The Robin Hood Tax?
10-21-2011
Occupy Wall Street has been looking for issues to coalesce around. Now the Canadian group Adbusters—the group that issued the initial call that began the protests—has proposed that Occupy Wall Street adopt a Robin Hood Tax on financial transactions as its first issue. Here is their call to action.
The Financial Transaction Tax (FTT) is an idea that has lots of support amongst some economists. My friend David Callahan has been arguing for the FTT for a while now. By far the best and most balanced analysis of an FTT is by the IMF, here. On the positive side, the FTT has the advantage of being simple and intuitively attractive. But is a Financial Transaction Tax really a good issue for Occupy Wall Street to coalesce around?
The main problem is that the FTT employs a sawed off shot-gun approach to a real but specific problem and unintended consequences. Thus, the IMF study cited above concluded that a FTT would not clearly target financial excesses:
Where the goal is to curb financial market excesses, [FTT] offer a less specific remedy for the excessive leverage that is believed to cause them than other tax and/or regulatory solutions. Financial complexity does not derive solely or even primarily from trading activity. The buildup of hidden financial risks in the recent crisis resulted predominantly from excess leverage, risk concentration, and product innovation such as asset securitization, which would have been largely unaffected by a transactions tax. An [FTT] also does not directly address systemic risk.
The point is that the real problem in speculation is leverage and volatility. The FTT doesn't address leverage, and it doesn't target the high frequency traders who drive volatility. Instead, the FTT taxes ALL transactions.
What is more, the FTT will penalize smaller and retail investors—precisely those in the 99%. As the chart below shows, most stock in the U.S. is held by middle-class investors—those between the 80th percentile and the 99th percentile. They are responsible for the vast majority of financial transactions (this is especially true since a large percentage of the equity holdings of the 1% in the chart are enormous trusts containing dividend paying stocks that have been held for generations and which never trade). Thus, the FTT falls most heavily on the people who own the most stock in the country and depend on that stock for our retirements and investments.
Another problem is that if the Financial Transaction Tax is not adopted globally, it may well drive trading off shore to even less well-regulated markets than our own. The U.S. tried a similar tax in the 1960s and repealed it when trading moved to London. Sweden tried a FTT tax in the 1980s and 1990s and repealed it later when trading fled to other countries.
Finally, the IMF concludes that the FTT would increase consumption and reduce savings by lowering the returns of investment and savings—a result directly opposite to at least some of the goals of Occupy Wall Street. In addition, the FTT discourages the rebalancing of portfolios, thus depressing total returns on mutual funds investments and 401ks.
So what might be some other ideas for Occupy Wall Street—and also our political leaders (such as they are)—to consider? Here are a few ideas that a number of professionals I spoke with mentioned:
1. Ban all High Frequency Trading. It has no purpose except to make some very big and wealthy firms money while increasing volatility for the rest of us. High frequency traders justify the practice as increasing market efficiency. But there is no economic justification to prefer a system that makes 1000 trades per second to one that makes 10 trades per second. Such trading is disruptive and very profitable. Ban it outright. Doing so would be much easier than getting the global cooperation needed to make a Financial Transaction Tax workable. And doing so would also make the U.S. markets more stable and thus give them a competitive advantage over other markets worldwide.
2. A Cancelled Order Tax. It turns out nearly 99% of the orders placed on Wall Street are never filled, but cancelled. A small percentage of these cancellations are just people changing their minds. But the vast majority of cancelled orders are used to manipulate prices by tricking other traders into thinking that a stock is moving in a particular direction. According to one study on an average trading day in 2010, only 1% of all the 89.7 billion orders were executed, which means that nearly 99% of all orders placed can be attributed to high frequency traders trying to manipulate stock prices. A tax on cancelled-orders has distinct advantages over a tax on all financial transactions. First, it will fall primarily on hedge funds and large high-frequency traders, and will not affect retail investors. Second, it will specifically target the casino-like aspect of Wall Street. A cancelled-order tax is not as simple or sexy as a financial transaction tax. Less has been written on it. But it actually seems like a better idea. Read more about the idea here and here.
3. Reinstate the Uptick Rule. Nearly every market professional I polled supports the re-instatement of the "Uptick Rule," a rule that was imposed in 1938 during the Depression and repealed in 2007—just before the market crash and the financial crisis. The Uptick Rule prevents hedge funds and traders from betting on falling stock prices when the markets are already falling, thus reducing volatility and reducing the ability of traders to make money by encouraging market panics. There is a debate about how effective the Uptick Rule is, but there seems to be little or no downside to reinstating it. The only people who oppose doing so are traders.
4. Taxing Corporate Debt and Leverage and Raising Margins. The IMF proposes taxing not financial transactions but corporate debt, thus discouraging corporations from using debt and leverage to finance their activities. As part of this approach, it would be wise to raise margin requirements, the amount of money that someone has to put up before buying a stock or financial instrument on credit.
While Hannah Arendt may not have been much interested in the minutiae of Wall Street regulation, she did care deeply about the importance of facts in thoughtful and reasoned argument. In just one week, on Friday Oct. 28, the Hannah Arendt Center will open our two-day conference on Truthtelling: Democracy in an Age Without Facts. When facts and opinions blur, reasoned argument falls prey to spin and deception. Politics is a realm of conflicting opinions, Arendt argued, but the opinions must necessarily be grounded on facts.
Whether or not the Financial Transaction Tax is a good idea, the debate around it should be based on solid knowledge of the financial system, the affects of such a tax, and also the alternatives. These are very complex issues and, in all honesty, much of the debate so far has traded in simplifications, soundbites, and falsehoods.
If Occupy Wall Street really wants to distinguish itself from the Tea Party and change our political culture, let's use this first foray into politics as an opportunity to model adult argument, something that has been absent from our public life for far too long. If they do want to model a future of fact-based decision making, they will do well to look deeply into the cons as well as the pros of a financial transaction tax. They would also do well to consult those people who work in financial markets daily. Many of these people—both those in the 99% and the 1%—want to eliminate market excesses and reign in the speculation and insanity that helped lead to the recent financial crisis. In the name of common sense and a way forward, let's have a real debate based in both fact and expertise.
-RB