Here's an Idea -- Reduce the Deficit By Taxing Securities Trades
The European Union has dithered in solving its sovereign-debt crisis, but it is leading the way on another important economic front -- proposing a small tax on securities trades.
Resistance will be fierce. Some EU countries, such as the U.K., are already balking, with adoption of the plan requiring support from all 27 member states. U.S. Treasury chief Tim Geithner also has come out against a so-called financial transaction tax, while large financial firms are, unsurprisingly, already trying to kill the idea dead. Still, it's a bold move.
If the plan is approved, starting in 2014 all banks, brokerage firms, insurance companies, hedge and pension funds, and other financial players doing business in the EU -- and anyone who trades securities there, it's worth noting -- would pay a 0.1 percent tax on stock and bond trades and a 0.01 percent tax on derivatives. (Debt issued by corporations and governments would be exempt from the tax.)
The EU wants to introduce a FTT tax for two reasons. First, it would generate enormous public revenue -- roughly $78 billion a year, according to the EU. That would help offset the costly bank bailouts in the region following the 2008 financial crisis and help countries reduce their budget deficits. Second, the tax might help limit the kind of excessive financial speculation that weakened big banks during the meltdown, solidifying Europe's financial markets. European Commission President José Manuel Barroso added a third rationale in pushing for the tax in a speech on Wednesday:
It is a question of fairness. If our farmers, if our workers, if all the sectors of the economy from industry to agriculture to services, if they all pay a contribution to the society also the banking sector should make a contribution to the society.Broad support for "Tobin tax"And if we need â€"- because we need â€"- fiscal consolidation, if we need more revenues the question is where these revenues are coming from. Are we going to tax labor more? Are we going to tax consumption more? I think it is fair to tax financial activities that in some of our member states do not pay the proportionate contribution to the society.
Debate over the merits and impact of a tax on securities trading goes way back. In 1936, John Maynard Keynes proposed the idea in his seminal "The General Theory of Employment, Interest and Money," arguing that it could reduce dangerous speculation in equities. From 1914 to 1966, the U.S. imposed a "transfer" tax for issuing and trading both equities and debt. In the 1970s, economist James Tobin suggested levying a tax on currency trading as a way to stabilize exchange rates and reduce volatility in these markets.
The "Tobin tax," as it has come to be known, has been a hornet's nest ever since. Like the EU, advocates say such taxes are a good way to raise revenue. The U.K. generates some $4 billion a year in applying a 0.5 percent fee on stock trades -- not a huge amount, in other words, but at roughly 0.2 percent of its GDP not a pittance, either. By contrast, the U.S. could raise anywhere from $150 billion to $350 billion a year by putting a 0.5 percent tax on securities trading, according to some estimates.
Such fees raise trading costs, which can reduce the sort of liquidity essential in any well-functioning securities market. Yet such costs have plunged over the last three decades as trading has become computerized. As a result, even a 0.5 percent tax, let alone the far lower rates the EU wants to charge, would raise trading costs only back to their level in the 1980s, notes economist Dean Baker.
A FTT has attracted support from a number of prominent economists, including Baker; Nobel laureates Paul Krugman and Joseph Stiglitz; and Simon Johnson, former chief economist of the IMF. A range of notable corporate executives, investors and financial industry pros have also voiced support, such as Warren Buffett, Bill Gates, George Soros, former IBM chief Lou Gerstner Jr. and noted investment banker Felix Rohatyn. As John Bogle, founder of pension giant the Vanguard Group, has said in championing a FTT:
I love it. The financial institutions that control 75 percent of all stocks are tax free. Pension funds are tax free. Mutual funds are about half tax-deferred, but the other half is run by managers who pay no attention to taxes. So we've got these two giant industries basically operating without any frictional costs when they trade stocks back and forth-- and that helps explain why we've had this orgy of speculation. No question about that. So I like the idea of a transaction cost.The Swedish experiment
Critics of the tax contend it would do little to discourage the kinds of activities that worsened the financial crisis. It's not clear, for instance, what effect the EU's plan would have on credit default swaps. More significantly, and as European officials acknowledged in announcing the FTT proposal, a trading tax would almost certainly fail unless it's applied broadly around the world. Without such coordination, trading is likely to migrate to low-tax countries.
In 1984, Sweden imposed a 0.5 percent tax on stock trading, doubling it two years later and later introducing a lighter tax on fixed-income securities. Investors fled. Within five years, the country had lost more than half its trading volume for stocks, as business migrated to the U.K. and other financial tax havens. Said Swedish finance minister Anders Borg recently in explaining why Sweden opposes a FTT:
"Basically, most of our derivative and bond trading went to London during the years we had a financial transaction tax, so if you don't get a solution that is universal, it is very likely to be detrimental for European financial markets."In principle, though, there is no reason why the U.S., EU and other countries with large financial sectors couldn't agree on such a tax. Such global coordination is common on other issues, such as cracking down on tax-avoidance and coordinating efforts to improve transparency in tax havens.
A potentially larger problem, one that's harder to predict, is rooted in the financial industry's time-tested ability to adapt to new costs and regulations. The FTT could work for a few years, in other words, but gradually lose effectiveness as financial firms adjust their pricing and capital flows.
That may not be a bad thing, of course. An FTT has much to recommend it as a way for countries to generate revenue and reduce their deficits. And ultimately, as Barroso says, it's a matter of fairness.
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