By Robert Hahn and Peter Passell
Would a tiny tax on securities turnover corral the frightening volatility of global financial markets and raise a ton of revenue painlessly in the process? Or would it undermine innovation and drive trading to friendlier climes? There will soon be no need to speculate (pun intended). Eleven EU countries are about to embark on a large-scale experiment in what some commentators label the “Robin Hood tax,” and others see as a self-defeating exercise in revenge against the wonderful folks who gave us the financial meltdown of 2008.
Back up for a moment. Financial transactions taxes (FTTs) are nothing new; Britain has been levying a “stamp duty” on some securities sales since the 17th century. And myriad other tax jurisdictions around the world have used FTTs in one form or another as a revenue source in the interim.
Economists have historically been disinclined to give such taxes the benefit of the doubt because they tend to undermine the efficiency of markets by driving a financial wedge between buyer and seller. John Maynard Keynes added a twist to the argument in 1936, arguing that sometimes that wedge is a good thing – that an FTT would curb the sort of speculation that led to the stock market crash in 1929. But Keynes' intellectual reach was greater than his influence on public policy. And his novel rationale only built a serious following after the 1972 endorsement by the soon-to-be-Nobel Prize Winner James Tobin, who proposed an FTT as a means of reducing volatility in foreign exchange markets.
Thereafter, the idea gained intellectual currency (we can’t help ourselves); Larry Summers, then the wunderkind of academic economics, sung its praises in an article published in 1989. But the FTT might have remained only fodder for debate over drinks at the faculty club were it not for the financial follies of 2008 and Europe’s turn toward fiscal austerity as the cure for what ailed the EU.
FTTs and the Real World
The financial services industry, which has presided over what seems to be a perpetual explosion in trading volume, has generally been able to dispatch proposals for broad-based FTTs with a flick of a checkbook. But popular fury with the role of banking in the meltdown, combined with Europe’s urgent search for government revenue, opened the door.
Last month, the European Commission gave the green light to an FTT, assuring cross-border enforcement within the EU. Eleven EU members (which produce two-thirds of the union’s GDP) plan to implement broad-based taxes covering the exchange of stocks, bonds, mutual funds and derivatives -- but not new capital issues, trade in sovereign debt or most ordinary household/business financial transactions like credit cards and casualty insurance. The rates seem low (0.1% on securities, 0.01% on derivatives on both sides of the transaction); nonetheless, the FTT is expected to raise €30-35 billion annually.
Real Money at Play
No big deal, you say? Surely not for small investors taking a flyer on a few hundred shares of Vodafone. But it could alter the calculations of banks and funds that shuffle around billions of euros daily and multinational corporations that routinely hedge against changes in the prices of fuel and other commodities.
Moving transactions to New York or Hong Kong won’t, in theory, help law-abiding participants since the tax will apply “if any party to the transaction is established in the FTT-zone.” But even as we speak, corporate lawyers on six continents are dreaming of retirement on the Riviera as they search for ways to rework the terms of financial contracts or fiddle with the residences of the contracting parties in ways that escape the levy. And just how the tax will affect the volatility and liquidity of global markets in everything from stocks to oil to credit default swaps is anybody’s guess.
Results from number-crunching are scattered all over the place. Anna Pomeranets, an economist at the Bank of Canada, concludes that the research offers little comfort to those who believe that “throwing sand in the wheels” of the financial juggernaut (Tobin’s phrase) would reduce price volatility. But evidence that it would increase volatility or widen bid-ask spreads by noticeable amounts is pretty slender, too. Pomeranets also notes that, while the EU’s tax won’t be imposed on new issues, it could still raise the cost of capital a bit because traders would demand higher gross returns in anticipation of taxes they would pay when they recycle their portfolios.
A little perspective is probably in order. The anticipated yield from the FTT represents a very modest portion of the revenues of the financial services industries, let alone the non-financial corporations on the buy and sell side of affected transactions. Accordingly it is hard to imagine that taxes at the approved EU rates will change the behavior of markets very much. Nor could it conceivably change the distribution of income or wealth by more than a token percentage. Some very specialized services will be disproportionately affected – notably, high-frequency trading, which depends on inconceivably high volumes, and which the world managed to do without before the last decade.
Perhaps the real risk is that tax authorities will be tempted to lean more heavily on financial markets as a source of revenue in the future precisely because this FTT blends in so easily with the background noise. From little acorn mighty oaks sometimes grow. If you doubt it, take a gander at Europe’s value-added taxes.
Robert Hahn is director of economics and professor at Oxford's Smith School and a senior fellow at the Georgetown Center for Business and Public Policy. Peter Passell is a senior fellow at the Milken Institute and the editor of its quarterly economic policy journal, The Milken Institute Review. They co-foundedRegulation2point0.org, a web portal on economic regulation.