Support Building for Tobin Tax

Bloomberg is reporting a Tobin Tax is gaining momentum.

John Maynard Keynes proposed a tax on financial transactions in the middle of the Great Depression, and another economist, James Tobin, revived the idea in the 1970s as a way to counter currency market speculation. Neither effort gained much acceptance. Now, a growing number of economists and politicians argue that it’s time for a levy on trading stocks, bonds, currencies and derivatives.

U.K. Prime Minister Gordon Brown said on Nov. 7 that a transaction tax might compensate for the billions of dollars that the public has spent on bank bailouts. Government officials in France, Germany and Austria have voiced their backing. U.S. Treasury Secretary Timothy Geithner answered Brown a day later, saying the tax was not something the U.S. would support. House Speaker Nancy Pelosi, on the other hand, says the idea has “substantial currency” among congressional Democrats.

Even if political consensus on a transaction tax is lacking -- and Brown and Pelosi both say it would need to be implemented everywhere or not at all -- the idea is attracting supporters worldwide.

Just a few days ago, Paul Krugman wrote about a Tobin tax as a good strategy to tax the speculators.

Why is this a good idea? The Turner-Brown proposal is a modern version of an idea originally floated in 1972 by the late James Tobin, the Nobel-winning Yale economist. Tobin argued that currency speculation — money moving internationally to bet on fluctuations in exchange rates — was having a disruptive effect on the world economy. To reduce these disruptions, he called for a small tax on every exchange of currencies.

Such a tax would be a trivial expense for people engaged in foreign trade or long-term investment; but it would be a major disincentive for people trying to make a fast buck (or euro, or yen) by outguessing the markets over the course of a few days or weeks. It would, as Tobin said, “throw some sand in the well-greased wheels” of speculation.

While Treasury Secretary Tim Geithner tries to throw the plan under the bus, many are calling for Geithner to be thrown under a bus instead.

If the globe agrees to implement a Tobin Tax, finally we might not only be able to curb speculation on critical commodities such as oil, but be a truly progressive tax, focusing in on hedge funds and other speculative and flash trading that adds little value to the real economy.

Basically a Tobin tax is like a tax on casino hall gambling.

It is estimated such a tax could raise $76 billion dollars annually. How's that for a budget balancer?

The funds raised would be substantial: With stock and currency markets ringing up about $900 trillion in turnover each year and derivatives another $625 trillion, a tax of 0.005 percent might raise $76 billion annually.

The main issue for a Tobin tax to be successful is it must be uniform and implemented globally.

It's amazing how difficult it is to get the general public to shift that paradigm. Claims a Tobin tax is radical still abound, yet if one thinks about it, taxing a business for hiring a worker, now isn't that just a wee bit more radical?

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London derivatives market as big as NY?

In 2007 London boasted $600bn/day of derivatives trading, approximately 40% of worldwide trades. No wonder Gordon Brown favours a Tobin tax, no other way to refresh the UK treasury coffers remotely in sight, but don't hold your breath. Nicholas Sarkozy was the only one polite enough to even reply to my suggestion for a derivatives trading tax over 2 years ago.

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Tim Goldwell

Very nice blog you have and I'm glad you are promoting and crafting a derivatives trading tax.

I hope you would consider creating an account on EP and joining us.

It appears derivatives legislation is stalled &/or gutted and right now it seems there is much debate on this entire concept...

much coming from day traders, investors making a living from trades....

I would like to see more posts and good commentary on EP w.r.t. derivatives in general, esp. w/ the window of reform opportunity seemingly closing.

but I do not believe this really would affect them that much, it would be the large milli-second institutional speculators.

Also, aren't derivatives trading the entire market limited to about 5 major players? So, why is a market that small of players enabled to bring about a global financial collapse?

