FINANCIAL TRANSACTIONS TAXES: INACCESSIBLE AND EXPENSIVE.

• Author: Zuluaga, Diego

Financial transactions taxes (FTTs) have become increasingly popular since the 2008 financial crisis. During the 2020 Democratic presidential primary race, FTTs featured prominently on the platforms of both moderate Michael Bloomberg and socialist Bernie Sanders. The likely nominee, Joe Biden, has also expressed support for an FTT, albeit without offering any details in his election platform (CNBC 2019).

FTTs are taxes on the purchase or sale of financial instruments. Some countries, such as Britain and Hong Kong, have long had a form of FTT they call "stamp duty" on shares. Yet, while still by no means exceptional, FTTs had declined in popularity during the 1990s and 2000s, as countries abolished them in a bid to make their capital markets more competitive. But the 2008 crisis prompted a revival, as some regulators called for curbing "socially useless" financial market activity and politicians looked for retribution against the financial services industry. The need to balance government budgets after the Covid-19 pandemic may give these efforts new vigor in many countries.

Some politicians advocate FTTs as a progressive revenue-raising measure to help taxpayers "get even" with financial institutions that benefited from their support in the past. But although some economists argue that well-designed FTTs can serve to deter socially harmful financial activity, even they tend to regard FTTs as a relatively inefficient way to raise revenue because of the large behavioral changes they cause. And despite their theoretical usefulness as a behavioral tax, actual instances in which FTTs might be desirable have been fewer than proponents claimed.

Theoretical Case for FTTs

In his General Theory of Employment, Interest, and Money, John Maynard Keynes advocated for "a substantial Government transfer tax on all [investment market] transactions ..., with a view to mitigating the predominance of speculation over enterprise in the United States" (Keynes [1936] 1965: 160). He worried that wider access to stock and bond markets thanks to innovation and affluence, and the growing liquidity of financial instruments, would make short-term speculation--"the activity of forecasting the psychology of the market"--predominant over long-term investment, or enterprise-"the activity of forecasting the prospective yield of assets over their whole life" (ibid.: 158). In proposing such a tax for the United States, Keynes had the British model in mind, noting approvingly that it made the London stock market "inaccessible and very expensive" to the ordinary investor (ibid.: 159).

Keynes's proposal, on which he didn't elaborate further, and the U.S. experience notwithstanding, the academic case for FTTs was first made in earnest by James Tobin in a 1972 lecture and a subsequent article, "A Proposal for International Monetary Reform" (Tobin 1978). What motivated Tobin was the breakdown of the Bretton Woods regime, with a consequent dramatic increase in cross-border capital movements as investors responded to (and helped amplify) fluctuations in exchange and interest rates. That breakdown "severely restricted] the ability of central banks and governments to pursue monetary and fiscal policies appropriate to their internal economies" (ibid.: 154).

To preserve domestic policy autonomy, Tobin called for "an internationally uniform tax on all spot conversions of one currency into another," the goal being to "particularly deter short-term financial round-trip excursions into another currency" (ibid.: 155). Because he was skeptical that such moves "by traders in the game of guessing what other traders are going to think" could guide economies toward efficiency, Tobin viewed short-term trading as harmful on the margin. If that was true, a "Tobin tax," as the proposal has come to be known, could restore trading to its socially beneficial level--at least in the friction-free setting of theoretical welfare economics.

As U.S. and international financial markets liberalized in the 1980s, other academic economists joined Tobin in his advocacy for an FTT. Harvard's Lawrence Summers, who would become Secretary of the Treasury during the Clinton administration, coauthored a 1989 article making "a cautious case" for a tax on securities transactions (Summers and Summers 1989). His argument, similar to Tobin's, was that short-term trading causes volatility without bringing stock prices closer to their fundamental (i.e., tme) values (ibid.: 170-71). He saw further evidence of a "market failure" in the legions of talented graduates then flocking into the securities business, and the vast resources devoted to investment research relative to corporate profits (ibid.: 174). Summers also noted that many countries with developed financial markets, such as Britain, Japan, the Netherlands, and Switzerland, had an FTT (ibid.: 177).

Not all economists are enthusiastic about FTTs, though. In his review of the British tax system, James Mirrlees (2011) argued against transactions taxes, including FTTs. He contended that, while "their continued use reflects the ease with which such taxes can be levied, ... they are unattractive from an economic point of view" (ibid.: 151). By discouraging mutually beneficial transactions, FTTs hinder the movement of assets into the hands of those who value them most, creating inefficiency. Nor are they obviously progressive, falling "arbitrarily heavily on those who...