Old idea, new thinking

August 27, 2009

The comments by Adair Turner, chairman of Britain’s Financial Services Authority, have reignited a debate over a Tobin tax on financial transactions. A number of commentators including our own Matthew Goldstein have advocated one, but the fact that a financial regulator is publicly floating the idea adds some substantial heft to the discussion.

The tax was proposed by Yale economist James Tobin in 1972, as the fixed exchange-rate system was falling apart, to discourage destabilizing short-term currency speculation.

Megan McArdle, however, is not impressed, questioning how a transaction tax would reduce leverage, one of the prime factors in the financial blow-up. What such a tax would do, she says:

is make a lot of people freak out. If you tax debt transactions, you’ve suddenly got more points on your mortgage, your money market account stops paying much of anything, your credit card comes with a hefty annual fee, and businesses small and large have more trouble borrowing short money to cover temporary cash flow issues. If you don’t tax debt transactions, the largest effect of the tax will be to punish actively traded investment funds.

Tobin, however, who died in 2002, saw such a tax as leading to greater economic stability, notes Larry Elliot in the Guardian.

“Most disappointing and surprising, critics seemed to miss what I regarded as the essential property of the transactions – the beauty part – that this simple one-parameter tax would automatically penalise short-horizon round trips, while negligibly affecting commodity trade and long-term capital investments,” Tobin said [in 1995].

One can imagine many obstacles to such a tax. The regulatory apparatus needed to enforce it would certainly be unwieldy and national tax schemes would only move trading to other more tax-friendly markets. Even amid the public anger over banker bonuses, such a tax would still be a tough sell in the United States.

Still, it is Turner’s willingness to consider ideas that run against the grain of free-market cant that is so refreshing.

As Peter Thal Larsen says: “Turner is right to launch a debate. His comments will also help counter accusations that financial regulators have been captured by the industry they are supposed to police.”

And Gillian Tett of the Financial Times, says that Turner “is to be applauded for at least trying to think the unthinkable again and move away from a crude reliance on creeds.”


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