Now, Seriously: Financial Transaction Tax

Liberal-minded economists are usually skeptical of taxation: taxes distort markets and lead to the inefficient allocation of resources. However, some taxes are better than others, and financial transaction taxes, such as the Tobin Tax, are certainly in that category.

Now, the European Commission is getting serious about introducing a financial transaction tax. Their proposal: levy a tax of 0.1% on every financial securities transaction performed by a financial institution based in the EU. Their reasoning: First, the financial industry should pay its fair share for past government bailouts. The Commission expects such a tax to raise €57 billion in revenue. Second, a financial transactions tax would stabilize financial markets, as it discourages short-term speculation.

Moreover, one type of speculation, in particular, would be discouraged: high-frequency trading. In high-frequency trading, computers are programmed to buy and sell high quantities of financial securities at a very small profit margins. A tax rate of just 0.1% would take a large bite out of such small margins and make high-frequency trading unprofitable. Stephan Schulmeister from the Austrian Institute of Economic Research (WIFO) expects the tax would lower the volume of speculative trade by 70%.

One of the reasons economists like financial transaction taxes (FTT), such as the one proposed by the EC, is that they have have broad bases but low rates — which makes them less distorting than taxes that have narrow bases and high rates.

But there are also critics of financial transaction taxes, first of all the banks who make money on speculation. Beyond that, two main arguments are put forward against FTT.

First, some would argue that financial markets function to allocate capital efficiently, i.e. to the firms and countries that are the most productive. A tax on financial transaction would distort that function, by not allowing the market to send the right signals.

Second, a financial transaction tax in one country or one bloc of countries, for that matter, would just push traders to other financial centers where they could trade untaxed. Therefore, particularly countries with flourishing financial markets, such as the UK, are skeptical of the tax. “We’re only willing to introduce such a tax if all the other countries do the same”, they would argue. They may be right, but someone has to make the first step.  And it seems to me that the EU has enough market power to risk the venture. The EU proposal is interesting because the tax is levied not in the country the securities are traded but in the country of the person or institution who orders the transaction. Tax evasion, at least within the EU, would therefore be impossible.

When it comes to the first criticism, defenders of FTT would argue that the kind of speculative transactions the tax targets are precisely those that are not indicative of investment opportunities. On the contrary, practices like high-frequency trading represent the complete de-coupling of financial markets from economic realities. According to Schulmeister, the volume of financial transactions is 70 times the volume of trade in goods and services worldwide. These kind of transactions ought to be curbed, they say, because they destabilize financial markets and economies as a whole.

The European Commission is pushing and France and Germany seem to be in favor. When it comes to the UK, which most commentators expect to oppose a EU transaction tax, Stephan Schulmeister has a simple answer: “Wait until the next recession hits the country and the government won’t miss a chance to increase their revenue”. It seems to me we’ve never been closer to realizing what is an economically reasonable tax.