A Virtuous Tax

One prime cause of the financial collapse is that financial trading markets have become speculative worlds unto themselves. Instead of adding efficiency to the real economy, they mainly add risk that the rest of us now have to pay for.

There are many ways to damp down financial speculation, but a very effective strategy is to tax it. Given the huge costs of the clean-up (now being borne mainly by taxpayers) it would make a lot more sense to require financial markets to pay for their own bailout.

One very neat way of doing this is through a very small tax on all financial transactions. Ordinary retail sales are taxed, as are wages. But oddly enough, financial transactions are exempt from tax.

This idea was first proposed in modern form by the Nobel Laureate James Tobin in 1972, after the collapse of fixed exchange rates led to massive increase in currency speculation. Tobin proposed a small tax on short term currency trades to make extreme speculation less profitable.

Since them, short term speculation and the invention of exotic securities that lend themselves to speculation has become the dominant activity of Wall Street. So a Tobin-style tax on all financial transactions has three big things going for it.

First, a very small tax in all kinds of financial transactions, say one tenth of one percent, would not be felt by legitimate long-term investors. But in the case of traders who get in and out of exotic derivatives minute by minute, making huge numbers of quickie trades, it would add up to a lot of money and would cut into both their profits and their entire socially destructive business strategy. So a universal financial transaction tax would discourage purely speculative activities and encourage investing for the long term.

Second, such a tax could pull in hundreds of billions of dollars a year, at a time when large deficits are giving the political right (and center) an excuse to cut social spending, and no form of taxation is popular. But this tax would be the least unpopular. It would not just fall primarily on the very, very wealthy. It would fall on the least socially defensible part of Wall Street, the people who make their billions from speculative short term trades. And that raises the third benefit.

What's missing from the entire debate about financial reform is a progressive brand of populism. Regular people know that they got done in by excesses on Wall Street, and they see a Democratic administration shoveling trillions of dollars to the same Wall Street banks that caused the mess. No wonder people are confused about whether government is on their side. What is overdue is a little bit of populist retribution against the people who brought down the system -- and will bring it down again if the hegemony of the traders is not constrained.

Do we have a shot of injecting the case for a Tobin Tax into the debate? In the past few weeks, Adair Turner, the head of Britain's Financial Service Authority, cautiously expressed support for the general idea.

Peer Steinbrueck, Germany's finance minister, explicitly called for such a tax last week, as did the AFL-CIO. In an unguarded moment early in his career, even Larry Summers, President Obama's market-friendly chief economic adviser, embraced the idea, as throwing some salutary sand in the gears when financial markets "worked too well."

The Group of 20 meetings next week in Pittsburgh are not likely to produce very much in the way of real reform, because even after the disgrace of Wall Street, the usual suspects are still making policy in most nations. But a global campaign for a Tobin Tax should begin in earnest now. It could bear early fruit, as speculative excess continues and as government finds itself searching for defensible taxes.

Robert Kuttner is co-editor of The American Prospect, www.prospect.org, and a senior fellow at Demos, www.demos.org. His recent best-selling book is Obama's Challenge.

 

 

Comments

[William1950]

a flat tax with no deductions and no exemptions .... the first $25,000. is tax free, would not cause a shortfall.. as it is now many corporations and the rich can hide income in exemptions and deductions.. they effectively pay very little, or many of them do... the first twenty five thousand would be free so the poor would not be hurt... and a flat tax of ten percent on all income over that free amount would be sufficient.. I don't buy the argument that a flat tax hurts those with little income more.. they make less so they pay less.. and the rich would not be able to hide income in exemptions or deductions... and we could get rid of the irs, or most of them.. our tax forms would be one page.. how much did you earn last year.. subtract twenty-five thousand and send ten percent of the rest.

[robinhood1]

Our convoluted income tax system enables politicians (especially incumbents) to extract campaign contributions (bribes) from the rich. Members of tax writing committees do very well collecting campaign contributions. Do you think the politicians will be willing to give up this money? I don't.

[research]

We have a flat tax: Social Security, but the conservatives refuse to remove the cap.

[schatsie]

thank you darline....It is not just a flat tax, it is a REGRESSIVE FLAT TAX on the working poor in this country....Take the DARN CAP off and call it a Bailout for Main Street...

[thnk4selfagain]

While this proposed tax *may* extract a bit of cover for the cost of the finance sector's parasitic activities, it will not prevent nor pay for another meltdown. This proposal is tangential to the crisis of reform. So why are we talking about it? Perhaps the US and global gov'ts are *powerless* in the face of so much speculative capital and reform is too difficult politically.

