Bring Back The Tobin Tax

The mere suggestion of a tax on the wealthy was one of the factors that caused last week’s dire slump in global markets. But this suggestion wasn’t made in the USA and it had nothing to do with earned income. (“EU Tobin tax” Financial Times Lex column 8/18/11 p10.)

Much as I appreciate Warren Buffet’s offer, as one of the wealthiest Americans, to pay a higher rate of  income tax, I can’t help but suspect that the wealthy are not eager to have us look at the other types of taxes they pay or don’t pay; taxes they could be asked to pay, i.e., the capital gains tax or the Tobin tax.

The capital gains tax rewards long-term (over a year) investors for saving and earning money. Money invested for the long-term earns the investor income (called “portfolio income”). This portfolio income is taxed at a rate that is about equal to the second lowest of the six income tax brackets in the US. The capital gains tax favors those who make their money long-term by buying (and selling) capital over those who earn their money by selling their own labor and those who make money by hiring workers in their small businesses.

The Tobin tax is the opposite of a capital gains tax. It is a transaction tax, i.e., a sales tax, on the financial transactions of investors. Money invested, including money invested repeatedly for the short-term is taxed at a minuscule percentage (such as .005 to .05 of a percent) every time a financial transaction (i.e., the buying and selling of investments) takes place. The Tobin tax obviously promotes the spending of money for hiring labor or buying property rather spending that cash solely on financial investments.

According to Representative Peter DeFazio who sponsored a 2009 bill to implement a Tobin tax in the US, the country previously instituted an even larger Tobin-type tax after the Great Depression, and this tax lasted with no ill-effects until the 1960s. The US Tobin tax was levied in order to dampen the type of financial speculation that led to the Wall Street crash in 1929.

However, it was a mere suggestion of a global Tobin tax in talks between France and Germany last week that sent European financial markets into a panic this week. “Deutsche Börse and the London Stock Exchange were down by 5 and 3 percent respectively.” (“EU Tobin tax,” Financial Times Lex column, 8/18/100 p10)

The history of the Tobin Tax

The Wall Street Journal in its article, “Lawmakers Weigh a Wall Street Tax,” reported at the end of 2009 that “Lawmakers are considering a financial-transactions tax that takes aim at Wall Street to help Main Street.” “But,” objected the article, “the tax could wind up striking others, too, including pension funds, commodity-dependent business, and even ordinary investors.”

Reporting on the same topic at the same time, the Financial Times said, “US lawmakers working on ways to pay for legislation to reduce unemployment are considering taxes on [investment] banks as a way to raise revenues.” Mr. Geithner, head of the US Federal Reserve, however was opposed to such a tax. Nancy Pelosi, speaker of the House, wanted the tax on the table, but said it must be a global tax. (“US lawmakers consider taxing banks to tackle unemployment” Tom Braithwaite, FT, 11/20/09 p 7.)

This is the sticking point about a Tobin Tax. Capital is a global phenomenon. So is investment banking. Wealthy investors can afford to take their money elsewhere if one nation, acting alone, imposes a Tobin tax. Gordon Brown prime minister of  Britain jumped on the global Tobin tax bandwagon and floated the Tobin tax idea at the meeting of G20 in 2009. The Financial Times wrote that Brown got a hostile response from the finance ministers from other countries who belong to G20. Discussion at this point shifted to the bank capital reserves that are now the popular solution for most governments in advanced economies to address the problem of “too big to fail.” (“Focus shifts on options for regulation” Beattie and Masters, FT 11/10/09 p2)

At the time Brown tossed the Tobin tax on the table, there were those who wanted to use proceeds from a .005 percent Tobin tax to foster economic development in the world through foreign aid programs to eradicate poverty. But the Tobin tax itself, does not include notions of how the funds collected will be used. The Tobin tax was originally created by a nobel laureate economist named James Tobin in 1972. Tobin suggested his tax as be used as a forex (foreign exchange) transaction tax to stop global currency speculation.