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Financial Transaction Tax

There are many small independent traders that trade commodities and financial derivatives and add liquidity to the financial markets. I for one am one of them, and I am not connected to any of the Wall Street firms. I was in the past, although I disliked the investment banking culture and decided to set up on my own with the goal of establishing a track record and one day assisting others with their investment and saving objectives. I am far from being a millionaire, in fact I earn less than a school teacher. But I enjoy my work and it provides an income for my family. I provide liqudity on a small scale by 'taking the other side of a trade' to a hedger, there is some risk involved on each individual trade but by managing my overall risk statistically I am able to generate a relatively steady income. I would be put out of business if the financial transaction tax was passed.

There is little doubt that Wall Street fuelled the property boom by re-packaging mortgage assets and selling them off to third parties and obviously the creation of other OTC derivatives etc has put the financial system at grave risk. But this has nothing to do with the actions of the commodity speculator or even the stock day trader. Traders acted as they always have since commodity exchanges were first established hundreds of years ago by providing liquidity and ensuring a fair price is achieved by both buyer and seller. No single body or central planner can achieve this goal of matching demand and supply more effectively than the market, though history shows that many Governments have tried and failed. As you can see from this year's rally when stock prices collapsed to a bargain level a successful and profitable trader would have been buying shares at these bargain levels and when prices extended too far during the bubble he/she would have been selling. Traders that sell at excessively low prices and buy at excessivley high prices do not last long. If they do, the markets will eventually catch up with them if they repeat such mistakes!

Although there is certainly justification for 'making Wall Street pay for its mistakes' the problem with the proposed financial transaction tax is that the large Wall Street firms that have strong relationships with Government such as Goldman Sachs, Merrill Lynch, Citibank...those firms that WERE reckless, paid record bonuses, put the system at risk, and took taxpayers money...will still exist if a financial transaction tax is introduced. Whereas the small independent trader will be put out of business overnight. Providing liquidity means looking for a small edge and attempting to repeat this multiple times. It is not as easy as it sounds!

Surely it is better in a capitalist economy to have, at its heart, a financial marketplace that is a TRUE market...that is, not one that is made up of five or six large investment banks that are all buddies with the US Treasury and Federal Reserve...'too big or too stupid to fail, with the full backing of the US taxapayer when they screw up'...but a marketplace comprising of a numerous and diverse mix of economic agents, small and large, not just those that are bailed out when they make bad decisions.

By passing a financial transaction tax and punishing those that had nothing to do with the crisis, whilst rewarding those banks like Goldman Sachs by eliminating any competition to them, the US economy will be a capitalist economy only in name.

Blame Wall Street's Banks, Government, Regulators, Mortgage Lenders etc for this crisis, but please don't show ignorance by punishing every member of the financial community for other's mistakes. Many of us in the financial community did not receive a dime of taxpayers money, on the contrary when we are successful a share of our money goes to the Government.

Clearly people are angry at the banks disgusting behaviour, especially now that they are paying themselves record bonuses, but if the goal is to achieve a more competitive, ethical and 'socially useful' financial sector to serve the general public, then other measures such as a levy on banks or windfall tax on bankers bonuses would be a fairer and more effective method of achieving such aims.

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you need to see the actual rules, agreement before judgment

We have day traders here making their living off of trades.

The plan, at least for most of these, should not really hurt the smaller investors bottom lines, even day traders who makes a lot of transactions.

There was a Progressive scaling, so it really hits those large institutional speculators and tuned to capture derivatives and manipulation of actual markets and not the little guys.

then there was a number of trades threshold per time period as well before any tax kicks in.

So, while small investors are "freaking out" on this, it's not what you think. But like any idea, the proof is in the details so even I, who think this is a good idea, will reserve final judgment until I read the rules and legislative text or whatever form it might take.

After all, it wouldn't be the first time a good idea was turned upside down to kill the little guys and enrich the large hedge funds, GS and so on, who truly can manipulate commodities markets and have unfair advantages... with exemptions.

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Hey, Ben W!

When the "MARKET" gets back to providing a primary function of allocating scarce capital to it's most efficient purpose for the benefit of society, I will sympathize with your argument. Right now it is nothing more than a casino and by your own admission you exploit it's weaknesses for your personal benefit. Somehow, in your view, small time players like yourself are a "good" thing even though you play the same game as the large WS financial instituions, just on a much smaller scale.

