The World's Best Tax?

January 13th, 2012

flickr / Silveira Neto

The global financial crisis—including the housing market bubble in the United States, the plummeting of the stock market, soaring unemployment and the resulting Great Recession worldwide—sparked an inundation of ideas about what we should do next or what we should have done differently. Many of these ideas are not new. In fact, many of them are very old. As a result, particularly in the United States and in Europe, we’ve seen a resurgence of economic thought from the full spectrum of thought—from Frederick Hayek and Milton Friedman to John Maynard Keynes.

One of Keynes’ ideas (though not his originally) that’s gained some traction and popularity in the wake of the crisis—which many perceive to be one of the most spectacular market failures of all time—is the financial transactions tax (FTT). In this idea, governments levy a tax on specific financial transactions (for example, on the sale of currency, bonds, or stocks), not on financial institutions themselves.

About a year ago the finance ministers of France, Japan, and Belgium, proposed levying an FTT to mobilize resources for development and poverty relief. The Taskforce on Financial Transaction for Development meanwhile reported that a levy of just 5 cents on every $1,000 traded on the foreign exchange market (or a .005% tax) could bring in more than $30 billion per year.  The ministers hoped these figures would show international organizations, like the United Nations, that financing alongside traditional foreign aid could fund safe drinking water, food, treatment for pandemics, and education for children.

A proposal for such a worldwide tax even made it into the agenda for the G20 Summit in Cannes at the end of last year. During those discussions, French President Nicolas Sarkozy called it “indispensable financially given the crisis” and “absolutely necessary…morally.” In the end, though, the tax did not win the support of the world’s most powerful leaders.

Given the rise of the European debt crisis and America’s own heated debate on debt, it should come as no surprise to you that the FTT is now gaining a lot more traction as a traditional revenue raising tax, rather than a philanthropic one. In September, José Manuel Barroso, the President of the European Commission, officially introduced a proposal that would create a new FTT within the European Union and noted it could raise 55 billion euros per year.

The debate is heated, though. Germany and France are the most enthusiastic about it. Italy has shown support. Denmark is opposed. Britain hates it. And across the Atlantic, the United States remains lukewarm. Many economists and policy makers fear the tax would only be effective if it were universal—perhaps even globally so. Politicians fear levying a tax within their own boarders would just push trading abroad.

That might be true and it might be a downside. But the upside is much greater. This is not only a question of raising revenue, although that reason is compelling, and neither is a case for humanitarianism, although that cause would be worthy. Rather there is a compelling argument that the tax would reduce volatility in financial markets as it would create an incentive for speculators to reduce their mass number of trades. This tax would not only raise revenue, it would also help markets function better, rather than distorting them. Here’s the wonkish jargon as written by the Trade Union Advisory Committee to the Organization for Economic Cooperation and Development:

“The economic justification for an FTT starts with the acknowledgement of the harmful effects of short-term speculation producing strong and persistent deviations of asset prices from their theoretical equilibrium levels. Such ‘overshooting’ in prices lead to speculative bubbles over the long run. A measured and controlled increase in transaction costs implied by an FTT would slow down trading activities so as to align capital flows with economic fundamentals and the real economy, while freeing up new sources of financing for global public goods.”

As such, it might just be the world’s best tax.

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Written by Ann Hollingshead

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