Tax Analysts Blog

Taxing Financial Pollution

Posted on Jan 28, 2013

European finance ministers ("finance minister" is equivalent to our Treasury Secretary) voted on January 22 to move forward with a plan to tax trades of stock, bonds, and other financial instruments. As a result a financial transactions tax will likely become law in eleven countries--including Germany, France, Spain, and Italy. Noticeably absent from the list is the United Kingdom, home of Europe's largest financial market. Back in the USA some Democrats want to impose the same tax here. Of course, the tax has gut appeal to anybody that resents Wall Street's rolling in riches just a few years after bringing the world's economy to its knees.

In an exception to the general rule that taxes are bad for the economy, taxes on negative externalities (like air and water pollution) can make things better by correcting the market's failure to put a price on these costs to the economy. Excessive risk taking is a burden on the entire economy, as the great crisis of 2008 should make crystal clear.

Beside the fact it raises desperately need cash, the main rationale for the financial transaction tax is that it it discourages socially wasteful and economically damaging stock trading. But too much trading was not the cause of our last financial crisis, nor is it likely to be the cause of our next one. Lack of liquidity and inadequate capital are the culprits. And these are best addressed by discouraging excess leverage at large financial institutions. Lehman Brothers was leveraged to the gills.

Moreover, unless a financial transaction tax is imposed worldwide, it will likely be avoided by moving transactions to locations that don't impose the tax. Sweden imposed such a tax in the 1980s but eventually gave up on it because of widespread avoidance, as noted in an academic paper:

    Widespread avoidance was one reason for the weak performance of the tax. Foreign investors avoided the tax by placing their orders with brokers in London and New York. Domestic investors avoided it by first establishing off-shore accounts (and paying the tax equal to three times the round trip tax on equity for funds moved off-shore) and then using foreign brokers.

A far, far better way to tax banks and reduce risk is the so called Financial Crisis Responsibility Fee proposed by the Obama Administration (p. 101) in every one of its budgets. In a nutshell, the proposal imposes a 0.15 percent tax on debt and debt-like liabilities of large banks operating in the United States. Other countries, including the United Kingdom (London is Wall Street's #1 competitor), impose a similar fee. But in the United States it has gotten almost zero attention which is undoubtedly a tribute to the incredible clout New York's financial giants have on Capitol Hill.

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