Tuesday, February 16, 2010

The Robin Hood tax

There’s a lively debate on the Robin Hood campaign’s website about whether the introduction of a transaction tax is worth all the controversy.

Unlike the original Tobin tax idea of 1% on currency markets, the Robin Hood tax would be 0.05% on all non-retail financial transactions. Its aim would be to raise revenue rather than curb speculation.

It’s worth pointing out that, quite apart from the 0.5% stamp duty on UK equities, there is already a far bigger private version of the Tobin tax in place - the transaction costs of financial intermediaries.

According to my back-of-a-fag-packet calculation*, the financial sector costs us roughly 2.5% of our total savings every year. With GBP 9 trillion in UK private wealth, that’s a lot of money being made to push savings around the City. No wonder Bill Nighy's banker, in the website video, seems a tad nervous.

I've heard more than one senior financier wonder aloud (in private) why financial intermediation is so lucrative. Is it brilliant at allocating capital (apart from, ahem, the recession and credit crisis) or is it in fact a fabulous cartel?

The industry has so many obvious and real benefits: mortgages, currency, stable peaceful economy, ATMs, capital markets that finance job creation etc. But at an annual cost of GBP 225bn, is it really good value, and would a Tobin or a Robin Hood tax make it better value?

In comparison to the 2.5% costs charged on average by the industry, a 0.05% transaction tax is unlikely to bring financial markets grinding to a halt. It might suck profits out of some business areas, such as high-frequency or currency trading, but most of us could live with that.

Some posts on the Robin Hood debate are concerned with how to use the proceeds. There are big ethical and political questions, such as the unfairness of taxing a specific sector (tempting after a bail-out but not great as a permanent feature in a market economy) and foreign versus domestic aid, but these are separate issues for a different forum.

Some posts also doubt the USD 400bn proceeds, as do I, considering the scope for avoidance and declining financial activity if the tax is implemented. One post suggested the tax would be better if applied to net margins as it would then penalise pure speculation but leave client hedging and other legitimate trades alone. This seems an idea for the Treasury or FSA to consider if the campaign ever gets that far.

A bigger benefit would be if the tax led to a reduction in pointless speculation, as James Tobin originally intended. At 0.05% it may not be big enough to do this - Tobin wanted 1%, a figure that would drive pretty well all activity offshore at a stroke. But it's worth considering a level in between, and whether it could be adjusted by regulators to fit the cycle.

The impacts of short term trading are not just theoretical (as I understand it, volatility and churning lead to rent-seeking and resource misallocation, which chokes the real economy) they are also quite real:

The damage done to employment, growth and non-financial businesses by the credit crisis, pension deficits and now the Greek financial crisis will have been magnified by short-term positions taken to cash in on those events. This is not to blame speculators for those events, which have their own separate causes, but it is surely worth asking what those trades contribute overall to the process of resource allocation.

Even without such events, the speculation industry pushes up the costs of all financial intermediation, as hedge fund pay culture spreads to banks and price volatility eats into long-term investment returns.

This is not to run down finance for the sake of it. But in some places, even bankers admit that the financial golden goose has gotten a bit fat. A transaction tax at the right level seems a good way to slim it down.

* total private UK wealth of GBP 9trn, divided into total financial services revenue of GBP 225bn, assuming financial services accounts for 8.5% of GBP 2.65trn GDP, or 2.5% of all UK savings every year.

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