One of the options being considered by Congress to fund jobs creation, reduce the federal deficit, and also to exert some control over financial markets is a tax on financial transactions. According to a Bloomberg report, seven House members are sponsoring legislation for a tax on financial transactions of more than $100,000. The proposed tax is 0.02 percent on swaps, futures and credit-default swaps and 0.25 percent on stock transactions. Transactions in options would be subject to the tax that applies to the underlying asset.
Arguments for a financial transactions tax
According to the lawmakers, the tax could potentially generate $150 billion a year in fiscal revenue. Half of that would be for reducing the federal deficit and the other half for funding jobs creation programs. Extending unemployment benefits and providing subsidies to help laid-off workers pay for health insurance could also be included in proposed legislation. According to a Wall Street Journal article, labor unions, especially the AFL-CIO, have proposed a financial transactions tax to fund health care reform.
British Prime Minister Gordon Brown expressed support for a global financial transactions tax at a meeting of the Group of 20 finance ministers in Scotland in November, 2009. The intent of the tax, as originally proposed by Adair Turner, Britain’s top financial regulator, would be to prevent excessive speculation and risk taking and provide a fund for potential future bank rescues.
Andrew Willis, in an article for the EU Observer, indicates that some world leaders have taken the potential of a financial transactions tax further, as a means of financing the fight against global climate change or to aid countries that have suffered natural disasters. Former Danish Prime Minister Poul Nyrup Rasmussen has said that a tax of 0.05 percent on financial transactions of the G20 would be enough to finance the United Nation’s Millennium Development Goals.
In an op-ed in the New York Times, Paul Krugman points out that the idea of a financial transactions tax was proposed back in 1972 by Yale economist and Nobel-prize winner, James Tobin. Tobin argued that currency speculation was having a disruptive effect on the world economy and a small tax on exchanges of currency would reduce the disruptions. The current proposal by Adair Turner and Gordon Brown expands on the original idea, including other types of financial instruments in addition to currency trading.
According to its proponents, the financial transactions tax would be a minor expense for people engaged in foreign trade or long-term investment, but would discourage short-term speculation, an activity that Tobin described as “socially useless”. Dean Baker of the Center for Economic Policy Research points out that investment banking and securities and commodities trading have nearly quadrupled as a share of GDP over the last three decades, generating enormous incomes for successful traders and bankers, largely from speculative trading and the creation of complex derivative instruments. But Baker argues that this growth in the financial sector produces little gain in the overall economy and contributes to instability.
Arguments against a financial transactions tax
At the Group of 20 meeting in November, 2009, U.S. Treasury Secretary Timothy Geithner expressed his concerns about a financial transactions tax, indicating that it is “not something we’re prepared to support”. John D. McKinnon reports in the Wall Street Journal that a spokeswoman for Republican House leader John Boehner of Ohio criticized the idea in that it would stifle capital investment and divert investment out of the United States.
In a paper for the International Monetary Fund in 2003, Karl Habermeier and Adrei A. Kirilenko concluded that “transaction taxes can have negative effects on price discovery, volatility, and market liquidity in securities markets” and that “these effects can lead to a reduction in market efficiency and may contribute to increased asset price volatility”.
Andrew Willis reports in the EU Observer that the position of Jose Manuel Barroso, president of the European Commission, is that a financial transactions tax is an initiative that would need to be implemented globally. Former Federal Reserve Chairman Paul Volcker echoed that concern, indicating that the biggest problem would be to get some consistency internationally, to avoid simply driving financial transactions to other countries.
Current status and the road ahead
As reported by John D. McKinnon, the $700 billion financial bailout legislation passed in 2008 does not call for a financial transactions tax but does include a provision that requires the president to submit legislation to recover any eventual shortfall in the Troubled Asset Relief Program (TARP) from the financial services industry. This recovery could take the form of a tax or a one-time fee.
Dean Baker notes that the U.S. already has a financial transactions tax on stocks and commodities, although it is very small. The revenue generated by the tax is used to finance the Securities and Exchange Commission and the Commodity Futures Trading Commission.
The G20 has pushed the International Monetary Fund to study the feasibility of an international financial transactions tax, which has received endorsements from some leaders, particularly in the UK and Germany. In the U.S. Congress, the financial transactions tax is one of many options on the table. Bloomberg reports that House Democratic Leader Steny Hoyer indicated that it was being discussed in a “neutral” way and had not yet come up in the House Ways and Means Committee chaired by Charles Rangel of New York.
Andrew Willis, “Financial transaction tax rears its head once again” – EU Observer
Dean Baker, “Financial Transactions Taxes” – Americans for Financial Reform
James Rowley and Ryan Donmoyer, “Hoyer Says Financial-Transaction Tax ‘On the Table’ in Congress” – Bloomberg
John D. McKinnon, “Democrats Weigh Tax on Financial Transactions” – The Wall Street Journal
Karl Habermeier and Adrei A. Kirilenko, “Securities Transaction Taxes and Financial Markets” – International Monetary Fund
Paul Krugman, “Taxing the Speculators” – The New York Times