In other words, day traders are collectively providing useful "liquidity", while the larger firms are just gambling and taking unwarranted risks. Can you offer a single example where your trading activities have supported a positive contribution to the American economy?

You have also stated -

Providing liquidity means looking for a small edge and attempting to repeat this multiple times. It is not as easy as it sounds!

I don't doubt that, but so what? Is this the preferred method to separate the proverbial "wheat from the chaff", the winners and losers in our society? Is our brand of capitalism really a zero sum game? If we all "played the market", then the best would thrive and the rest would fall into ... what?, some kind of societal abyss.

IMO, trading in the "Markets" on a small scale or a large, global scale is the same. The perfect "market" does not exist, and reaching "optimal equilibrium" is not a foregone conclusion. Only regulated markets will result in benefits to the larger society, and the traders supporting that. To that end, the financial transaction tax is one tool that will protect the larger stability of the general economy from the excesses of the investment class. And if it means that you, Ben W., lose your "edge" and have to resort to really allocating your resources to a useful purpose for yourself, then so be it. You have lots of company in that segment of the population.

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Hey commongood

I think that if the aim of the bill is to kill the market then this should be made explicit. But my understanding is that the aim is to create jobs and make Wall Street pay for the taxpayers funds that were used to support the financial system. The net impact would be to CUT jobs within the financial sector(brokerages, exchanges and several support industries such as IT), plus there will negative impacts on those agents like small traders and investors that are being unfairly punished for Wall Street's mistakes.

If the tax was passed then you would be left with a small number of large corporations with close Government ties and vested interests. You can have a very stable centrally planned economic system just like in North Korea but then you have no dynamism or accountability and there will be a far less efficient allocation of scare capital.

I do not dispute that both small and large traders can gamble their capital if they want to, but your capital doesn't last very long if you do that, with the exception being if you are bailed out by the Government! The trading houses that are 'too big to fail' will always be bailed out by the government so they have an extra incentive to gamble - heads they win, tails you lose. In a true capitalist system those companies that failed should not be bailed out. Personally I would protect depositors at all costs and let the shareholder take the hit for their bad investments as opposed to paying for their bad investments with taxpayers money.

When I take the other side of a trade I attempt to minimize risk as much as possible, if I do not hedge my risk successfully I will quickly lose my capital. And even if I do lose my capital nobody else loses out, so there is no risk to society. But when Goldman Sachs or JP Morgan re-packages mortgages or sells credit default swaps it takes an upfront fee, pocketing a cash profit and forgetting about the consequences. When the 'black swan' event occurs later on the firm or the poor guy who acquired the toxic asset loses a truckload and the taxpayer via the Government steps in.

The difference with a small trader is that no public funds are used to cap our downside so we have no incentive to act irresponsibly or else we risk losing our stake. A trader at an investment bank could act responsibly and some do I'm sure, but my re-collection of the business is that the traders play musical chairs, flipping between the various banks every couple of years and pocketing bonuses for short term profits. Meanwhile the risks remain for the firm and more importantly the taxpayer.

To answer your question, every time a trader makes a trade he is contributing to liquidity and making a very small positive contribution to society. Profitable and long standing traders play a vital role in the price discovery mechanism and pay a share of the fruits of their labour to the government in the form of taxes. Is this any different from any economic agent that sources a product and resells to someone else at a higher price? Isn't that the basis behind the capitalist economy?

When I buy it is because my bid price was the BEST price available to all sellers, when I sell it is because my sell price is the BEST price available to all buyers. The person on the other side of the trade may be an investor, corporate or agricultural farmer, and without my price and resulting transaction they would have otherwise have obtained a worse price and lost out. It is a win-win situation. It is of course no different to any other transaction conducted in a capitalist economy, if the two parties did not want to undertake the transaction they have the free will not to transact, but if they do trade it is because they both believe that they benefit from doing so.

