right mind can think a "Tobin tax" on liquid, core markets can do anything else than reduce global efficiency massively. Why not cut everybody's left hand (the impure one, the one that touches toilet paper), while we're at it?
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"But I really can't see how a global transactions tax would have prevented or even substantially altered the trajectory of the financial crisis of the past couple of years. The problem wasn't too-frequent trading, it was too-gullible (or too-greedy) buying of debt securities."
I really don't understand this fatalistic throwing up of one's hands whenever there is any attempt to regulate market fundamentalism. The financial crisis of the past couple of years was exacerbated by the strong positive feedback in the market both on the upside and the downside. A Tobin tax would dampen the feedback and make markets more stable. It may not be sufficient by itself, but it would be a useful component of an overall regulatory regime.
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Glad to hear you got back home safely.
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A generalized Tobin tax was always an excellent idea. Of course, it would mean a cut in traders' pay and a reduction in supernormal profits at financial firms - so it is bound to be fiercely opposed by Wall Street and the City. It would help reduce the fiscal deficit too - although that, by itself, can never be the justification.
One argument for a transaction tax that it might help dampen positive feedback loops. For this other measures are needed as well. A small transaction tax along with a whole package of other measures are sorely needed.
"But I really can't see how a global transactions tax would have prevented or even substantially altered the trajectory of the financial crisis of the past couple of years. The problem wasn't too-frequent trading, it was too-gullible (or too-greedy) buying of debt securities."
This isn't the only sort of financial crisis that can happen. In SE Asia, in the 90's for example, a transaction tax might have discouraged "hot money" from flowing in, and later rushing out.
The argument that financial markets are efficient and a transaction tax would make them inefficient is far too absurd to be taken seriously. It needs to be pointed out, though, that the speed with which a market reacts to new 'information' is not a measure of efficiency - neither economic efficiency nor informational efficiency.
"Such a tax would have the beneficial effects of curbing instability introduced by speculation, reducing the diversion of resources into the financial sector of the economy, and lengthening the horizons of corporate managers. The efficiency benefits derived from curbing speculation are likely to exceed any costs of reduced liquidity or increased costs of capital that come from taxing financial transactions more heavily."
---Summers and Summers -
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Oh those giants of economic thought - regulating out positive feedback in financial markets is the same as regulating waves in ocean.
Replace corporate income tax with a hike in personal income tax or capital gains tax and financial markets will shrink in both size and significance, taking down compensation levels along the way.
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@qqi239: That's an interesting claim. Care to elaborate?
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@pneogy
Positive feedback is a built-in natural property of all assets markets - in the same sense as waves are natural property of ocean water. We cannot regulate out natural properties - we can only hope to reduce the effect.
Fortunately, it is very easy in the case of modern capital markets. All we have to do is to replace the corporate income tax with less destructive tax - and these markets will shrink, because it will be less attractive for corporations both to go public and to finance unreasonable expansions.
Unfortunately, our economic "thinkers" are unable to add two and two together - say all readers of this blog are well aware that these said "thinkers" do believe in effective markets theory even now.
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[...] via Justin Fox, I learn that the new head of the FSA brought up the subject during an interview with Prospect [...]
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[...] Related Topics: bailouts, banks, regulation Economist Willem Buiter has a reaction similar to mine to UK financial regulator Adair Turner's suggestion that maybe we need a "Tobin tax" on financial [...]
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[...] –Lord Adair Turner, Britain’s chief financial regulator. (http://curiouscapitalist.blogs.time.com/2009/08/27/the-tobin-tax-is-back-in-fashion-would-it-help/) [...]
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[...] –Lord Adair Turner, Britain’s chief financial regulator. (http://curiouscapitalist.blogs.time.com/2009/08/27/the-tobin-tax-is-back-in-fashion-would-it-help/) [...]
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[...] –Lord Adair Turner, Britain’s chief financial regulator. (http://curiouscapitalist.blogs.time.com/2009/08/27/the-tobin-tax-is-back-in-fashion-would-it-help/) [...]
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[...] for DeFazio's proposal; she noted that financial regulators in the United Kingdom and elsewhere have spoken favorably of transaction taxes (also known as "Tobin" [...]
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[...] for DeFazio's proposal; she noted that financial regulators in the United Kingdom and elsewhere have spoken favorably of transaction taxes (also known as "Tobin" taxes). But even if House [...]
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