Note to the Financial Industry: Time to Put Up or . . . Well Just Put Up
Talk about a happy coincidence. The federal government needs money to deal with the budget deficits that will persist long after the Great Recession is over. And there’s a well-heeled potential source for those funds that’s rolling in dough and owes us big. That well-heeled source would be Wall Street. And it’s time to collect.
Let’s recap, in brief, the financial industry’s performance in recent years. Wall Street made dangerous gambles that put the entire global economy at risk. Those gambles came up snake eyes. Since then the entire world has suffered terribly as it tries to claw its way back. Actually, that’s not quite accurate. It’s an exaggeration to say the entire world is suffering. Take, for example, Wall Street. Its profits? Beating every other industry. Bonuses? Going strong.
In getting to this ennobled position from the brink of annihilation, our nation’s financiers got a little help—from you and me. At critical junctures in 2008 when the Wall Street was on its knees, the U.S. government, led by the Bush administration, came in with the capital needed to shore up the industry when no one else would. Some of that’s been paid back, some not. Some of those financial institutions didn’t need the direct cash, but most of them would also have gone down if we hadn’t propped up the rest of the industry.
Those infusions of capital were, however, just a part of what has been done to help the financial industry. The Federal Reserve and the Treasury department also have taken dozens of steps—involving trillions of dollars—to make Wall Street profitable.
The argument for taking these steps wasn’t, of course, that the financial industry ought to be drowning in prosperity. The argument was that the nation needs a financial sector and we were at risk of not having one. Nevertheless, the record profits and bonuses suggest that the mark was overshot. While the rest of the country seems to just be getting a basically functional economy that’s still very much hurting, Wall Street is raking it in. It hardly seems fair.
To be sure, not everyone on Wall Street was equally culpable and the industry gets to share its culpability. Bush administration regulators, practicing their blind faith in the perfection of markets, did let it all happen. But current public officials are trying to make sure it doesn’t happen again by reforming the regulatory system so that if we hand over the keys to the economy to incompetent, narrow-minded or foolish regulators, it will be harder for them to drive it into the ditch.
The response of many Wall Street players to these reform efforts? They are, shall we say, trying to “shape” the legislation. They know they can’t get away with being opposed to reform, but they’ve made clear from the beginning what’s okay with them and what’s not. They’re like drunk drivers who know that they wouldn’t have much credibility if they called for the legalization of drinking while driving, but when it comes to deciding whether the standard for drunkenness should be a blood alcohol level of 0.06 percent or 0.10 percent, well, they’re quite expert in these things and feel free to—for the good of the nation—offer their expert advice. In fairness, some of that advice may be public spirited, but much of it is just an attempt to keep up their extremely lucrative—if dangerous—business as usual.
But there’s another idea floating around, outside the regulatory reform debate, which much of Wall Street may like even less. It’s the financial transactions tax. The idea is to impose a very small tax on trades of stocks, bonds, derivatives, and other Wall Street financial instruments. Because trillions upon trillions of dollars worth of these instruments are traded back and forth every year, it’s estimated that a tax with a maximum rate as small as a tenth of one percent to a quarter of one percent—10 to 25 basis points in the lingo of Wall Street—could easily raise between $50 billion and $150 billion per year.*
This idea has not been well received by the industry. Opponents on Wall Street make two basic arguments: First, they argue, financial transactions of the sort that would be subject to the tax could easily be moved anywhere in the world so if you tax them, they will go. Even if the actual transactions aren’t moved elsewhere, derivatives based on those transactions—that is, placing bets on how such a transaction would turn out without actually buying or selling the object of the transaction—could be done anywhere in a mirror market, tax free.
Second, they argue that some transactions that are helpful to the economy wouldn’t be profitable even at these extremely low rates. This argument posits that traders who buy and sell constantly while making tiny profits on their many transactions would be driven from the market because the tax would eat mightily into those tiny profits.
Advocates of a financial transactions tax say that this second consequence is a good thing since these traders are actually bad for the economy—causing market volatility and exacerbating bubbles and crashes. The traders counter that they supply important liquidity to the market—that because of them anyone who wants to buy or sell a share in anything can find a counterparty because the traders are always in the market. This, they argue, makes investing more attractive—and more investment is good for everyone.
On the one hand, it’s a little hard to believe that a tiny tax would drive off or eliminate a book of business we particularly care about—and it would be foolish to take the opponents arguments at face value on this any more than on regulatory reform. On the other hand, it’s hard to know. Off-the-record conversations with people on Wall Street elicit different answers.
But instead of trying to figure that one out, let’s give Wall Street a choice. They either get a financial transaction tax or offer an alternative way for us to tax them. After all, they can surely afford to be taxed. This is an industry that, if defined narrowly, handles upward of $50 trillion worth of transactions in a year. Defined broadly the dollars are in the hundreds of trillions of dollars. It’s an industry where one large player, Goldman Sachs Group Inc., can offer up $16.7 billion in bonuses for one year in the midst of the Great Recession. It’s an industry that—with a huge amount of help from taxpayers—is now turning enormous profits. It’s an industry that enjoys substantial tax breaks with the capital gains and dividends top rate at less than half the rate of other income and the “carried interest” loophole benefiting the best-paid traders. It’s also an industry that really does owe something to the rest of the country.
So let’s say to that industry: U.S. taxpayers want $150 billion per year out of you. If the financial transactions tax creates the bad incentives you’ve described, then fine—come up with something different. You’re the experts. There are only two rules. Your alternative financial services tax has to raise $150 billion per year. And no sneaky business—a tax that’s on your industry but really comes out of the pockets of the people who clean your offices or targets middle-class 401(k) pension savings won’t cut it.
That seems only fair. If you do that—we won’t even call it a sin tax.
*The tax would operate best if all types of transactions are covered to avoid transactions jumping from one type of trade to another—from stock shares to futures, for example. A scale of rates could be established to keep the tax an equivalent share of transaction costs across different types of transactions. See Dean Baker, "The Benefits of a Financial Transactions Tax" (The Center for Economic and Policy Research, December 2008).
Michael Ettlinger is Vice President for Economic Policy at the Center for American Progress. To read more of the Center’s economic analysis and policy recommendations please go to the Economy page on our website.
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Vice President, Economic Policy