In Support of the 'Tobin Tax'

A "Tobin Tax" was originally designed to be a tax on foreign currency transactions with the goal of reducing short-term speculation. The economist James Tobin suggested that a tax of about 0.25% be levied on all foreign currency transactions; the income earned from the tax would be incidental; the greater effect would be to dampen speculative money flows that wreck havoc on economies. There is now widespread talk of applying a Tobin tax to all financial transactions.

The most obvious effect of the Tobin Tax would be to shrink the financial sector. As a professional trader at a large market-making firm, a Tobin tax would likely be devastating to my career, so my writing this week may surprise you. In this article I'll lay out a vigorous case for why the Tobin tax should be implemented. The objections to the Tobin tax are more obvious than its benefits so I'll present the case in a question and answer format.

1) Will a Tobin Tax Increase Unemployment?

If the financial sector shrinks, won't a lot more financial professionals be out of work?

By definition, investors as a whole will perform exactly as well as the market (minus transaction costs). If everyone expends a lot of time and energy to beat the market, as a group, they are wasting valuable resources. Now, a little bit of competition is healthy as investors research companies and help push asset prices where they should be. However, many of the smartest engineers and business minds now devote themselves purely to outwitting one another in completely useless ways. There are some twenty hedge funds filled with programmers and engineers trying to figure out how to send orders to stock exchanges a millisecond faster than one another. The fastest will make billions of dollars in profits. Yet reducing latency from 200 milliseconds to 190 milliseconds provides absolutely no value to society, or even to the market as a whole. These hedge funds soak up large amounts of the intellectual capital of the country. For the last few years about 30% of Harvard's MBA graduates have been heading to Wall Street jobs. These are the business leaders who could be entrepreneurs inventing new services or managers finding ways to increase labor productivity. Instead, they're "playing poker" (e.g. pursuing technical analysis, algorithmic trading, and low latency trading) with astrophysicists and electrical engineers who have also been enticed by the higher pay of Wall Street. It's impossible to estimate the cost to society of having these otherwise productive people spend their time siphoning money off the general public.

Depending on the scale of the Tobin Tax, it could well put 30% of all financial professionals out of business. That's a good thing. We want our electrical engineers working on cheaper energy, not trying to send stock orders a millisecond faster than engineers at another hedge fund.

2) Will a Tobin Tax Make the Market Less Efficient?

The "efficient market hypothesis" suggests that the more speculators are involved in a market, the more "efficient" the market will be. These speculators might push the value of stocks and other assets to "fair" value which helps the capital markets run smoothly. For example, by pushing the stock price of a good company higher, speculators let that company raise capital to expand. By lowering the stock price of an insolvent company, speculators signal to the company's creditors and suppliers that the company is in trouble. This is great in theory, except it doesn't actually happen.

When transaction costs are very high, only a handful of market participants can earn significant profits. The less skillful investors/traders go out of business quickly, because not only do they need to beat their competitors, they also need to overcome the higher costs of business. So with high transaction costs, the main market movers are the very best investors/traders. As the transaction costs are lowered, less and less skilled gamblers are enticed to play, and these gamblers do what you'd expect - they push prices in stupid ways. It's these less skilled gamblers that produced the tech bubble in the late nineties and the real estate bubble we're still dealing with. Lower transaction costs act similarly to easy credit - they encourage gambling. Gambling makes the market less efficient as the gamblers are more likely to act as a herd and send prices far from fair. So a Tobin Tax might make the markets more efficient. While this isn't clear, I judge it unlikely that a Tobin tax will make the markets any less efficient.

3) Will a Tobin Tax Drive Up Transaction Costs?

