Next Time, Tax 'Em

11/10/2008 05:12 am ET | Updated May 25, 2011

As soon as public hostility to using taxpayer money to prop up Wall Street appeared to subside, this week's stock market sell-off demonstrated that the financial crisis continues to intensify. Public anger will reignite once people realize there will be calls for more bailouts in the future. When they do, their outrage should be channeled into reducing the size of the financial sector and curbing the propensity for traders to take on excessive risk.

The bailout did not change the basic fact that in the American economy, the tail still wags the dog. Instead of reliably channeling savings into productive investment, US financial markets are so large and out of control that production and distribution are effectively held hostage to the whims of high-rolling legalized gamblers.

One way to downsize the role of Wall Street and help curb its excesses would be a tax on financial speculators, known as a security transaction excise tax (STET). STET is a sales tax on all transactions involving stocks, bonds, and other novel "products" developed by Wall Street -- products like collateral debt obligations and credit default swaps. Such a tax would make trading in financial assets less profitable, redirecting resources away from it and freeing them up for more productive uses. It would also generate a lot of revenue for the Treasury. Both are desirable outcomes.

We also need, as many point out, much stronger oversight and regulation of the financial sector. But nothing is quite so effective as a tax. Regulatory agencies may be captured by those they regulate, but it's much harder to defang a tax.

No one really knows how much revenue a STET would raise. The economist Robert Pollin recently estimated the figure to be about $100 billion. Whatever the figure, it will help offset the cost of the bailout. Furthermore, a STET will fall most heavily on the top income earners in the country, partially reversing record income inequality that is distorting the economy.

Of course, it will take a political donnybrook to pass it. The financial community has dominated political contributions since 1991, and still retains enormous clout. Indeed the passage of the bailout itself is testimony to its power. It's no accident that it rescued the financial sector without any real reforms.

Members of the House of Representatives who voted for the bailout received 40 percent more in political contributions from the financial sector over their careers than those who voted against it. In 2007 and 2008 individuals employed in Finance, Real Estate and Insurance contributed $21.4 million to members of the House Financial Services Committee and $35.9 million to those on the Senate Banking, Housing and Urban Affairs Committee. These sums are more than three times what members of these committees received from any other single sector of the economy. This can't help but influence what legislation emerges from these committees.

On the other hand, proponents of really reforming and downsizing Wall Street also have some grim weapons of their own, even if they can't compete cash-wise. Taxpayers' indignation at footing the bill to rescue speculators, coupled with dismal economic conditions that will surely result, could forge a very broad coalition, and fuel a successful reform movement.

Proposing a STET now would be a good way to find and rally potential members of this coalition. Such a populist strategy may seem a little politically naïve at the moment, but that may be changing. A new coalition of those on the receiving end of the financial crisis, as broad and inclusive as the Wall Street elites who caused it have been insular, as committed to the public interest as Wall Street has been indifferent, could eventually prevail and make the financial system work for a majority of Americans. Indeed, it may be the only thing that can.