The Price of Speculation: A Financial Transaction Tax
Here's some positive news out of Europe for a change: German Chancellor Angela Merkel and French President Nicolas Sarkozy called yesterday for a tax on financial trades. This isn't a new idea -- European leaders have pushed it before -- but a financial transaction tax (FTT) is a good idea that deserves to be taken seriously on both revenue-hungry sides of the Atlantic.
Different countries have taxed trading at different times in the past. John Maynard Keynes was an early advocate of an FTT, arguing in 1936 that it would be way to rein in the excesses and instability of Wall Street and "mitigate the predominance of speculation over enterprise in the United States."
Most countries got rid of their FTT's as global competition among stock exchanges increased and the finance industry gained more political clout. But a small tax on trades is still imposed in some places, including the London stock exchange.
An FTT makes sense today in the United States, and Europe, for several reasons. For starters, it could help achieve the goal that originally drew Keynes to the idea, namely reduce volatility in the market. The huge gyrations and "flash crashes" that we have seen in recent times -- and in the past few weeks in particular -- partly reflect the fact that there are virtually no costs to constantly jumping in and out of the market. (A big reason for such low costs is the computerizaton of trading.) Investors seeking a tiny edge can scare the daylights out of the rest of us and, in the worse case, trigger chain reactions that do real damage to the economy.
Imposing a small tax on trading wouldn't affect investors who hold stocks for long periods, but it could cause speculators to trade less frequently and thus dampen volatility. That would be a good thing. Indeed, an FTT has more support on Wall Street than you'd think, because it would make the life of value investors easier while penalizing the cowboys of the trading world. Among others, John Bogle, the legendary founder of Vanguard, is for an FTT.
Just as good would be the new tax revenue from such a tax. A 2008 study by the Center for Economic and Policy Research estimated that an FTT could raise $100 billion a year in the United States even as trading volumes decline. (A few years earlier, the Congressional Research Service found that a 0.5 percent FTT -- similar to the UK rate -- could raise $65 billion.)
Whatever the exact amount, we're talking about the potential for some serious money here -- probably more than $750 billion over the next decade. To be sure, some of the costs of this tax will be passed along to ordinary investors, but the brunt will hit deep pocketed entities like hedge funds that have a business model built around frequent trading.
An FTT has strong support among many economists who see it as an economically efficient way to raise revenues. A 2009 letter in favor of including an FTT in financial reform, signed by 200 economists, academics, and business leaders, said that even a tiny tax would help raise trading costs back to the pre-computerization levels of a few decades ago and reduce transactions that have "little economic or social value."
Legislation to enact an FTT was introduced in Congress in 2009 by Representative Peter DeFazio. It attracted a few dozen co-sponsors but ultimately went nowhere, in part because the Obama Administration opposed a FTT.
One reason that DeFazio's plan generated such a lukewarm response -- besides the huge campaign donations that Wall Street gives to Democrats -- is that the bill would have raised the cost of trading in the United States alone. “I believe that the transaction tax still has a great deal of merit,” Speaker Nancy Pelosi said. “The concern that many of us or others have had is that it will send, it will send transactions overseas."
While there is no evidence that the UK's FTT tax has hurt the trading business in London -- last I checked, that city still had hordes of traders -- competiveness concerns should be addressed in future proposals. Pelosi's suggestion back in 2009 was to push for a global FTT and Prime Minister Gordon Brown pushed this idea at G20 meeting that year, calling for coordinated action to enact an FTT.
Now's a good moment to try again to get that ball rolling given mounting revenue woes worldwide. So kudos to Markel and Sarkozy for taking a first step here.