The more speculators are involved in a market, the more liquidity the market will have. The idea is that the speculators reduce the bid/ask spreads and therefore reduce the transaction costs to all involved. For example, today you can buy Microsoft stock for $28.51 and sell it at $28.50. This suggests that the fair value is $28.505, so the theoretical cost to execute the transaction is just half a penny. If there weren't so many speculators constantly willing to bet on Microsoft's stock, you might have to pay $28.61 to buy the stock and you'd only be able to sell it at $28.40. The fair value is still $28.505 but now you're paying more than a dime to execute the trade. Wouldn't the Tobin tax drive up transaction costs and therefore be a burden on all of society?

A Tobin tax would certainly raise transaction costs, but this isn't necessarily a bad thing. For example, we deliberately make cigarettes more expensive with a tax to discourage people from smoking. In this analogy, the effect of speculation on society is similar to that of smoking. It's true that anyone buying or selling Microsoft stock would effectively pay more to do so, but for investors, the cost is negligible. Warren Buffett deliberately kept the bid/ask spread of Berkshire Hathaway wide to discourage speculation. Most people lose money trading stocks. In fact, more than 70% of professional mutual fund managers underperform the indexes they try to track. In other words, the more you play the stock market game, the more you're likely to lose. Yet, many retail investors believe they can consistently beat the stock market and are convinced to gamble and try. They're lured by "low commissions" on stock trades and they're lured by small bid/ask spreads. The low transaction costs make it seem inexpensive to gamble. The low costs make it seem like they have a great chance of wining. With higher transaction costs, many of these hopeless gamblers would be dissuaded from gambling in the first place. Not only does stock market gambling cost the general public great amounts of money, it produces a deadweight loss to society. Where does the lost money go? It goes to professional traders who only exist because the public keeps losing money. If the public stopped gambling on stocks, the traders (who are generally bright and well educated) would find gainful employment producing something of value to society. The higher transaction costs from a Tobin Tax would keep more money in the public's pockets.

4) Isn't a Tobin Tax a "tax", and aren't taxes bad?

Whatever money the Tobin tax raises will be coming out of the already weak financial sector, businesses, and even an individual's 401K. Isn't this bad?

The most obvious "benefit" of the tax - the generation of revenue, is the least important benefit. Taxes aren't inherently a good thing or a bad thing; they redistribute income and depending on how intelligently the government spends the money, that could be productive or destructive. It's also important how the tax is collected. For example, income taxes have been proven to reduce the amount of time people spend working, obviously a destructive side effect. The Tobin Tax is about as productively collected a tax as I can imagine. If managed properly, it would have little impact on the kind of financial transactions that benefit society, but would eliminate a great bulk of the kind of transactions that are harmful. For example, if a company is a great investment, that 0.25% tax wouldn't dissuade any intelligent long-term investor from buying their stock. However, it would completely end stock day trading. The effect on an individual's 401K would be negligible; the vast majority of the tax would initially come from financial speculators, many of whom would quickly leave the industry. The remaining burden of the tax would fall on legitimate hedgers and the remaining profitable speculators.

5) Can We Trust That the Tax Will be Intelligently Applied?

Isn't it likely that big financial firms would find ways to outsmart the regulators and gain legal loopholes or simply escape enforcement? The big firms have ignored other rules like the "uptick rule" for shortselling, or the ban on naked shortselling.

This is a very real and serious criticism. If you believe the federal government is not competent enough to impose meaningful financial regulation, you are justified in opposing a Tobin tax as it could be abused to merely solidify the oligopoly of the major financial players. To implement an uniform Tobin tax, we will probably need the kind of populist anger and political consensus that existed in the great depression and gave rise to the Glass-Steagall Act.

In Summary: A Tobin tax would reallocate smart hardworking people from the "poker game" of trading and wealth management, to more productive enterprises. If applied intelligently, it would reduce speculation, dissuade the public from wasting time and money gambling in the stock market, and have few negative effects. It seems unlikely to gain enough political support to pass, and even if it was passed by all the major financial centers, there would be a real risk that it would not be uniformly applied.

