could robin hood do good?

Last week, Syon sent me a link for a group called ‘The Robin Hood Tax’, advocating a financial transactions tax in the UK and globally. I have been thinking about it over the past week and decided to post some of my thoughts here. I hope some of you will respond, whether here or elsewhere, as we could all benefit from thoughtful dialogue.

To quote directly from the website, the pitch is broadly as follows:

The Robin Hood Tax is a tiny tax on bankers that would raise billions to tackle poverty and climate change, at home and abroad.

By taking an average of 0.05% from speculative banking transactions, hundreds of billions of pounds would be raised every year.

That’s easily enough to stop cuts in crucial public services in the UK, and to help fight global poverty and climate change.

There are a few implicit assumptions underlying the proponents’ line of reasoning. The first is that the volume of transaction in the financial services industry is unnecessarily large relative to the economic activity, and effectively just bloats the financial industry. As I will discuss below, I think there is some truth to this argument, although a tax as outlined must be globally adopted in order to address this. The second is that bankers and their speculative trading were largely to blame for the current crisis, and therefore it is appropriate that they should be punitively taxed. This argument, I think, oversimplifies the issue and has more to do with targeting misinformed public sentiment than in making a thoughtful claim.

Framing and the Fungible

While I believe there is merit in considering the implications of a financial transactions tax, I take exception with the campaign’s framing of the policy. Invoking Robin Hood alludes clearly to the idea of stealing from the rich to provide for the poor. The notion of the fortunate subsidizing the less fortunate in society is nothing new. Most developed nations, for example, have progressive income tax rates (the tax treatment of capital gains and dividends for US investors is a glaring counterexample). A tax on financial transactions may have substantive merit and should be defensible as a natural extension of this philosophy and through appeals to reason. Instead, the focus on vilifying bankers creates an adversarial scenario that appeals more to rage than to thoughtful consideration.

The other aspect that irks me is the false assertion that the revenues produced by the tax will solely serve to benefit domestic poverty programs, social services, and climate change initiatives. These are worthy causes, to be sure. While the framers may legitimately be advocating for this allocation, the reality is that existing commitments to these causes are likely to be reduced. Unfortunately, money is fungible. Governments have revenue and they have expenses. An increase in revenue will broadly impact the amount a government can spend, and is likely to do so across the board. While money from programs can be earmarked to a specific cause, there is always enough money to move around elsewhere in a budget to render this meaningless. Given the amount of discretion available to governments in setting budgets, it is at best naïve (and at worst misleading) to put forth the notion that these new revenues will be strictly additive to the intended programs.

Blaming Bankers

Are bankers solely responsible for the economic crisis, and are they fair targets of punitive measures? Without a doubt, bank share a role in the blame. On one hand, the banks in many cases took on irresponsible levels of risk in order to produce profits. Furthermore, their role in packaging huge amounts of risky loans surely contributed to a global decline in the quality of outstanding credit. When the banks were on the verge of collapse, governments around the world rescued them. Given this eventuality, should we be surprised that they were driven to take excessive risks? It may be unreasonable to expect corporations to act in socially responsible ways, which is why government is so critical to establishing boundaries and rules. In Canada, for example, banks are more heavily regulated than they are in the UK or the US. Consequently, these banks had few of the major problems that were happening elsewhere. Canadian authorities, on these grounds, have expressed skepticism about adopting a financial transactions tax in Canada.

In the case of the risky loans, I would argue that banks were trying earnestly to help society better manage risk. That the models underlying these efforts ended up being seriously flawed is hardly evidence of malicious intent. Moreover, many other agents were involved. Governments that irrationally and excessively encouraged home ownership, and most importantly that failed to adequately regulate the banks. Perhaps most significantly, the high frequency trading most likely to be affected by the proposed financial transactions tax is quite distinct from the securitization markets that were at the heart of the credit crisis. Thus, when the website claims “So it’s time for the people who caused this mess to pay to clean it up.”, it seems misguided.

My point here is that law and policy should prevent banks from being able to make a mess of the entire economy. To put in place a framework that motivates these institutions to act dangerously and to demonize them when they do so seems unreasonable.

Substantively Speaking

A financial transactions tax of .05%, while it may seem nominally small, would have tremendous effects on most traded markets. In particular, businesses that make profit through high frequency trading would be adversely affected. Keep in mind that .05% of the notional value of every transaction may represent a far more substantial share of the profit. With many trading strategies, this would probably eliminate all profit. So while the figure may appear small, the implications are huge. Those engaged in high frequency trading argue that they are providing a service by making markets more efficient and liquid, which benefits companies that use markets to finance themselves. I don’t find this argument terribly convincing. Primary market participants don’t typically have a need to transact at these speeds. The main beneficiaries turn out to be speculators who are involved in the markets to make money as secondary participants. To the extent that their businesses are harmed, this may not be socially problematic.

My substantive critique of the financial transactions tax is that these ends are only met if the policies are adopted globally and across asset classes. This is incredibly difficult to effect in practice. The Robin Hood website bizarrely cites a tax in the UK on stock transactions as evidence of why this idea could be successful. I say bizarrely because the consequences of this policy were a shift of stock trading from London to other markets, and a dramatic increase in the use of untaxed derivatives rather than stocks in London. Sophisticated investors were able to replicate the economics of a stock transaction through the derivatives, thus avoiding the tax. I entertain serious doubts about whether the proposed tax could be coordinated globally and across different types of financial transactions.

I think I’ve written just about enough for now! Thoughts?