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A Virtuous Tax

One prime cause of the financial collapse is that financial trading markets have become speculative worlds unto themselves. Instead of adding efficiency to the real economy, they mainly add risk that the rest of us now have to pay for.

There are many ways to damp down financial speculation, but a very effective strategy is to tax it. Given the huge costs of the clean-up (now being borne mainly by taxpayers) it would make a lot more sense to require financial markets to pay for their own bailout.

One very neat way of doing this is through a very small tax on all financial transactions. Ordinary retail sales are taxed, as are wages. But oddly enough, financial transactions are exempt from tax.

This idea was first proposed in modern form by the Nobel Laureate James Tobin in 1972, after the collapse of fixed exchange rates led to massive increase in currency speculation. Tobin proposed a small tax on short term currency trades to make extreme speculation less profitable.

Since them, short term speculation and the invention of exotic securities that lend themselves to speculation has become the dominant activity of Wall Street. So a Tobin-style tax on all financial transactions has three big things going for it.

First, a very small tax in all kinds of financial transactions, say one tenth of one percent, would not be felt by legitimate long-term investors. But in the case of traders who get in and out of exotic derivatives minute by minute, making huge numbers of quickie trades, it would add up to a lot of money and would cut into both their profits and their entire socially destructive business strategy. So a universal financial transaction tax would discourage purely speculative activities and encourage investing for the long term.

Second, such a tax could pull in hundreds of billions of dollars a year, at a time when large deficits are giving the political right (and center) an excuse to cut social spending, and no form of taxation is popular. But this tax would be the least unpopular. It would not just fall primarily on the very, very wealthy. It would fall on the least socially defensible part of Wall Street, the people who make their billions from speculative short term trades. And that raises the third benefit.

What's missing from the entire debate about financial reform is a progressive brand of populism. Regular people know that they got done in by excesses on Wall Street, and they see a Democratic administration shoveling trillions of dollars to the same Wall Street banks that caused the mess. No wonder people are confused about whether government is on their side. What is overdue is a little bit of populist retribution against the people who brought down the system -- and will bring it down again if the hegemony of the traders is not constrained.

Do we have a shot of injecting the case for a Tobin Tax into the debate? In the past few weeks, Adair Turner, the head of Britain's Financial Service Authority, cautiously expressed support for the general idea.

Peer Steinbrueck, Germany's finance minister, explicitly called for such a tax last week, as did the AFL-CIO. In an unguarded moment early in his career, even Larry Summers, President Obama's market-friendly chief economic adviser, embraced the idea, as throwing some salutary sand in the gears when financial markets "worked too well."

The Group of 20 meetings next week in Pittsburgh are not likely to produce very much in the way of real reform, because even after the disgrace of Wall Street, the usual suspects are still making policy in most nations. But a global campaign for a Tobin Tax should begin in earnest now. It could bear early fruit, as speculative excess continues and as government finds itself searching for defensible taxes.

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