Comments

[Taxprey]

Tobin/financial/securi... transaction tax is like a sick, morbid, act of self-immolation, an act of wealth destruction of the middle class. Even Tobin himself was against his own tax towards the end of his life. The tax will not stop the long-term speculation that moves the markets to extreme bubbles and crashes as shown by the few countries left that still have the tax during this financial crisis. Proponents of the tax claim financial activity will be reduced by 90%, back to the 1980's levels. For every job lost in an industry, 6 more unrelated jobs are lost, so expect a few million innocent bystanders to be hit in this drive-by tax. Where will all these people find a job when there are already tens of millions unemployed? Are these millions of people supposed to be engineers and what are they going to engineer? They would all have to be working on a government funded project costing trillions. All that trading activity is what makes the markets since the demise of the market makers. How much will it cost the average investor? A study shows that in 1986 the average spread was $0.53, that's a 2% loss upfront on a $25 stock. Plus the tax itself and much higher fees because of all the brokerages failing. Reduced compounding will be the greatest loss, expect to see returns reduced by one third to one half over a working lifetime. Even the IMF and Russia are against such a draconian tax. The increased cost of firms own transactions will increase the cost of doing business to be passed down to the rest of us through higher fees. Another negative to be spun into a positive: 10-14-09, Taiwan tax commission wants to introduce for a 3rd time a stock transaction tax. 1973 was the first time they introduced the tax, result: the market fell 63% within a year. In 1988 they reintroduced the tax for a second time, result: 19 consecutive losing days, down 43% in less than 3 months. Source: taiwannews.com.tw

2009 Nov 13 08:50 AM

[Ferdinand E. Banks]

I can remember when the Tobin tax was being talked about at my university. My reaction was that if anyone mentioned it in a seminar or lecture where I was present, they would hear some very unacademic language about their intelligence. The Tobin tax is nonsense.

2009 Nov 13 09:05 AM

[William Legrand]

I cannot disagree more. The whole point of this "tax" is for money-grubbing politicians to skim money from the top of millions upon millions of dollar-cost-averaging and 401(k) investors, who tend to make small purchases ranging from weekly to monthly. An 0.25% upfront "tax" could easily double or triple their upfront investment cost, possibly making them less likely to invest, and certainly having a large negative impact on their portfolio's worth over the long haul. If there is any hope of encouraging people to stand on their own in retirement, rather than assuming Uncle Sam (that is, working taxpayers) will be there to fund their retirement costs through social security and various "entitlement" handouts, then upfront investment costs must be as low as possible (not the other way around). No, sir, the idea of a universal Tobin tax is foolish beyond measure.

A far better approach is to impose a huge federal tax margin, say 50%, on gains from equity and bond purchases held less than 60 days or so. I guarantee this would greatly discourage wild speculation and market timing (ultra shorts), while having very little to no impact on the average mid- to long-term investor.

2009 Nov 13 10:04 AM

[User 176317]

From your article:

" For the last few years about 30% of Harvard's MBA graduates have been heading to Wall Street jobs. These are the business leaders who could be entrepreneurs inventing new services or managers finding ways to increase labor productivity. Instead, they're "playing poker" (e.g. pursuing technical analysis, algorithmic trading, and low latency trading) with astrophysicists and electrical engineers who have also been enticed by the higher pay of Wall Street. It's impossible to estimate the cost to society of having these otherwise productive people spend their time siphoning money off the general public."

Wait -- you want THEM to go back to work, presumably so that it can be YOU who is sitting around writing these articles and adding no value? Come on.

The answer is not to tax the system, and not to question the usefulness of the people working in it. The answer is to let the free market operate. Right now, the reason why there is money to be made in the markets (from, for example, high-frequency trading) is because the markets have a ways to go before they are efficient. And efficient markets (ones which react quickly and correctly to news) ARE a good thing for society. Companies that make good decisions SHOULD get rewarded with higher stock prices. Companies that make poor decisions SHOULD get punished with lower stock prices. The fact that engineers are working to shave off milliseconds should not be a concern to you or other people sitting around articles about things they know nothing about. What we should ask ourselves is, "Why is there so much money to be made doing that, and not much money to be made curing cancer or creating cheap energy?". The answer is twofold: First, investors are idiots. Second, there is no reward system for being brilliant anywhere EXCEPT for Wall Street.

