GLORY be, we are to be saved! As the TUC, President Nicolas Sarkozy, Chancellor Angela Merkel and the European Parliament agree, impose a Financial Transactions Tax (FTT) upon the banks and Europe, or at least the euro, will be saved. The banks shall pay for their errors and kittens will gambol in sunshine once again.
The FTT is a Tobin Tax, the Robin Hood Tax. Levy just a teensie 0.05 per cent tax on every financial transaction and raise hundreds of billions to do lovely things. Support the euro perhaps, or pay off the Greek debts. Oxfam wants to alleviate poverty, the eurocrats think they should just spend it.
There are, however, a few problems with the idea. We had a global economic crisis due to mortgages and securitised bonds, and today we’re on the lip of another thanks to an excess of government bonds. None of these things are heavily traded, so a transactions tax has little to no effect on them. In fact, none of the things likely to be taxed caused problems: the foreign exchange markets, options, futures, money markets, interbank loans... Not taxing the problem and taxing what was not a problem is about par for the political course.
Another justification offered is that speculation causes price volatility. Volatility is bad, so why not tax speculation in order to reduce it. Unfortunately, only outside the economic literature do we find the assertion that speculation increases volatility: inside it, the insistence is that speculation reduces such volatility. As Adam Smith told us it did 235 years ago in book four, chapter five of The Wealth of Nations. So the FTT aims to tax away the activity that reduces volatility: entirely counterproductive.
What’s worse than these childish misunderstandings, though, is an entire gawping ignorance of tax incidence. Who hands over the cheque for a tax is not necessarily the person who is carrying the economic burden of that tax. We’ve known for over a century, since Edwin Seligman’s On the Shifting and Incidence of Taxation, published in 1899, that companies do not pay taxes. A tax leads to a lighter wallet for some live human being: companies are not live human beings so it cannot be them that are paying. So while the desire to make the banks pay might be sincere, imposing a tax upon the banks isn’t going to achieve that. Banks, being companies, cannot and do not pay taxes.
Who pays a transactions tax? We, the consumers do. Start with Sir James Mirrlees (Nobel Laureate, knows his economic onions) who has pointed out that transactions taxes are a bad idea where alternatives are available, for they cascade through the economy, multiplying. We could add Joe Stiglitz (beard, Nobel, onions known, etc.) who in 1980 pointed out that the incidence of a corporate tax could be greater than 100 per cent. That is, the revenue gained is less than the amount lightened from the wallets of those human beings bearing the burden.
Imagine a 0.005 per cent, 0.5 basis points (bps) tax on foreign exchange. A well-traded pair these days might have a 0.5 bps spread. As intended, this reduces liquidity, drives the excessive speculation out of the market. Excellent, less liquidity, spreads will widen. They only have to widen to 1 bps for the burden of the tax to be 200 per cent of the revenue raised. The consumer in the end, of course, coughs up. And it cascades: much Italian pasta eaten in Britain is made from Canadian wheat, so before it hits the plate there will be transactions in the wheat futures market, currency transactions from loonie to euro to sterling, a bit of hedging here and there. These real transactions, not speculation, all leading to a plate of spag bog, will have paid the tax five, 10 times and each time potentially the cost on the final meal is higher than the revenue raised.
This isn’t taxing the banks, this is taxing us, in a grossly inefficient manner.
Another part of the FTT proposal is that overnight interbank loans should be taxed at 0.05 per cent (5 bps). With 250 banking days a year this makes overnight Libor 12.5 per cent or 25 per cent depending upon whether the tax is once or both in and out. Does anyone really think that high short-term interest rates are a good idea just now?
Thus the major problem with the FTT: it’s based upon ignorance. It won’t be banks that pay it. It will be us, the average consumer, stung on every minor and major transaction in the economy. Further, the amount we’re stung will be higher than the amount raised in tax. Whether those who are proposing it are ignorant of all this is unknown: it could be that they are sufficiently cynical to know but think that we are ignorant enough to not.
As to calling it the Robin Hood Tax, perhaps we should remind them of the original Robin of Loxley. He made his bones resisting those collecting unjustly levied taxes, not imposing them.
Tim Worstall knows more about the metal scandium than is perhaps wise. He is the author of Chasing Rainbows: Economic Myths, Environmental Facts.
While the desire to make the banks pay might be sincere, imposing FTT won’t do that.