Sense on Cents

British economist John Maynard Keynes

When in doubt, increase taxes.

Further taxing of the financial industry seems like an appropriate policy given the bailouts provided over the last few years. Screw Wall Street, right? Yeah, hit them harder!! They deserve it. While I understand and appreciate the current rage directed at the financial industry, increasing taxes strikes me as an overly simplistic answer to a complex problem.

Increasing taxes on the financial industry is not a new idea. In fact, the noted economist John Maynard Keynes promoted this idea back in the 1930s. It was neither put into practice then nor again when resurrected in the 1970s. Will it be implemented currently? Bloomberg addresses this topic in writing, Taxing Wall Street Today Wins Support for Keynes Idea:

John Maynard Keynes proposed a tax on financial transactions in the middle of the Great Depression, and another economist, James Tobin, revived the idea in the 1970s as a way to counter currency market speculation. Neither effort gained much acceptance. Now, a growing number of economists and politicians argue that it’s time for a levy on trading stocks, bonds, currencies and derivatives.

U.K. Prime Minister Gordon Brown said on Nov. 7 that a transaction tax might compensate for the billions of dollars that the public has spent on bank bailouts. Government officials in France, Germany and Austria have voiced their backing. U.S. Treasury Secretary Timothy Geithner answered Brown a day later, saying the tax was not something the U.S. would support. House Speaker Nancy Pelosi, on the other hand, says the idea has “substantial currency” among congressional Democrats.

While on the surface increasing taxes on Wall Street seems reasonable, its success presumes that nothing would change in how Wall Street transacts business. We should not be so naive.

Remember, Wall Street right now is an oligopoly. Even if a tax were implemented globally, I still believe it would not work. Why?

The financial wizards on Wall Street and around the world would quickly adapt. How so?

1. They would pass along the increased cost of transacting business to customers in the form of a wider bid-ask spread.

2. They would structure derivative transactions to circumvent the tax.

3. They would cheat and lobby for loopholes to beat the tax.

What would be the results?

Higher costs for end users . . . that is, you and me.

Remember, history has taught us that The Great Depression was exacerbated by increased taxes and protectionism. Whether those taxes are levied on individuals, businesses, or an industry, all taxes ultimately get passed along to the public.

What would I recommend for the financial industry? I am personally much more in favor of increasing capital standards and ratios on the financial industry in order to mitigate systemic risk.

What do you think?

LD

This entry was posted on Monday, November 30th, 2009 at 1:14 PM and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.