Wednesday, September 30, 2009

Tobin Club - tax financial transactions

In the aftermath of the sub-prime mortgage crisis, James Tobin's proposal for a tax to deter speculative short-term cross-country currency transactions, is finding increasing support among economists, regulators and policymakers. In fact, they have gone further ahead and proposed taxes on various other forms of financial transactions, including the likes of "bailout" and "too big to fail" taxes.

The fundamental rationale behind such taxes is that many types of financial transactions, especially those involving complex financial instruments whose risks are both difficult to locate and assess, generates negative externalities. In similar circumstances, taxes have been found to be more effective than regulation in internalizing the external costs by aligning private incentives with social costs and benefits, with the least distortions and the greatest efficiency. Apart from restraining undesirable complex and high-risk financial transactions, such taxes would also raise revenues to finance the enactment of measures to more effectively regulate such transactions and build up an account to fund bailouts when required.

Edward Glaeser is the latest addition to the Tobin Club by favoring the imposition of a tax on banks which would be based on their respective systemic risks. He feels that such taxes are easier to administer and superior to regulations,

"Slapping an appropriate tax on these entities would have generated revenue and limited their desire to impose extra risks on the American taxpayer... Calculating such a tax may seem incredibly hard, but well-designed regulations require even more knowledge. Consider the proposal to ban certain firms from trading in derivatives. To determine whether this ban makes sense, we would need to know both the impact of such trading on expected bailout costs and the private benefits that such trading yields for each firm. To micromanage a firm’s trading strategy, a regulator needs to know private benefits and social costs. Designing a sensible tax just requires knowing the costs to the taxpayer.

A tax is also less likely than regulation to stifle innovative activity. Giving a firm the option to act, for a price, is less intrusive than banning actions altogether. Regulations have often served industry insiders by creating barriers that prevent the entry of smaller competitors. An appropriate systemic-risk tax would have no such effect, since new firms would usually be small enough to fail...A tax also generates revenues, which offset the cost of future bailouts."

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