I agree with you that there needs to be more effective regulation where the regulators have real powers. Personally I also believe there should be complete separation of the risk taking entities and the commercial deposit taking banking businesses. They should not be mixed together as they are presently, but of course the large investment banks will lobby against that! And you could argue that the off-exchange (over the counter) transactions generate additional risks to on-exchange transactions which are fully transparent and easier to regulate.

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Financial transaction tax

My point to the various Finance Ministers etc was "where else can you raise significant taxes without a hue and cry from those NOT responsible for the recent risky casino behaviour" Might do some good by putting sand in the oil too. Call it temporary, like income tax, if you like:-)
Our website sports a new design today: http://thebrowser.com.

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and more why

if one can charge a tax on food, why would charging such a small tax on market transactions causing us to get blasted by some daytrader forum? (they are). They act like a 0.000005% tax is somehow going to wipe out the market, just absurd.

If profits are there to make, nothing will whip out the market it will just adjust for the new taxes.

Rep. Peter Defazio introduced a modified Tobin tax on oil commodities futures....to specifically address and stop speculation on oil. I think this is really worth a try because it's fairly clear the oil commodities bubble of 2008 was manipulated.

I hope you join us, just create an account, upper right, so you an track your comments. You an also cross post if you have a mind, create a signature sporting your new site design. ;)

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Tobin/Transaction Tax to be introduced next week

Bloomberg is reporting a transaction tax bill will be introduced into the House and Senate next week.

Even Ben Bernanke said in the hearing today it's a good idea. (shocking).

A group of congressional Democrats proposed taxing large transactions in stocks and derivatives, an idea that has received a cool reception from the Obama administration.

Iowa Senator Tom Harkin, Oregon Representative Peter DeFazio and five other House Democrats proposed the measure, designed to raise $150 billion a year to fund a new jobs bill and help close the federal budget deficit.

“Let me be blunt: We need new revenue,” Harkin said at a news conference today in Washington. He called a tax the “most painless way” to raise revenue and stop risky market speculation. “Ask not what America can do for Wall Street, but what Wall Street can do for America,” Harkin said.

House Speaker Nancy Pelosi said there’s a “great deal of merit” in imposing a tax on large stock transactions as long as other major nations do it as well.

Treasury Secretary Timothy Geithner said during a Nov. 7 meeting of Group of 20 finance ministers in St. Andrews, Scotland, that a “day-by-day” tax on speculation is “not something we’re prepared to support.”

Harkin said he will introduce the bill in the Senate next week with Senator Bernard Sanders, a Vermont independent who caucuses with Democrats.

0.25 Percent for Stocks

The measure would be based on legislation DeFazio proposed in the House that would apply a tax of 0.25 percent or 25 basis points to stock transactions in excess of $100,000, and a levy of 0.02 percent or 2 basis points on derivatives including futures, options, swaps and credit default swaps.

Harkin and DeFazio said the proposed new levy is backed by more than 200 economists, the AFL-CIO labor union federation and business leaders including Warren Buffett and Vanguard Group Inc. founder John C. Bogle, now president of Bogle Financial Markets Research.

“I endorse the Harkin-DeFazio bill in principle,” Bogle said in an e-mail released by the lawmakers. He urged “careful study” to find appropriate tax rates. His office confirmed the authenticity of the e-mail.

I'm going to wait for the actual bill for Defazio has two pieces of legislation involving transaction taxes. One was to pay for TARP and the second is specific to oil commodities futures, to stabilize oil and stop speculation on such a critical commodity.

So, since this is obviously getting serious momentum in Congress, I'll wait until we see the actual legislative text to update.

If you notice, there are some high flying investors who are on board for such a tax and they are right, the levels, percentages and thresholds are critical for it to work.

Another problem is it needs to be global, although obviously where derivatives are majority just 5 players, that's much more easy to monitor and tax.

If the U.S. takes the lead, it assuredly could help momentum in other markets, esp. the U.K. and EU.

Example of why a financial transaction tax would be harmful

Dear Robert

Perhaps a numerical example will elucidate my argument against the financial transaction tax. Please bear with me here..