[schatsie]

And that is EXACTLY why I want Ike's Tax Rates back...
To restore the middle class and fund Medicare for ALL...or at least the little children and the soldiers and their families for life....

[mcmchugh99]

And I like the idea of a Tobin Tax, that could be used to fund development in the poorer countries, and perhaps be used for similar purposes here, such as a national investment and infrastructure bank, or to help fund the Medicare and Social Security Trust Funds.

In nay case, real reform of the IMF/World bank system is long overdue, especially making it more "user-friendly" for the developing countries.

[mcmchugh99]

Capitalism goes through cycles of boom and bust, and has a major recession or depression every 30-40 years. That was well known even in the 19th Century.

As far as socialism goes, I favor a mixed economy that will have a regulated capitalist sector, but also a strong state sector, as well as cooperatives and non-profits.

I would not want the state to own everything, but neither should capitalists own everything, but the economy should be some mixture between capitalism and socialism

[viper234]

If you're in a 401k, the fund managers that handles your 401k have to do the buying and the selling to get you the kind of gains you're depending on. In other words, there's a high frequency trader out there somewhere working for someone to get you the return on your investment to fund your retirement. So a big portion of that tax everyone here seems so excited about should be passed along to the people who just sit back while olthers work to manage their money. Now if you own a stock or two and just decide to ignore charts that tell you to sell because you believe an investment must only go in one direction, namely "up," then you deserve whatever you get if those investments tank and you refuse to sell. As for high frequency trading, it costs quite a bit of money. It's not a free ride. Every entry and exit has a fee that has to be paid and traders who are not part of any exchange trade their own accounts, with their own money. Why should these people be taxed when they are already being charged fees on all their trades, use their own funds for trading and are running their own businesses?

[marxmarv]

If you're in a 401(k), you're a sucker in the first place for putting your retirement money into nothing more or less than a casino.

[Javani]

This--

Ban derivatives. Specially non-real estate derivatives.

They are the increasers of risk.

Ironically, sold as decreasing risk. But people like Alan Greenspan are easy to fool.

[schatsie]

Alan Greenspan was not fooled, he was part of the FAMILY OF SECRETS....Read the Lowenstien book about Long Term Capital Management Failure...Bufett and Gates were there and so was Greenspan, and ALL THE BANKSTERS,,,,and it was all about derivatives...

They are all laughing their way to the SWISS BANK ACCOUNTS....

[Rhetticent]

Do none of you see the irony in all this hand-wringing, when Waxman-Markey will add billions of dollars to the traders' incomes with cap and trade? You ain't seen nothin' yet.

[Javani]

Although your fears are well taken,

I don't think carbon backed derivatives will be as big as mortgage backed derivatives.

But as big as credit card and auto derivative markets combined.

And multiply riskier.

It is scary to think that persons in the US government may be "promising" overseas purchasers that the consumer credit derivatives are "government backed." I hope not!

[research]

You are absolutely correct:

ACES is the largest new derivatives market ever created.

Kill ACES.

1$ per ton carbon emitted.

Simple, unavoidable.

Pump the money into 3 cent per KWH, rooftop solar and Waste BioChar.

See my profile for details and links.

[arktig]

But that's too transparent. There may not be any loopholes in it. So how are the cheaters going to survive without market manipulation, loopholes, twisted rules, lots of litigation, etc?

[Romeover]

Forget one tenth of one percent tax on financial trades. Try one percent. That should damp down the speculation.

[schatsie]

Heck, just try tax withholding on the stock transactions...you buy fine, the seller pays his 50% tax up front and can file for the return.....

[T4]

Basic idea for resetting the economy around real people - read more detail at prosperitynow4u.org / ccra. aspx - the reason these econ guys can't think out of the box is that they made the box, they like the box and all their friends are with them in the box and they all feel comfy in a theoretical world that doesn;t exist. For $100,000 we can change the economy by the end of the year. Here’s how:

The government establishes Consumer Confidence Accounts (CCA) with a $100,000 balance for all citizens that filed individual tax returns during last year. Think of this as a debit account. This money is not disbursed, it is held by the federal government. It can only be used for debt associated with specific existing activities (home loans, car loans, credit cards, medical bills, etc.). Funds can be applied to multiple types of debt with the total not to exceed $100,000. Funds can be disbursed either by the debtor authorizing the creditor to access the account for a specific amount or by the government releasing the funds to the creditor after the taxpayer submits identifying paperwork. The CCA balance times out at the end of the year.