In the summer of 2009, along with US bankers protesting the idea of the tax in the US, the British Bank’s Association opposed Lord Turner’s proposal for a Tobin tax in Britain. Germany’s BDB banking association reportedly said at that time,  “it was ‘unrealistic’ to think that a Tobin tax could be applied in practice to ‘undesirable’ speculative capital movements.” German businesses considered this idea to be an extreme leftist view. One European bank official said, “Global taxes don’t happen.” (“Business hostile to ‘Tobin tax’ proposal, Jenkins et al, Financial Times 8/28/09 p 3)

Flash forward two years and we see Nicolas Sarkozy, the French President suggesting a Tobin Tax to Angela Merkel, the German chancellor this week. However, a study by The Austrian Institute of Economic Research estimated a .05 percent Tobin tax could provide Europe with Euro 215 billion dollars annually, certainly a start towards addressing the sovereign debt crises in the EU.

The Financial Times Lex column op ed on the EU Tobin tax last week concluded that the risks for Europe would come from “geographical arbitrage” if every part of Europe didn’t sign on to collecting the Tobin tax, a dampening of non-speculative risk-taking (non-speculative risk-taking was not defined by the article), and a possible further consolidation of the banking industry.

In my opinion, the latter “unintended consequence” is a current trend already, and it appears to be taking place without any need for help from a Tobin tax! In fact, a Tobin tax might help the banking industry by making it focus more on lending rather than investing.

Contrary opinions about the Tobin tax

Back in September of 2009, Willem Buiter, a professor at the London School of Economics argued against the Tobin tax, saying that instead, the unsecured creditors of institutions too big to fail should pay the price if they fail.  Professor Buiter was concerned about the “moral hazard” involved with the government removing the risk from risky investments of the private sector. This idea doesn’t seem very popular today. In hindsight most people believe the American financial system would have toppled without government intervention in 2008. (“Forget the Tobin tax: there is a better way to curb finance” Willem Buiter, Financial Times 9/2/09 p9)

Writing about the Tobin tax a few months later in December of 2009 Professsor Luigi Zingales said the European Union had urged the IMF (International Monetary Fund) to consider the Tobin tax on financial transactions. Zingales, a professor at the University of Chicago Booth Business School, urged instead that the Tobin tax be targeted specifically toward short-term trading, especially trading that is based on borrowing. He is not the first or only one who has urged that mutual funds and other ordinary long-term investments be exempt from a Tobin tax.

Professor Zingales argued that while individual short-term traders can get out of the market quickly in the case of a crisis, all short-term traders cannot exit the market at once. Hence, the need to discourage short-term traders who bet on the margin with highly-leveraged borrowed funds or pension funds that gamble with other people’s money. But short-term trading on the margin has been fostered for quite awhile by the Fed’s low interest rates on borrowing over the past few years. In particular, Zingales wanted the US to take aim at financial institutions who are engaging in short-term trading. (“A tax on short-term debt would stablise the system.” Luigi Zingales, Financial Times 12/16/09 p 13)

Pros of a targeted Tobin tax

Looked at in another light, Mitt Romney’s remark that corporations are people isn’t quite as utterly ridiculous as it sounded to his audience last week. Corporations offer the ability to “pass through” their expenses as well as earnings. A sales tax on the transactions of any corporate entity offering investments means that as long as the market permits, the cost of a Tobin tax would be “passed on” to the buyer of the investment. In the case of the exotic investments that froze up in 2008, the buyers are corporations, institutions that invest, and/or wealthy individuals. This is why a Tobin tax can be thought to dampen the particular kind of financial market speculation we all worry about happening again.

In essence a Tobin tax is a sales tax that is levied mainly on the rich. It impacts individuals and corporations who can better afford to pay a minuscule tax of .005 to .05 of a percent than can the unemployed and workers who now pay as much as 10% sales tax on any goods they purchase. Without these basic goods workers could not enable themselves to go on offering their labor skills and knowledge for sale.

When those who earn a living by employment and self-employment are paying almost the same amount, or even more, for sales taxes as they are for income taxes, the fruit doesn’t have much juice left in it to squeeze out. That’s why an speedy economic recovery without the participation of everyone involved right now seems a dubious prospect.

Given the huge amounts of money that global corporations are gaining, paying proportionately little actual tax on, and hanging onto out of fear of another Great Depression; while the ordinary worker is steadily losing ground in terms of employment, wages, and benefits; a Tobin tax, however unlikely, still seems like a proposal well worth putting back on the global table right now.

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