Monday, November 15, 2010

Economist's View: Why No Financial Transactions Tax?

Economist's View: Why No Financial Transactions Tax?:
Saturday, November 13, 2010

Why wasn't a financial transaction tax part of the Bowles-Simpson deficit reduction proposal?

It would raise substantial revenue and has desirable properties in terms of cooling speculative money flows.

I guess the problem is that the tax falls largely on the wrong people -- those who can afford to pay it.

Posted by Mark Thoma on Saturday, November 13, 2010 at 09:09 AM in Budget Deficit, Economics, Politics
Comments (52)

Reply Saturday, November 13, 2010 at 10:20 PM
don said...

If (as I suspect), the effect on quantity of transactions would be large, the standard economic analysis would indicate that it would have a bigger welfare deadweight loss attached to it than most other taxes.

To offset this, one could argue that the financial transactions are somehow 'evil,' that those who 'trade' add less to society than those who 'invest.' This may have some validity when the trading is pernicious, but I am unconvinced that this describes more than a minimum of transactions. For example, the recent oil price 'speculative' bubble can be seen as a reasonable guess that the future value of oil would be much greater than the present and that we should conserve more now (so prices should change to encourage such behavior).

Speculators win when they are right, in which case they reduce price swings and produce a more efficient outcome for society. If they exacerbate price swings, they lose along with society. I see no need to throw sand in the market mechanism that brings these results. If you say rank speculation helped bring us the financial crisis, I would counter that the crisis was the result of other forces that created huge imbalances, and that speculators brought it to a head more quickly than would otherwise have occurred.

Reply Saturday, November 13, 2010 at 05:17 PM
johnchx said in reply to don...

Don wrote: the standard economic analysis would indicate that it would have a bigger welfare deadweight loss attached to it than most other taxes.

No, the analysis you're thinking of applies to taxes which reduce the output of the taxed good or service. Asset swaps -- such as the exchange of cash for financial instruments -- are not analogous to the purchase of real goods and services. The volume of asset-swap transactions is not a measure of the quantity of goods and services created. So a transaction tax could lead to a drastic reduction in trading volume with minimal loss of welfare.

Reply Sunday, November 14, 2010 at 01:33 AM
don said in reply to johnchx...

? I take the production decline to be the reduction in financial services provided to effect the transactions, including commissions, book keeping costs, etc. The net profits and losses to the traders from asset price changes cancel each other, so they should never be confounded with the social benefit provided by speculative trading ...

While I'm at it, the IRS treats speculation more harshly than other income producing activities. For example, capital gains from futures transactions are marked to market for gains, whereas losses cannot be recognized against most other income, such as interest income. Thus, there is a net taxation of the capital gains from speculative activity, even though the net gains are zero (futures trading losses cannot be netted against most other income, such as interest income). This already discourages futures speculation relative to other income producing activities. It's as if the IRS agrees with those who think 'investing' is a superior social activity to 'trading' (on some quasi-religious grounds not clear to me).

Reply Sunday, November 14, 2010 at 08:18 AM
Bozat said in reply to don...

johnchx gets it right, don wrong.
Applying std econ analysis
to assert welfare deadweight loss,
inappropriate here.

[Nevermind std econ analysis
flawed anyway
re: rational actors,
perfect & symmetric information,
Minsky, Stiglitz,
Akerloff, Fehr,
Loewenstein, Baker,
Galbraith, Ariely
unclog their noses
in Don's general direction.]

Maybe not 'evil', but
to extent 'trading' = speculation
(as opposed to 'investing' or even hedging);
certainly doesn't contribute
to productive output.

'When trading is pernicious... unconvinced'???
With support offered equal
to that offered for your view
(to wit, none... at least so far),
I say systemically calamitous
and positively persuaded.

Ballooning trading volumes,
ballooning weight of Fin sector
in S&P 500 index,
ballooning derivatives'
(CD swaps & otherwise)
notional values greater than
real global GDP,
too many clown-crafted
balloon animals to cite...
particularly while
real economy sputters
and median household income suffers
and income/wealth inequality concentrates
[Gilded Age blossoms again... Huzzah!].
Suggest checking your dictionary again
for definition of 'pernicious'.

'Speculators win when they are right'...
or just plain lucky.
But 'reduce price swings'?
Interesting how VIX correlates
to bubble growth & bursts
and ensuing recessions.
Efficient outcome for society is
explosively carbonated fluid dynamics?

'If they exacerbate price swings,
they lose along with society.'
Unless of course they exit
the trade before the bubble pops,
and the greater fool - society -
is left holding the bag.

'Trading' is a net zero sum game?
Ready, set, debate:
Most evidence suggests it is,
some suggests sub-zero.
Hard to find empirical
(or even logical)
evidence it is above-zero.
Open-minded to proof otherwise,
just don't see it yet.