This propsal is ismple and clean - think about your personal situation and how instant restructuring could your personal financial picture overnight. You could even give yourself performance bonus like a banker.

[marxmarv]

That's up to twenty trillion dollars per year you're talking about. There's a sure way to hyperinflation and the dollar in the tank without hard resources to back all that funny money up.

[Jannsmoor]

Mr. Kuttner is right, as usual. This is a reform that needs to be enacted immediately. The income generated should go into the general fund to pay down our deficit. The reason the money should go into the general fund is because when the markets screw up we bail them out from the general fund anyway.

But it is only the beginning. Many other reforms need to be enacted, not the least of which is to take owner occupied home mortages away from the Wall Street Profiteers. They have proven themselves far too greedy to be trusted with the most important investment most Americans will make in their lifetimes. Fannie Mae and Freddie Mac should carry all owner occupied home mortgages.

[Lavina]

Our government is a disgrace.

[progpro1]

I have a much better idea. A two tier tax system. 15% tax for the short term traders and 1/10 of one percent for long term investors. This one single reform would do more to bring real stability to our financial markets and be extension the overall economy than any thing else that has been proposed.

[taxman92571]

Would that be on every transaction? Or would that be on a one year timeline like our tax system is now?

[betrayed1]

Obama will never pass such a law. He is terrified that GS and JPM will stop supporting the stock market. Wall streeet investment banks are his biggest contributers (more htan all the money raised on the internet combined), it will expose the fact that he has not saved the economy.

[dshwa]

It's not just Obama. The Financial sector contributes heavily to almost everyone in congress on both sides of the isle. Chuck Grassly said it best about the banks "Frankly, they own the place (congress).

[Lauren SoFlo]

Love it! Even if some things are not traded on an exchange, they can still do their accounting just like a retail store that makes sales that aren't part of an exchange. Its bad enough that capital gains taxes are taxed much lower than the marginal rate, I mean, why should someone that makes $100,000 through investments pay much less tax than someone who works hard at a regular job to make that $100,000? Its fundamentally not fair and causes great imbalances in the tax code and the economy overall.

[taxman92571]

Yeah, but with those lower tax rates on Capitol Gains puts more money into the markets.

[research]

Probably better than a low capital gains tax, would be the ability to income average over 10 years. It's not fair for someone like myself to work 10 years for often no pay, starting and growing my company, till I can sell my stock, to pay all the tax in the year I take my gains from ten years of effort.

[harveyr2]

Derivatives do not trade on an exchange. Taxing a private transaction between to entities is impossible. Instead, an exchange should be created to eliminate private financial transactions. Next, set appropriate capital requirements. And, finally, break apart traditional banking from investment banking. I don't care if speculators speculate. However, they should not be able to bring down the banking industry.

[taxman92571]

Now seperating banking from investment banking makes sense. If the portion of the investment banking looses money it would not have any effect on the banking sector?? Maybe not..

[arktig]

Amazingly, the separation was in force up until year 1999 when the Demoblicans repealed it. It's called the Glass-Steagall Act of 1933 and it was one of the crowning achievements of FDR. Here is the history lesson, the economy operated without Glass-Steagall in the periods from 1913 to 1929 and from 1999 to 2008. In both cases it ended up with depressions. If that's not an argument for reinstating this law, I don't know what is.

[nova07]

Derivatives do trade on exchanges. There are two types, exchange traded derivatives and OTC derivatives. OTC derivatives are specially designed to fit the two parties which enter into the contract so they can't simply be placed on an exchange. Derivatives work on a collateral posting system, not capital requirements. It's the job of the institution’s prime broker to manage their book.

[jrsmee]

I'll start off by agreeing that we need to make sure there are safeguards in place to prevent a few institutions from bringing down the whole market. This can be accomplished through capital requirements, better exchanges, obviously regulation, etc...
I must correct your first comment however. A derivative is simply anything that derives its price from another instrument. This obviously includes credit default swaps, but also includes simplier things such as oil futures and soybeans. These and many other derivatives trade on an exchange (CBOE, NYMEX, ICE, etc....), they have margin requirments and use a clearing house to minimize counterparty risk. A key (but difficult) would be to move more transactions to organized markets while still allowing sufficient customization.

[donaldw6]

The transaction tax has long been my favorite financial reform idea. And your phrase "what's overdue is a little populist retribution" is one I plan to be quoting a lot, Mr. Kuttner.