To the first point: For a long, long time investors have been absolute idiots when it comes to investing their money. They plop money into their 401K and let Fidelity manage it, and the fees that Fidelity charges (while not onerous to any single investor) really add up when spread across millions of accounts. If people would use sites like Morningstar to actually look at survivorship bias and fund performance AFTER fees and AFTER all of the other numerical obfuscations, they would see that their funds suck. And they would pull their money out, thus reducing the fees and removing money from the system. If this were to happen ("efficient investing"), then you would start to see the engineers leave Wall Street because there would be no fees sloshing around to pay them. I don't think it will happen anytime soon though, because people just don't seem to take much of an interest in their portfolios.

To my second point, the reason why there is no reward system for curing cancer is because of how corporations are set up. They need to pay upper management less and reward the researchers more. But that's a whole other topic....

2009 Nov 13 10:05 AM

[mikeethegerman]

Maybe this could work if all capital markets in the world had it. If only a few have it, all it will do is push the speculative capital to the cheaper markets. I am just stunned by the era of "neo socialism" that the US is in. Wake up people, what made this country great is freedom of all sorts, not stupid taxes and the Department of Homeland Security.

2009 Nov 13 12:07 PM

[Vega]

Society accepts that the "free market" produces many negative externalities. For example, we make hard drugs illegal and dis-incentivize smoking with taxes. This is a similar idea. The same way the Consumer protection agency prevents you consumers from buying asbestos tainted oven mitts, the SEC protects consumers from idiotic investment decisions. This would act to further dis-incentivize harmful decisions for both the individual and society.

On Nov 13 10:05 AM User 176317 wrote:

> From your article:
>
> " For the last few years about 30% of Harvard's MBA graduates have
> been heading to Wall Street jobs. These are the business leaders
> who could be entrepreneurs inventing new services or managers finding
> ways to increase labor productivity. Instead, they're "playing poker"
> (e.g. pursuing technical analysis, algorithmic trading, and low latency
> trading) with astrophysicists and electrical engineers who have also
> been enticed by the higher pay of Wall Street. It's impossible to
> estimate the cost to society of having these otherwise productive
> people spend their time siphoning money off the general public."
>
>
> Wait -- you want THEM to go back to work, presumably so that it can
> be YOU who is sitting around writing these articles and adding no
> value? Come on.
>
> The answer is not to tax the system, and not to question the usefulness
> of the people working in it. The answer is to let the free market
> operate. Right now, the reason why there is money to be made in
> the markets (from, for example, high-frequency trading) is because
> the markets have a ways to go before they are efficient. And efficient
> markets (ones which react quickly and correctly to news) ARE a good
> thing for society. Companies that make good decisions SHOULD get
> rewarded with higher stock prices. Companies that make poor decisions
> SHOULD get punished with lower stock prices. The fact that engineers
> are working to shave off milliseconds should not be a concern to
> you or other people sitting around articles about things they know
> nothing about. What we should ask ourselves is, "Why is there so
> much money to be made doing that, and not much money to be made curing
> cancer or creating cheap energy?". The answer is twofold: First,
> investors are idiots. Second, there is no reward system for being
> brilliant anywhere EXCEPT for Wall Street.
>
> To the first point: For a long, long time investors have been absolute
> idiots when it comes to investing their money. They plop money into
> their 401K and let Fidelity manage it, and the fees that Fidelity
> charges (while not onerous to any single investor) really add up
> when spread across millions of accounts. If people would use sites
> like Morningstar to actually look at survivorship bias and fund performance
> AFTER fees and AFTER all of the other numerical obfuscations, they
> would see that their funds suck. And they would pull their money
> out, thus reducing the fees and removing money from the system.
> If this were to happen ("efficient investing"), then you would start
> to see the engineers leave Wall Street because there would be no
> fees sloshing around to pay them. I don't think it will happen anytime
> soon though, because people just don't seem to take much of an interest
> in their portfolios.
>
> To my second point, the reason why there is no reward system for
> curing cancer is because of how corporations are set up. They need
> to pay upper management less and reward the researchers more. But
> that's a whole other topic....