'... the crisis was the result
of other forces
that created huge imbalances...'
Including 'rank speculation'
or exclusive of such?
Can't tell which is your view?
The latter is pure turd-polishing.

What 'other forces' and why
are these alone culpable?

When speculators all make
the same mistake(s)
in the same direction,
they don't just
'bring it to a head more quickly',
but rather exacerbate it
[the crisis]

Who says speculative bets
are nicely normal distributed
around a Pareto optimal
equilibrium price?
Behavioral econ suggests otherwise.

And why is
'bringing it to a head
more quickly'
an efficient, socially utile
macro result?

Allowing air to escape
from bubbles
more slowly, not faster,
seems more socially utile
than increasingly frequent
and increasingly precipitous
chaotic concussions
of irrational exuberance.

Markets fail
and fail to self-correct.
Sand in gears not full answer,
but better than
c'est la vie, c'est la guerre.

Especially considering
cost/benefit equation.

Agree that unintended consequences
need to be factored
and properly structured around.
But, so far, the only
secondary/tertiary effects
raised to date
have been from parochial self-interests
wringing their hands
over the fate of their
dubious business models.

Reply Sunday, November 14, 2010 at 06:58 AM
don said...

The coloring of speculation as somehow 'evil' relative to good christian 'investing' reminds me of nothing so much as the ignorance Alexander Hamilton had to battle in the debate over establishing a 'modern' system of banking and financial markets. In one notable episode, Jefferson and others wanted to deny the profits to speculators who had bought up Continental script from the soldiers who were paid with it during the Revolutionary War. When the new government honored the script, its value soared. I suppose there are a good number of people visiting this board who would have agreed with Jefferson. I fear the result if they ever start to get their way.

My view - a special tax on speculation will do little more than give markets a case of arthritis, causing them to lurch from one equilibrium to the next with discrete movements after pressures build up sufficiently to overcome the tax. Sort of like friction that prevents movement of the earth's crust until pressure build up sufficiently for an an earthquake.

Reply Sunday, November 14, 2010 at 08:44 AM
Bozat said in reply to don...

Nice piece of history,
will have to read for myself.
Thanks for interesting anecdote.

Don't, however, mistake anecdotes
for evidence.

If proposed FTT rate(s)
were sufficiently high
your view might have
(some) merit.

If, say, they were
so high as to bring
trading volumes to
screeching halt.

But, as presently proposed,
they are not.
Most analyses I've seen
suggest return to
pre-dot com bubble levels.
Don't recall seeing threat
of systemic melt down then.

More like impedance circuit
than tectonic friction.

Heat given off by such an
'impedance' tax
might generate $70B/year;
would help provide resources
for recovery and/or resolution authority,
which is needed given tough
fiscal/political constraints
government faces now.

Especially if deliberately reserved
exclusively for such purposes.

Speculation not 'evil',
just socially non-utile, at best.
Investment IS socially utile
(raises capacity for productive output),
hedging less so
(neutral to marginal positive),
but not objectionable.
Speculation can/does distort
real capital formation,
and offers nothing for
the common weal.

Not 'evil', per se,
but clearly not 'good' either
from a social perspective.

has nothing to do with it.
Stop proffering the red herring.
Like pagan sacrifice of same name,
your straw man is already in ashes.

Reply Sunday, November 14, 2010 at 12:22 PM
don said...

'Heat given off by such an
'impedance' tax
might generate $70B/year;
would help provide resources
for recovery and/or resolution authority,'

Agreed. But I think there are more efficent ways to do this. In particular, requiring insurance payments for implicit insurance now received by the TBTF's.

'Speculation not 'evil',
just socially non-utile, at best.'

Here, we disagree strongly. The classic arguments on this issue were made by Milton F in the context of currency markets. The arguments cross over nicely to most financial markets, and almost certainly to large commodity markets such as oil.

Reply Sunday, November 14, 2010 at 05:03 PM
Bozat said in reply to don...

Glad we agree on something. ;@)

TBTF institutions' assessments
fine idea IMHO,
'tho why we allow TBTF
in the first place
is Bizzarro world logic.

Expand anti-trust
to include systemic risk,
not just monopoly/anti-competition et seq...
Volcker Rule appropriate, too,
tho it seems destined
to be emasculated
by Spencer Bachus
and/or gamed by TBTF institutions.

Haven't seen numbers...
How much would/will
such additional assessments
generate in receipts to fund
resolution authority?

Is it enough
(frankly, would $70B+ from FTT be enough)?

Comparative efficiency analysis
would be nice, too.
Curiouser and curiouser!

