One Way to Make Banks Pay for the Bailout

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

While in the middle of the Great Depression, John Maynard Keynes proposed that financial transactions be taxed. The idea gained no traction at the time and it was not remembered again until the 1970s, when another economist, James Tobin, revived it as a way to curb excess speculation. These days, the “Tobin tax,” as many are still calling it, on bonds, stocks, currency and derivatives transactions is being dusted off again, with proponents arguing that it may be a way to compensate the public for all the billions of dollars spent on bailing out wayward banks.

At the head of the pack was the U.K.’s Prime Minister Gordon Brown, who suggested a Tobin tax in early November and was joined by France, German and Austria on the same day. However, the next day, U.S. Treasury Secretary, Timothy Geithner, said that the U.S. was not interested for the time being on pursuing this levy against trading financial instruments.

The political consensus on transaction tax is lacking, at least this early in the game; granted, for the idea to work, it would have to be implemented everywhere or nowhere at all. However, the good news for proponents of the Tobin tax is that the idea is gaining more and more supporters worldwide.

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imposing a gambling tax on reckless investing. Trades that bring too much risk into global financial systems with least amount of benefit to the society should be taxed to oblivion, if you ask me. If such a tax is actually imposed, it actually might succeed in doing so, too, because taxing transactions would exponentially increase the costs of complex financial products that typically require execution of multiple layers of transactions. At the same time, profit margins would get slimmer and slimmer.

Moreover, just consider the revenues government would raise from taxing financial transactions. According to data collected by Bloomberg, stock and currency markets have been ringing up approximately $900 trillion in annual turnover, while derivatives have registered another $625 trillion. Imposing a tax of only 0.005% would raise about $76.0 billion every year.

Opponents of taxing the financial transactions argue that it would harm the markets. The job of stock, bond, currency and derivatives traders is to make sure that markets remain liquid. But if traders are afraid to transact too much for fear that taxation and/or the potential for their returns to take an ugly downward turn, a plausible assumption could be made that liquidity could dry up and that markets could become less accessible.

On the other hand, proponents of the financial transactions’ tax argue that this is just what the global economy needs to prevent another financial meltdown. Additionally, a policy would have to accompany the tax to ensure banks’ capital liquidity and more transparency. The American public is so angry after the financial system nearly collapsed in 2008. This is why perhaps the idea of Tobin tax has a sporting chance of actually being passed into law. Anyone can see it is a politically sexy idea.

But what is politically sexy and fiscally prudent does not always go hand in hand. There are various forms of other reasoning of how to prevent future financial crises. For starters, the government could impose tough capital requirements and strict excess risk-taking policies on banks and withdraw the “too-big-to-fail” safety net. Additionally, banks’ insurance policies should be renegotiated to reflect excess risk-taking in higher premiums

When Keynes first thought of taxing financial transactions, he saw the capital markets arena as one big casino that was out of control. Keynes thought the market has lost its vision and purpose. It stopped benefiting society, leaving only misery in its path. Three-quarters of a century later, the resurrection of the tax on financial transactions reveals that not much has changed and that behavioral finance should be studied more in business schools. The Tobin tax may not be the answer, but something needs to be done, for sure, and sooner rather than later