Making finance the servant not the master.

Author:Addison, Tony

Today, there is much frustration with the financial sector. Society's precious savings are not being put to the best of uses--investing for the social good. It is unnecessary to repeat at length what has gone wrong over the last few years. The situation can be summed up as one where greed met incompetence, with near fatal economic results.

This has renewed interest in a financial transactions tax (FTT), sometimes known as a 'Tobin tax' (after the late James Tobin, who first argued for a tax on currency transactions to dampen destabilizing speculation). Many recent proposals for an FTT go beyond currency trading to encompass a far wider set of financial transactions. Some forms of FTT are technically feasible. Britain has had a stamp duty since 1694 (currently applied to transactions in shares and property). France seems likely to go ahead with a similar FTT. Some EU member states are pressing for a more comprehensive European-wide levy to tax financial transactions where at least one party is located in the European Union.

But I have two concerns: what is the principal aim of the tax? And, secondly, what will the generated revenue be used for? Others have raised concerns over whether 'financial engineering' can be used to avoid the tax. However it seems to me that this technical issue while important, and one that will affect the design of any tax, is less crucial than reaching clarity on the aims of an FTT and the use of the resulting revenue. If neither is clear then a more comprehensive FTT will not gather the support it probably deserves.

A variety of aims

First, what is the aim of an FTT? If the main purpose of a tax is to collect revenue, then the activity to be taxed must be buoyant. Setting the tax rate too high chokes off the activity, and therefore the revenue. To maximize revenue from the financial sector, the FTT needs to be set low. But if instead the aim is to reduce the size of the financial sector, or some parts of it (undesirable forms of short-term trading, for example) then the tax rate needs to be high. If society decides that large financial sectors, or parts of them, do social harm then, like the taxation of cigarettes, an FTT needs to be set high to discourage the activity.

Does finance harm society? The recent financial crisis has taught us that banks can reach a size and complexity beyond which they can do real harm. As size and complexity rise, so managers lose their understanding of what risks they face. Capital...

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