2009 Nov 14 10:26 AM

[Vega]

I would be happy if a Tobin tax was implemented and it cost me my job. I am working on transitioning from being a trader to being a an investor. That's part of the reason why I write this blog, it lets me work on my analysis.


On Nov 13 10:05 AM User 176317 wrote:

> From your article:
>
> " For the last few years about 30% of Harvard's MBA graduates have
> been heading to Wall Street jobs. These are the business leaders
> who could be entrepreneurs inventing new services or managers finding
> ways to increase labor productivity. Instead, they're "playing poker"
> (e.g. pursuing technical analysis, algorithmic trading, and low latency
> trading) with astrophysicists and electrical engineers who have also
> been enticed by the higher pay of Wall Street. It's impossible to
> estimate the cost to society of having these otherwise productive
> people spend their time siphoning money off the general public."
>
>
> Wait -- you want THEM to go back to work, presumably so that it can
> be YOU who is sitting around writing these articles and adding no
> value? Come on.
>
> The answer is not to tax the system, and not to question the usefulness
> of the people working in it. The answer is to let the free market
> operate. Right now, the reason why there is money to be made in
> the markets (from, for example, high-frequency trading) is because
> the markets have a ways to go before they are efficient. And efficient
> markets (ones which react quickly and correctly to news) ARE a good
> thing for society. Companies that make good decisions SHOULD get
> rewarded with higher stock prices. Companies that make poor decisions
> SHOULD get punished with lower stock prices. The fact that engineers
> are working to shave off milliseconds should not be a concern to
> you or other people sitting around articles about things they know
> nothing about. What we should ask ourselves is, "Why is there so
> much money to be made doing that, and not much money to be made curing
> cancer or creating cheap energy?". The answer is twofold: First,
> investors are idiots. Second, there is no reward system for being
> brilliant anywhere EXCEPT for Wall Street.
>
> To the first point: For a long, long time investors have been absolute
> idiots when it comes to investing their money. They plop money into
> their 401K and let Fidelity manage it, and the fees that Fidelity
> charges (while not onerous to any single investor) really add up
> when spread across millions of accounts. If people would use sites
> like Morningstar to actually look at survivorship bias and fund performance
> AFTER fees and AFTER all of the other numerical obfuscations, they
> would see that their funds suck. And they would pull their money
> out, thus reducing the fees and removing money from the system.
> If this were to happen ("efficient investing"), then you would start
> to see the engineers leave Wall Street because there would be no
> fees sloshing around to pay them. I don't think it will happen anytime
> soon though, because people just don't seem to take much of an interest
> in their portfolios.
>
> To my second point, the reason why there is no reward system for
> curing cancer is because of how corporations are set up. They need
> to pay upper management less and reward the researchers more. But
> that's a whole other topic....

2009 Nov 14 11:38 AM

[auto44]

I gave your comment a + but investors are not idiots. If they were they would not have money to invest. Most of them are hard working folks raising families and they don't have the time or energy to do what we do. I give investing a great deal of time and energy as I am sure you do and find it very difficult to make wise decisions.


