Wall Street speculation tax: a way to address corruption
from Dean Baker
Over the past week, the business news has been filled with stories about major British banks manipulating the LIBOR rate. While these stories are undoubtedly confusing to most of the public, which is not generally familiar with the intricacies of different interest rate indexes, the basic story is fairly simple: Big banks were caught lying about interest rates in order to make big profits.
For the most part the victims were other high-rollers who were taking the other side of bets on complex financial derivatives. However there were also pension funds and even governmental units such as school districts and park services that were persuaded by their financial advisers to get into this high-stakes game. These folks were among those who lost because of the LIBOR liars.
A Fundamental Problem
While there should be a thorough investigation that results in the guilty parties being severely punished, this incident sheds light on the fundamental problem with the modern financial industry. There is enormous money to be made by shaving a small fraction of a penny here or there. When this shaving is done on trades that can run into the hundreds of billions or even trillions of dollars, those fractions of a penny can run into really big bucks. And when we give people enormous incentive to lie and steal, it is likely that many will take advantage of the opportunity.
There is an obvious answer to this problem and a simple way to do it. The answer is to take the money away. If bankers didn’t have the opportunity to make hundreds of millions or billions of dollars by manipulating the market, they wouldn’t do it. And the simplest way to take away this opportunity is to reduce the size of these markets with a modest tax.
A small tax on flipping stock, options, credit default swaps and other derivative instruments would drastically reduce the size of these markets, thereby reducing the opportunities for market manipulation. Such a tax could also raise a substantial amount of money.
The Joint Tax Committee of Congress calculated that a 0.03 percent tax on all trades, as was proposed by Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio, could raise more than $350 billion in the first nine years that it was in place. This is almost ten times the sum at stake with the Buffet rule and more than 10 times the amount of money that would be saved by ending subsidies for the oil industry.
A Targeted Tax
The great thing is that almost all of this tax would come out of the hide of the Wall Street crew. While many of us hold some stock either directly or through a mutual fund in a retirement account, there is a considerable amount of evidence that shows people respond to higher trading costs by trading less.
This means, for example, that if this tax doubled the typical cost of a trade (it doesn’t), then most people will cut back their trading by roughly 50 percent. That means that a typical investor will pay little or nothing as a result of this sort of tax. They may pay more money on each trade, but they will make fewer trades, leaving their total trading costs pretty much unchanged.
It’s also important to remember that trading costs have been falling rapidly as a result of the advance of computer technology. While the financial industry’s lobbyists have been claiming that the Harkin-DeFazio tax would be the end of the world, in reality it would just raise trading costs back to where they were 5-10 years ago.
Shrink the Financial Sector
In addition to be being less corrupt, a smaller financial sector is likely to better serve the economy. Finance is an intermediate good, like trucking. We need the financial sector to allocate money from lenders to borrowers, just like we need trucking to move goods from point A to point B. But the financial sector doesn’t directly produce items we consume, like food, housing or health care. In principle, the smaller the financial sector, the better.
Recent research indicates that countries with large financial sectors have slower growth. It appears that a bloated financial sector pulls highly skilled people away from research intensive sectors of the economy such as computers and biotechnology. The sort of financial shenanigans we saw with the manipulation of the LIBOR rate also seems to pull capital away from start-ups that need to borrow to finance investment.
In short, there are some very good reasons to want a smaller, more efficient financial sector. And a tax on financial speculation is a great way to get there.
While there may be a case for transaction taxes a far better way to control this gaming of the system is to regulate the system more effectively. Most of this questionable activity is not necessary for the proper functioning of the financial system.
It is well past time for the financial industry to be compelled to conform to its proper function – an essential service to facilitate productive activity – not an end in itself.For those with criminal and gambling propensities there are casinos and the underworld.These are controlled by the justice system and the habitues pay the price – we hope.
It would also help to stop referring to the financial services “industry”. It produces nothing. It ought to be a service but has become parasitic – it is a sucker-up of wealth. The mechanism by which it does this needs to be properly understood so that it can be properly dealt with. Regulation and transaction taxes are mere tinkering.
As soon as they stop this unnecessary (for the vast majority) handholding over where people put their retirement savings and when and how they can access those retirement savings the financial sector will cease being force fed and will shrink naturally. What is keeping it so attractive to gamblers is the fact that its a steady diet of other people’s money they can feast on for years with no accountability. There are a lot of people out there now very unhappy over superannuation. Its time to reclaim our rights and control over our own savings and tell financial institutions (and their crony government representatives) to make their own way without our massive collective subsidy of this sector (or their crony government representatives). The financial sector is a parasitic sucker up of wealth but it was our political systems that mandated the feeding frenzy.
Transaction taxes would not be mere tinkering, and they could do far more good more easily than regulation.
My estimate is that the financial system trades 50-100 times faster than it would need if it were confined to its proper function of serving the productive economy. This means 98-99% of trades are for speculation, which is both parasitic and destabilising and dramatically reduces the efficiency of the productive economy.
A tax that takes most of the profit out of the speculation would stabilise the system, dramatically reduce the damage done to the productive economy, and dramatically shrink the financial system back towards its proper role.
There would be a revenue bonus, but that would not be the primary purpose. People who talk only of a Robin Hood Tax miss the major potential benefit – cutting the destructive power of the out-of-control financial system.