The Overselling of Financial Transaction Taxes
CAMBRIDGE – However November’s presidential election in the United
States turns out, one proposal that will likely live on is the
introduction of a financial transaction tax (FTT). While by no means a
crazy idea, an FTT is hardly the panacea that its hard-left advocates
hold it out to be. It is certainly a poor substitute for deeper tax
reform aimed at making the system simpler, more transparent, and more
progressive.
As
American society ages and domestic inequality worsens, and assuming
that interest rates on the national debt eventually rise, taxes will
need to go up, urgently on the wealthy but some day on the middle class.
There is no magic wand, and the politically expedient idea of a “Robin
Hood” tax on trading is being badly oversold.
True,
a number of advanced countries already use FTTs of one sort or another.
The United Kingdom has had a “stamp tax” on stock sales for centuries,
and the US had one from 1914 to 1964. The European Union has a
controversial plan on the drawing boards that would tax a much broader
array of transactions.
The
presidential campaign of US Senator Bernie Sanders, which dominates the
intellectual debate in the Democratic Party, has argued for a
broad-based tax covering stocks, bonds, and derivatives (which include a
vast array of more complex instruments such as options and swaps). The
claim is that such a tax will help repress the forces that led to the
financial crisis, raise a surreal amount of revenue to pay for
progressive causes, and barely impact middle-class taxpayers.
So
far, Hillary Clinton, the likely Democratic nominee, has embraced a
narrower version that would target mainly high-speed traders, who
account for a large percentage of all stock transactions, and whose
contribution to social welfare is open to question. Clinton, however,
may well shift closer to Sanders’s position over time, as she has on
other issues. Donald Trump, the presumptive Republican nominee, has not
yet articulated a coherent position on the topic, but his views often
come down remarkably close to those of Sanders.
The
idea of taxing financial transactions dates back to John Maynard Keynes
in the 1930s and was taken up by Yale professor and Nobel laureate
James Tobin (who, incidentally, was my undergraduate professor) in the
1970s. The idea, in Tobin’s words, was to “throw sand in the wheels” of
financial markets to slow them down and make them hew more closely to
economic fundamentals.
Unfortunately,
this rationale has not held up particularly well either in theory or in
practice. Particularly misguided is the idea that FTTs would have
significantly muted the buildup to the 2008 financial crisis. Centuries
of experience with financial crises, including in countries with FTTs,
strongly suggests otherwise.
What is really needed is better regulation of financial markets. The unwieldy and deeply imperfect 2010 Dodd Frank
legislation, with its thousands of pages of provisions, is a stopgap
measure; few serious people view it as a long-term solution. A far
better idea is to force financial firms to issue much more equity
(stock), as Stanford University’s Anat Admati has proposed.
The
more banks are forced to evaluate risks based on shareholder losses
rather than government bailouts, the safer the system will be. (On this
score, Boston University professor Laurence Kotlikoff’s more radical ideas
for taking leverage out of the financial system merit serious
attention, even if his own quixotic presidential campaign otherwise goes
unnoticed).
The
fundamental problem with FTTs is that they are distortionary; for
example, by driving down stock prices, they make raising capital more
expensive for firms. In the long run, this lowers labor productivity and
wage levels. True, all taxes are distorting, and the government has to
raise money somehow. Yet economists view FTTs as particularly
troublesome because they distort intermediate activity, which amplifies
their effects. A modest tax that is narrowly targeted, like the UK’s,
does not seem to cause much harm; but the revenue is modest.
To
get more revenue requires casting the net much wider. For this reason,
the Sanders plan covers derivative instruments that would circumvent the
FTT (for example, by allowing people to trade income streams on assets
without trading ownership). But extending the tax to derivatives is a
messy business, because their complexities make it difficult to define
precisely what should be taxed. And as the impact of the tax expands, it
becomes hard to know what the ultimate effects on the real economy will
be.
It is certainly difficult to determine whether the outsize revenue estimates of the Sanders campaign could be realized; many studies suggest otherwise.
The claim is that the US can collect more than five times the amount
the UK collects on its narrow tax – an amount equal to more than 10% of
revenue from personal income tax. The problem is that trading will
likely collapse in many areas, and many financial trades will be
executed in other countries. If economic growth is affected, eventually
other tax revenues will fall, and if government bonds are covered,
borrowing costs will rise.
The
US desperately needs comprehensive tax reform, ideally a progressive
tax on consumption. In any case, a properly designed FTT can be no more
than a small part of a much larger strategy, whether for reforming the
tax system or for regulating financial markets.
Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University.
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