On Nov 13 10:05 AM User 176317 wrote:

> From your article:
>
> " For the last few years about 30% of Harvard's MBA graduates have
> been heading to Wall Street jobs. These are the business leaders
> who could be entrepreneurs inventing new services or managers finding
> ways to increase labor productivity. Instead, they're "playing poker"
> (e.g. pursuing technical analysis, algorithmic trading, and low latency
> trading) with astrophysicists and electrical engineers who have also
> been enticed by the higher pay of Wall Street. It's impossible to
> estimate the cost to society of having these otherwise productive
> people spend their time siphoning money off the general public."
>
>
> Wait -- you want THEM to go back to work, presumably so that it can
> be YOU who is sitting around writing these articles and adding no
> value? Come on.
>
> The answer is not to tax the system, and not to question the usefulness
> of the people working in it. The answer is to let the free market
> operate. Right now, the reason why there is money to be made in the
> markets (from, for example, high-frequency trading) is because the
> markets have a ways to go before they are efficient. And efficient
> markets (ones which react quickly and correctly to news) ARE a good
> thing for society. Companies that make good decisions SHOULD get
> rewarded with higher stock prices. Companies that make poor decisions
> SHOULD get punished with lower stock prices. The fact that engineers
> are working to shave off milliseconds should not be a concern to
> you or other people sitting around articles about things they know
> nothing about. What we should ask ourselves is, "Why is there so
> much money to be made doing that, and not much money to be made curing
> cancer or creating cheap energy?". The answer is twofold: First,
> investors are idiots. Second, there is no reward system for being
> brilliant anywhere EXCEPT for Wall Street.
>
> To the first point: For a long, long time investors have been absolute
> idiots when it comes to investing their money. They plop money into
> their 401K and let Fidelity manage it, and the fees that Fidelity
> charges (while not onerous to any single investor) really add up
> when spread across millions of accounts. If people would use sites
> like Morningstar to actually look at survivorship bias and fund performance
> AFTER fees and AFTER all of the other numerical obfuscations, they
> would see that their funds suck. And they would pull their money
> out, thus reducing the fees and removing money from the system. If
> this were to happen ("efficient investing"), then you would start
> to see the engineers leave Wall Street because there would be no
> fees sloshing around to pay them. I don't think it will happen anytime
> soon though, because people just don't seem to take much of an interest
> in their portfolios.
>
> To my second point, the reason why there is no reward system for
> curing cancer is because of how corporations are set up. They need
> to pay upper management less and reward the researchers more. But
> that's a whole other topic....

2009 Nov 14 11:13 PM

[tool]

I disagree with a Tobin Tax. Politicians only want to use this tax to make some easy money while the tax initially was supposed to stop speculation. Well I think if you tax 0.1% of the total value of each transaction indeed all speculation will stop.For a trader it is just impossible to make 0.1% on average on every transaction.

I will pull all my money out of the stock market for sure because why would anyone want to be invested in stocks? Management of listed companies pay themselves on average 350 times that of the average worker so they absorb all profits made if they make any at all. The only reason stock markets go up is because they create more money and not because these listed companies create any value. Look at these companies. Most go bankrupt within 2 years after the IPO and the management has their pockets filled with millions of dollars. Why the hell would anybody put their money into something like that.

The only thing what will happen if you introduce this tax is that holders of assets will jack up prices. If I would have an oil company I would make sure these oil futures will be high. No more traders to worry about. I expect you will get a dead market with improper valuations all over the place. I for sure will have nothing to do with it. The people who own the assets will determine everything and the world will be a bit more unfair as it already was.

If you politicians want money why don't you look at some people who have been compensating themselves outrageously for years. Dick Fuld with 1 billion on his bank account and many more of these crooks. Management of listed companies paying themselves 100-s of millions of dollars. That is just unfair. If they want to do that they should take the company private. But that's not what they want because if they were a private company they would be gone within 6 months with the compensations they give themselves.

The markets are a closed system. It is not like all traders can get rich. Some lose some win. Myself I follow the trend with only small transactions. It makes me sick they always find some easy way to steal from you.

2009 Nov 18 07:49 AM

[ray b]

I don't see how such a small tax would make any difference in day trading in securities. This seems like more populist rhetoric. Tax wall street bonuses - tax Amgen drug profits - tax Cadillac health plans - a sign of the times......

Jan 10 11:48 AM