Consider an especially liquid interest rate future such as Dec-09 Eurodollars. This acts as a benchmark for three month US dollar deposit rates and is used as a hedging instrument by many (all?) large companies, government bodies and investors that choose to hedge their risk exposure to interest rates. Typically companies or government entities do not want exposure to interest rate fluctuations that are not central to their core business activity, but such risk naturally arises from the business cycle and funding requirements. The use of such a derivative enables companies to reduce interest rate exposure to a negligible level and manage a component of their non core business risk.

The current two way price of Eurodollars traded on Chicago Mercantile Exchange is 99.7375 offer, 99.7350 bid implying an interest rate of 0.265% to the borrower and 0.2625% to the lender of 3month USD funding. The future instrument is settled against the 3month USD Libor rate in the third week of December 2009. If a transaction tax on derivatives is imposed at 0.02% on both legs of a derivatives transaction, any market maker in Dec-09 Eurodollars would have to reduce his bid price by 0.0200 and increase his offer price by 0.0200. To incorporate the tax into his spread even the most aggressive liquidity provider (market maker) would have to adjust his price to at least as wide as 99.7575 offer, 99.7150 bid.

So the spread for this product would increase from 0.0025 (0.25 basis points) to 0.0425 (4.25 basis points), a ninefold increase in the spread.

Of course volumes would drop enormously due to the additional costs of hedging...many end users would decide not to hedge at all creating additional risks for their business, whilst market makers that currently provide liquidity would be forced to withdraw completely. In my estimate volumes would drop at least 70-95% in most derivatives in which case brokers and exchanges would also be required to increase their fees and commissions in an to attempt to compensate for lost revenues to stay in business. This in turn would cause market makers to adjust their pricing again to an even wider spread level than the theoretical 9 basis points.

In addition the theoretical tax revenue that would be generated from the tax is based on the assumption that volumes will not drop after the imposition of such a tax when the reality is that volumes would be be 5-30% of the present volumes in the derivatives markets. Possibly less, many of the products will simply not trade at all. I have not even mentioned the lost revenue to the taxpayer that would otherwise have been generated from the profits of the trading community, brokerages, exchanges and financial software support companies.

The Eurodollar example is just one picked at random, I could give countless other derivative examples, but when you compound the effects across every equity, bond, commodity derivative and the foreign exchange markets then you are creating an enormous total cost and additional risks to every business that wishes to periodically manage its financial risks. Not to mention the adverse effects on investors and savers when the effects are compounded up over each transaction during the course of the year or their investment lifetime. They key to successful investing is the compounding of small positive returns over long time periods. Negative compounding can have an equal but opposite impact on long term savers and investors that wish to actively manage their investments.

When the public or politicians hear a number like 0.02% it sounds very small but the reality is that any such tax would be devastating for global capital markets. I really don't think you can underestimate how big an impact it would have in terms of jobs lost and revenue lost to the taxpayer when volumes drop across all derivative markets to such an extent. It will be the death bed of capitalism because there will be significant reduction in capital flows, I am certain of that, and there is no doubt in my mind that it will send the US and global economy into a Depression, just as the Smoot–Hawley Tariff Act (the equivalent 'anti-trade' measure introduced in the 1930s when a similar public backlash was taking place against Wall Street) was a major cause of the Great Depression, leading up to World War II.

In my humble opinion, it really would be history repeating itself but with a different flavour. Do you and those pushing for the tax seriously want a policy measure that seems harmless at first glance but on greater inspection would risk such economic and human hardship?

Please reconsider the transaction tax in greater detail. We need support from smart economists that have looked at every aspect of the tax.

Respectfully,
Ben W

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Smoot-Hawley

Firstly that is pure fiction. The U.S. economy simply did not have that much trade and secondly it's been proved time and time again Smoot-Hawley did not cause the Great Depression. It was well under way and the actual amount of GDP created by trade at that time was not very large.

You should look to the falling of the Austrian bank for a major event.