Yes, we do disagree strongly
re: social utility of pure speculation.

I don't dispute
price stabilizing function.
Just see crowd behavior
& positive feedback loops
creating ever larger
bubbles, bubbles everywhere
more rapidly & frequently.

Last one triggered
10+% peak unemployment
and 18% underemployment
and massive bailout
and risk of deflation
and so on and so forth.

At the end of the day,
net net,
scales tilt towards
social non-utility.

Anyone done
an inter-temporal,
infinite horizon
study that calcs
and compares
the NPVs?

Til then,
I will remain skeptical...
open to being persuaded,
but classical arguments
fall short (so far).

I love Uncle Miltie!
Slept with 'Free To Choose'
under my pillow
as a young man.
Then I grew up.

Problem is, MMT
- like classical, neo-classical,
neo-liberal, et al schools -
suffers from faulty first principles:
Assumes perfectly rational actors
and symmetric information,
among other things.

Behavioral econ refutes the first,
Information econ refutes the second.
Where's that leave Uncle Miltie?

Not wrong, at least completely.
But not entirely right, either.
MMT works within limits,
but can burp wildly at the extremes.

Above the entrance
to the temple of Phoebus Appollo
at the Oracle of Delphi
was inscribed:
μηδέν άγαν (mēdén ágan = 'nothing in excess').
True then, true now.

A minuscule FTT
is an attempt to set
a reasonable limit.

The goal is not
to sound the death knell
for speculative trading.
Witness the LSE's stamp duty:
Trading not dead in London.

Finally, I'm not dead set
in favor of an FTT.
Just more in favor of such
than I am
of classical econ logic.

Reply Sunday, November 14, 2010 at 08:39 PM
derangedlemur said in reply to don...

Given that the swings in price caused by speculation are observably faster than the underlying produciton can react to, the theory you quote is plainly bollocks.

Reply Monday, November 15, 2010 at 07:23 AM
don said in reply to derangedlemur...

It is precisely the limits of production that give speculation its greatest potential social benefit.

The notion that speculation is destabilizing is highly suspect. It is possible, but it requires that the (weighted) sum of speculators must lose, which would make the endeavor a curious economic phenomenon.

Yes, I know that the vast majority of speculators (by number) who participate in the Chicago market lose on net - the answer must lie in the utility of wagering in a venue with much, much fairer odds than offered by Vegas. And no, I can't see the majority of these markets being gamed by insiders - certainly not currency markets or those of major commodities.

Bubbles don't require speculators. Our housing bubble could have appeared with only home owners making what they viewed as 'investments.' In fact, I doubt true speculation played much of a role in the housing market - those buying with intent to sell short term (flip). In the first place, the opportunities for taking naked short positions were lacking (I know - I was looking for them since in 2005, 2007 and 2007).

Reply Monday, November 15, 2010 at 09:43 AM
Bozat said in reply to don...

'Potential' social benefit
is not actual social benefit.
don speculates again
- clearly it's in his make-up -
apparently believing
that the possible
better represents true value
than the actual.
I think he ignores
big externalities.

'The notion that speculation is destabilizing is highly suspect.'

You seem to conflate
'is' with 'is always'.
How very Clintonion.
Do we really have to debate
what the meaning of 'is' is?
Change the first 'is'
to 'is sometimes'
and the second 'is'
becomes 'is not'.

'It is possible, but it requires that the (weighted) sum of speculators must lose, which would make the endeavor a curious economic phenomenon.'

So close, yet so far,
and so stubborn.
If 'is possible' = HAS happened
then '(weighted) sum' = HAS lost,
n'est-ce pas?
Then curious but real nonetheless.
Curiouser and curiouser, indeed.

[Some] Bubbles don't require speculators,
that's true,
but on the other hand
some do, too.
Your housing market analysis
is incomplete.
Credit default swaps
on mortgage backed securities
totaling $70 Trillion (notional)
more than entire global GDP
all based on models
that assumed *and then magic happens*
(i.e., housing price growth always > 0%)
at the center of all their equations.
CDS are derivatives,
but not 'true' speculation?
Maybe you have a different definition?

To whatever extent
speculation contributed
to the financial meltdown
and ensuing real economic recession,
I doubt John Paulson's winning bets
or Goldman's or whoever's
compensate for the externalities
imposed on the rest of us.

As Jack Sparrow said,
'Ah-ha! So, we’ve established my proposal
[in this case, an FTT]
as sound in principle.
Now, we’re just haggling over price.'
I'll even stipulate to tailoring
rates by type/category.
Number of bips worth
of sand in the gears
needed to adequately compensate
and/or to mitigate is debatable
and worth quantifying.

Reply Monday, November 15, 2010 at 05:21 PM
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