Salvation or suicide? Experts react to a Tobin tax

Warning signs: would increased regulation stifle or save the banks?

Following headlines over the past week about FSA chief Adair Turner’s comments in Prospect magazine on the “swollen” financial sector and his calls for a Tobin tax, we’ve gathered a diverse selection of opinions from industry experts and commentators to argue about Turner’s ideas.

Robert Kuttner, editor of the American Prospect, argues that a Tobin tax may be the only answer for the Obama administration and that, while Wall Street will no doubt protest loudly, Obama’s chief advisers may well back the idea. Early in his career, Larry Summers, Obama’s economic policy chief, was a supporter of the Tobin tax, as evidenced by a 1989 paper he wrote entitled: “When Financial Markets Work too Well: a Cautious Case for a Securities Transaction Tax.”

In contrast, the British economist Tim Congdon deems a Tobin tax “national economic suicide,” and instead asks: “Are we the British supposed to be anxious or ashamed that at least one part of our country is so fantastically productive?”

He adds, “Given that Britain’s financial services sector is so heavily an exporter it is ludicrous for Adair Turner to allege that the sector has grown too much. How can any export industry be too large for the country that hosts it?”

UBS senior economic adviser George Magnus believes that a Tobin tax would only destroy financial activity, arguing instead that “governments should summon the political courage to break up the largest banks… with the express purpose of introducing more competition.”

Meanwhile the Times’s Oliver Kamm is in no doubt that while the financial system is “broken,” a Tobin tax is not the answer. “There is no patriotic imperative to defend British banking… But the activities of the banks are far from valueless. The shame is that awesomely incompetent bankers were at the helm.”

“Even if the main financial centres were to apply a tax consistently, what incentive would offshore tax havens have to follow suit?”

Exclusive online responses from Tim Congdon, George Magnus, Oliver Kamm and Robert Kuttner

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A Tobin tax for Wall Street?

Read our other exclusive online responses to Adair Turner from Tim Congdon, George Magnus and Oliver Kamm

Professor Tobin first proposed his tax to address currency speculation. This was in 1972, when the fixed-rate regime of Bretton Woods had collapsed. His concern was that speculative trades were fundamentally distorting currency values and damaging the real economy. The tax that he proposed was intended to damp down the volatility in currency movements, and take much of the profit out of purely speculative, short-term moves.

The early 1970s was a period just after currencies were freed from fixed rates, but before the general financial deregulation that followed. Since that time, speculative trading has distorted not just currency markets, but the broad financial market itself. The volume of short-term trades has grown far faster than the value of the stock market or the real economy. The most recent case in point is ultra high-speed computerised trading, in which very sophisticated traders make trades ahead of ordinary investors. In principle, this is illegal “front running,” and the SEC has begun an investigation. But there are larger policy issues here about how to discourage trading when it engenders risk rather than general efficiency of capital allocation.

From time to time, variations on the Tobin tax have been put forward as responses to crises caused by excess financial speculation. Now is surely such a time. A small tax on very short-term financial transactions would have two immense benefits. It would discourage purely speculative trades, while having no significant effects on long-term investments, and it would thus help restore the legitimate function of financial markets: connecting investors to entrepreneurs. Secondly, it could raise a substantial amount of revenue in a highly progressive fashion—at a time when large deficits loom.

The Obama administration might take a serious look at a Tobin tax for both of these reasons. Early in his career, Larry Summers, Obama’s economic policy chief, was a supporter of the Tobin tax. In a 1989 paper, co-authored with his former wife, Victoria Summers, he wrote that there might be times when it was salutary to throw a little sand in the gears of trading markets. The paper was titled: “When Financial Markets Work too Well: a Cautious Case for a Securities Transaction Tax.”

However, the Obama administration’s regulatory stance is still a long distance away from taking serious measures to discourage speculative trading markets as a general policy goal. The more likely motivation would be concerns about the federal budget deficit. Recent projections by the Congressional Budget Office show that the deficit is on track to exceed ten percent of GDP this fiscal year; and more seriously, it is likely to stay in the four percent range even after the economy is in recovery—meaning that the ratio of debt to GDP does not decline much, if at all.

So Obama’s advisers will be looking for new sources of revenue as an alternative to cutting spending. Various other ideas have been proposed, from increased taxes on estates to a national VAT. But for its sheer power to raise money while leaving the overwhelming majority of taxpayers untouched, nothing beats a Tobin tax. The effective rate on legitimate long term or even medium-term investment would be zero.

The tax, of course, would be fiercely resisted by Wall Street. For a reform administration, Obama’s government has approached any confrontation with Wall Street very gingerly. But sooner or later, difficult issues must be engaged. Even if Obama comes to a Tobin tax via the back door of revenue needs, this would be most welcome, as it would also lead to examination a larger, neglected issue: how to rein in financial engineering for the good of the larger economy.

More debate on the Turner interview will be featured in the October issue of Prospect, published 24th September

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