Secondly, on the transaction tax, maybe that's an issue but the idea is to stop hedging as well as dramatically reduce derivatives. There are various proposals. One is to have a transaction tax ONLY on critical commodities, that being oil speculation. Another idea is to only have a tax on a "sell", so you wouldn't have you double tax. Then there are thresholds on the amounts of the trades or the frequency of the trade of a particular item.

It's also fairly clear one needs a global, uniform tax else, why bother to trade on U.S. exchanges or in U.S. markets (in these shores)....

So, while you're digging up examples, I would first take a look at the proposals. It can work and it's a great idea and I find those who oppose it absurd. Of course investors should pay taxes. My God, if one can tax food, social security and employees then why not.

that said, I agree with you that it must be very fine tuned in order to not disrupt markets...

but putting a killing on some of these derivatives, esp. the CDOs and the "black box" ones where the mathematical models are flawed and also, btw, create systemic risk...

sounds like a plan.

but here on EP, there is one thing we know very well and that's trade, so trying to run that crap pushing by those wanting more bad trade agreements that are not free trade, by the theory, in any way, shape or form.....that stuff won't fly.

I seriously suggest reading Baumol and Gomory (see the Reads top link), which goes through the trade theory by layman's descriptions and a host of mathematical proofs and you can see so clearly that it's not a "win-win" game, esp. when enables the means of production to be mobile. Not by a long shot and we're seeing the results in the U.S. as we speak.

That's bad trade, and smart, multilateral trade if one looks at the mathematics of it and the implications.

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Smoot -Hawley, Trade

Thanks Robert for the reading suggestion and point about the Smoot-Hawley...it's been a few years since I studied Trade Theory.

Agree also about the systemic risk caused by several of the 'over-the-counter' derivatives that banks create...even putting a valuation on a lot of the exotic products is a fuzzy affair. I'll let the banks speak for themselves here, I'm sure they will present a case that is difficult to argue against!

And having worked at a high frequency trading firm for a short time I do suspect that there may be an even bigger danger. Nothing untoward or unethical is occurring, and I believe that something like 60% of equity volumes derive from high frequency trading, but mistakes do happen. One day our firm sent something like 100,000 instantaneous cancellation orders and brought down an exchange for 30 seconds, it did make you wonder what would have happened if they had been buy/sell orders...all because of some faulty code...as you know the regulators are typically one step behind the curve, it will only be when something really scary happens that sufficient safety checks will be put in place.

There is certainly a lot for the regulators and industry to look at to make sure that the system is a lot more bullet proof and doesn't have the same potential to adversely impact the rest of the economy. But exchange traded derivatives in particular have stood the test of time pretty well...maybe some tinkering could be made with regard to position limits and regulatory aspects, etc..but little systemic risk here, easy to regulate and serve a useful purpose. Clearly I have a vested interest but nevertheless I'll keep my fingers crossed that any transaction taxes stay clear of exchange traded derviatives!

Thank you for your feedback and publishing my comments.

Best regards
Ben W

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Global Trade and Conflicting National Interests

Global Trade and Conflicting National Interests - Ralph E. Gomory William J. Baumol. is one of my favorite books. The reason is it gets really out of the religion and into the details. I wish the U.S. would implement trade based on some of these book's implications because I don't know about you, but I like to plain win economically, not just give away the farm for nothing.

How about creating an account and being our resident naysayer?

;)

In all seriousness, at least for myself, while I'm very focused on the U.S. middle class, part of this is because when the U.S. middle class is economically strong, the national economy is economically strong....so instead of coming from a socio-cultural view (although that's in there) it's really coming from a "what's the best way to win" viewpoint.

With that, such is the concept of a transaction tax. It could enable much stability, assuredly create a progressive tax, stop some of the naked never take ownership speculation that can cause such havoc as well as deter these "black box" derivatives that are so much a systemic risk....

but examining the details is something few can do because things become so complex and if people are looking at policy, legislation for what actually works and are rational in their discussion, analysis, based on results, stats and so forth....I think that's a very good thing.

I think if the public gets a higher comprehension of policy details, we might be able to beat back the special interests, who usually end up writing these bills (or the ones that get passed at least).

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