I propose that the Congressional leadership re-introduce the Troubled Asset Relief Program accompanied by a major new policy: a small tax on securities market transactions. This will accomplish the political goal of aiming a silver bullet into the heart of the (understandable) popular outrage that blocked passage of the TARP bill on Monday. It will simultaneously accomplish the fiscal goal of raising revenue, which the federal government sorely needed even before the need for the bailout arose and will need even more if the taxpayer is to be protected against subsidization of the financial sector.
A tax on securities market transactions might sound like a wild populist policy that would damage the functioning of the economy. But in fact it is far more sensible than such populist measures as banning short sales which have already been tried to no effect.
Proposals along these lines have a distinguished pedigree. Best-known was the Tobin tax proposal, by Nobel Prize winner James Tobin, which was specifically aimed at volatility in foreign exchange markets. More relevant to what I am proposing are two articles by the pre-Treasury Larry Summers: “A Few Good Taxes” and “When Financial Markets Work Too Well: A Cautious Case for a Securities Transactions Tax” (1989). Add another Nobel Prize Winner, Joe Stiglitz.
There is extensive experience with securities transaction taxes, especially in other countries, and there have been quite a few studies of their effects. On the one hand, often the motivation for such proposals is to reduce short-term speculative turnover (a tax of 0.1% means nothing to a long-term investor, but is a strong disincentive to those who trade hold their positions for only minutes or hours), with the idea that this will reduce volatility. On the other hand, often the defenders of unfettered financial markets argue that such a tax will reduce liquidity and thus hurt the customers who depend on the market. The historical experience with small taxes seems to be that there is no discernible effect on volatility. In some cases the volume of trading within the country is affected. But what the tax does usually do is raise a lot of money.
The UK has long had a securities transactions tax known as a stamp duty on the order of 0.3%. Sweden introduced a 0.50 per cent tax on the purchase and sale of equities in 1984, and kept it until 1991. (Froot and Campbell, studied these two examples in a 1994 book that I edited.) India introduced a securities transactions tax in 2004 and Japan, Korea, Taiwan and Hong Kong did so earlier; in these cases there were not significant reductions in either price volatility or market turnover. Other countries that have had financial turnover taxes of at least 0.10% include Australia, Austria, Finland, Germany, Malaysia, and Singapore. In addition there are other countrires that have smaller trading fees.
Even the United States imposes an SEC fee of .0033%. Thus our virginity is already lost.
An important potential drawback if the US were to impose a more substantial transactions tax alone, is that it might drive financial business offshore. There is an answer to this point. As noted, lot of countries already have such transactions taxes. Furthermore, lots would love to cooperate with the United States in an international program to harmonize such taxes internationally. This is precisely the sort of thing that many abroad have always asked Americans to participate in, but that we have not hitherto wanted to do.
The level and longevity of the tax could be adjusted over time to achieve the goal of Section 134 the TARP bill: that the taxpayer recoup the costs of the bailout. A 2004 study by the Congressional Research Service reported that an 0.5% tax on stock transfers could raise $65 billion a year. (Others have produced higher revenue estimates.) A tax extended to bonds and derivatives (especially derivatives!) would of course raise more. Remember that one does not compare this annual revenue to the $700 billion headline cost of the bailout; rather one compares the present discounted value of the annual flow to whatever of the $700 billion is left over after the government (we hope) collects something on the troubled loans and also recoups something on the warrants obtained from the banks.
The tax might, on the margin, contribute to a shrinking of the size of the financial sector; but this shrinking needs to happen anyway, as Ken Rogoff has pointed out. And most important politically, it would give expression in a non-damaging way to the blood lust that the public feels toward Wall Street, a venting that needs to take place if the bailout bill is going to be approved.