Kenneth Rogoff
Kenneth Rogoff, Professor of
Economics and Public Policy at Harvard University and recipient of the
2011 Deutsche Bank Prize in Financial Economics, was the chief economist
of the International Monetary Fund from 2001 to 2003. His most recent
book, co-authored with Carmen M. Reinhart, is This Time is… read more
The Overselling of Financial Transaction Taxes
CAMBRIDGE
– However November’s presidential election in the United States turns
out, one proposal that will likely live on is the introduction of a
financial transaction tax (FTT). While by no means a crazy idea, an FTT
is hardly the panacea that its hard-left advocates hold it out to be. It
is certainly a poor substitute for deeper tax reform aimed at making
the system simpler, more transparent, and more progressive.
As American society
ages and domestic inequality worsens, and assuming that interest rates
on the national debt eventually rise, taxes will need to go up, urgently
on the wealthy but some day on the middle class. There is no magic
wand, and the politically expedient idea of a “Robin Hood” tax on
trading is being badly oversold.
True, a number of
advanced countries already use FTTs of one sort or another. The United
Kingdom has had a “stamp tax” on stock sales for centuries, and the US
had one from 1914 to 1964. The European Union has a controversial plan
on the drawing boards that would tax a much broader array of
transactions.
The presidential
campaign of US Senator Bernie Sanders, which dominates the intellectual
debate in the Democratic Party, has argued for a broad-based tax
covering stocks, bonds, and derivatives (which include a vast array of
more complex instruments such as options and swaps). The claim is that
such a tax will help repress the forces that led to the financial
crisis, raise a surreal amount of revenue to pay for progressive causes,
and barely impact middle-class taxpayers.
So far, Hillary
Clinton, the likely Democratic nominee, has embraced a narrower version
that would target mainly high-speed traders, who account for a large
percentage of all stock transactions, and whose contribution to social
welfare is open to question. Clinton, however, may well shift closer to
Sanders’s position over time, as she has on other issues. Donald Trump,
the presumptive Republican nominee, has not yet articulated a coherent
position on the topic, but his views often come down remarkably close to
those of Sanders.
The idea of taxing
financial transactions dates back to John Maynard Keynes in the 1930s
and was taken up by Yale professor and Nobel laureate James Tobin (who,
incidentally, was my undergraduate professor) in the 1970s. The idea, in
Tobin’s words, was to “throw sand in the wheels” of financial markets
to slow them down and make them hew more closely to economic
fundamentals.
Unfortunately, this
rationale has not held up particularly well either in theory or in
practice. Particularly misguided is the idea that FTTs would have
significantly muted the buildup to the 2008 financial crisis. Centuries
of experience with financial crises, including in countries with FTTs,
strongly suggests otherwise.
What is really needed is better regulation of financial markets. The unwieldy and deeply imperfect 2010 Dodd Frank
legislation, with its thousands of pages of provisions, is a stopgap
measure; few serious people view it as a long-term solution. A far
better idea is to force financial firms to issue much more equity
(stock), as Stanford University’s Anat Admati has proposed.
The more banks are
forced to evaluate risks based on shareholder losses rather than
government bailouts, the safer the system will be. (On this score,
Boston University professor Laurence Kotlikoff’s more radical ideas
for taking leverage out of the financial system merit serious
attention, even if his own quixotic presidential campaign otherwise goes
unnoticed).
The fundamental
problem with FTTs is that they are distortionary; for example, by
driving down stock prices, they make raising capital more expensive for
firms. In the long run, this lowers labor productivity and wage levels.
True, all taxes are distorting, and the government has to raise money
somehow. Yet economists view FTTs as particularly troublesome because
they distort intermediate activity, which amplifies their effects. A
modest tax that is narrowly targeted, like the UK’s, does not seem to
cause much harm; but the revenue is modest.
To get more revenue
requires casting the net much wider. For this reason, the Sanders plan
covers derivative instruments that would circumvent the FTT (for
example, by allowing people to trade income streams on assets without
trading ownership). But extending the tax to derivatives is a messy
business, because their complexities make it difficult to define
precisely what should be taxed. And as the impact of the tax expands, it
becomes hard to know what the ultimate effects on the real economy will
be.
It is certainly difficult to determine whether the outsize revenue estimates of the Sanders campaign could be realized; many studies suggest otherwise.
The claim is that the US can collect more than five times the amount
the UK collects on its narrow tax – an amount equal to more than 10% of
revenue from personal income tax. The problem is that trading will
likely collapse in many areas, and many financial trades will be
executed in other countries. If economic growth is affected, eventually
other tax revenues will fall, and if government bonds are covered,
borrowing costs will rise.
The
US desperately needs comprehensive tax reform, ideally a progressive
tax on consumption. In any case, a properly designed FTT can be no more
than a small part of a much larger strategy, whether for reforming the
tax system or for regulating financial markets.
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