Three cheers for a financial transaction tax

Updated: Mar 7, 2019

An international financial transaction tax is levied on transactions involving particular assets, such as stocks, bonds, currencies, or derivatives. Depending on the type of asset, the tax rate is somewhere between 0.01 and 1 percent of the value of the transaction.

Gabriel Wollner argues that among other reasons, by effectively reducing capital mobility, a financial transaction tax would make it easier for states to ensure social justice. Furthermore, an international financial transaction tax would make international finance less volatile and ensure that assets are put to long-term productive use.

Think about some of the taxes that European citizens pay during the course of an ordinary day. Taking a car to work, they will pay tax on the fuel they are using. Working to make a living, the state will keep some of the money they earn as income tax. And going for a beer after work, part of the money left in the bar will also go to the state. Car-driving, hard-working and beer-drinking citizens may rightly worry that the last thing they need is yet another tax. But I suggest they should think twice. There is at least one other tax that is needed precisely to correct some of the imbalances and injustices in the existing system of taxation. The European Union should introduce a tax that will have to be paid whenever particular financial assets, such as bonds or derivatives, are sold or bought. The EU should introduce an international financial transaction tax.

Justifying taxation

Taxes are generally justified by two ideas. They generate revenues, which most importantly are needed for states to fund their activities. And by making certain types of action more costly, they make it less likely that individuals will engage in undesirable behaviour. To see the case for an international financial transaction tax, consider why taxes on fuel, income, and beer are a good idea. Going to work by car comes with costs that are not covered by those using the car. These costs, such as for the building and maintenance of roads or for dealing with the environmental damage of traffic, fall on everybody, whether they walk to work or ride a bike. A tax on fuel helps to cover these costs in a way that makes those pay who have the benefit of car-travel. A tax on income is essential for providing the goods that make earning an income possible to begin with. Without schools, universities, and courts, no incomes could be earned. Yet, without tax revenues, no schools, universities, or courts could be funded. A tax on income also allows for redistribution between the rich and poor. The tax on beer is a special case as it aims to not only generate funds, but also to influence people’s behaviour. For example, giving bar-goers a financial incentive to have fewer beers makes it less likely that they will have one beer too many. Taxes in general, then, are a good idea because they make sure that citizens bear the full costs of their behaviour, that they contribute to goods enjoyed by everyone, and that they do not harm themselves or others. At the same time, taxes are one of the most important policy tools to fight inequality.

Unfortunately, it is increasingly difficult to achieve these aims by relying on taxes as we know them. Individual actions – think of CO2 emissions or climate change – create costs not only for one’s fellow citizens, but also for people all over the world. An ever larger portion of the goods that make wealth and prosperity possible in the first place cannot just be provided within one state. Indeed, a globalised economy does not only rest on good national roads, but also on a fair and functioning international trade regime and a stable international financial system. The globalised economy in which billions can be transferred across borders by the click of a button also makes it easier and easier to avoid taxes – taxes that could generate the revenue needed to pay for goods enjoyed by everyone or to reduce inequality, but also taxes that could help prevent potentially harmful behaviour, such as financial speculation that increases the risk of financial crisis. The value of international financial flows by far exceeds the value of international trade in goods and services. A majority of global financial transactions take place through unregulated instruments, such as derivatives, which are bought and sold rapidly, causing price fluctuations, instability, and bubbles. Big companies shift profits to locations with low tax rates, and the super-rich hide their money in tax havens. Taxation, once among the most powerful policy tools at the state’s disposal, no longer delivers on its original promise.

Rescuing taxation

How, then, could taxation be rescued? I believe that there is at least one tax that is justified by the same reasons as taxes on fuel, income, and beer, yet avoids the shortcomings associated with taxation as we know it. A financial transaction tax of as little as 0.01 percent of the value of a financial asset sold would help to make sure that people bear the full costs of their behaviour, contribute to the provision of important public goods, alleviate inequality, and make harmful behaviour less likely. Just like a tax on fuel, a financial transaction tax will help to make sure that people bear the costs of their behaviour. In the recent past, one of the greatest economic costs has been created through the financial crisis that began in 2007, leading to unemployment, low growth, and high public indebtedness. The financial actors chiefly responsible for the crisis have, however, largely been let off the hook. Levying a tax on their daily activity, namely, buying and selling financial assets, is one way of making them pay. Just like a tax on income, an international financial transaction can be used to provide the public goods that make the income- or value-generating activity possible to begin with. Since financial activity presupposes the existence of states and regulatory institutions, those benefitting from the existence of these institutions should pay for their maintenance. At the same time, an international financial transaction tax would be effective against inequality in ways similar to a progressive income tax. Not only would this tax be paid predominantly by the rich, as only they can buy or sell financial assets, but the revenues generated by the tax, estimated by the EU to amount to as much as 20 billion euros per year, could be spent in ways that benefit the poor. And finally, just like a tax on beer, an international financial transaction tax would make harmful behaviour less likely. Short-term speculative transactions on financial markets have harmful effects; they make financial crisis more likely and redirect investments away from the real economy, where they would create goods, services, and jobs. A transaction tax would make it less likely that financial actors will have one speculative transaction too many.

While achieving what taxation is meant to achieve, a financial transaction tax avoids the problems of taxation as we know it. Since, unlike the other taxes discussed, it is not levied within the confines of the nation-state, it succeeds in tackling global problems, and it is at the same time hard to avoid. People can be made to pay for harm that they cause across borders, such as destabilising the financial system, if the tax applies to behaviour even if their action takes place across borders. The revenues generated by a financial tax could contribute to the provision of international public goods, including the institutions and regulation required for a stable international financial system. Moreover, redistribution to alleviate inequality does not have to focus on the domestic context, but may tackle global inequality. An international financial transaction tax would work because it would be hard to avoid. Shifting profits to locations with low corporate tax rates would not help companies because they will still want to sell shares, invest their earnings, and insure against risks. For all these activities, they will have to buy or sell on international financial markets. Rich individuals will also not be able escape from such a tax in the same way as they currently avoid income tax by hiding their wealth in tax havens. In managing their assets and the revenues generated from it, they simply cannot avoid buying and selling on financial markets.

What does the EU have to do with this?

Why, given the many undeniable advantages of a financial transaction tax, have our democratic societies not introduced and levied such a tax since long ago? The problem lies in the need for coordinated international action. If our hope was to see individual states, such as Germany, introduce the tax, many of its advantages would disappear. To avoid the tax, financial firms would just move from Frankfurt to, say, Luxembourg and thus avoid Germany as a place for doing business. But if we try to avoid this problem by hoping that all states would simultaneously introduce such a tax, such hopes would most likely be unrealistic and unmet. Indeed, do we really trust all states to forgo the tremendous individual benefit of attracting foreign financial firms just to bring about a solution that is in everyone’s best collective interest? What is required is some supranational institution coordinating the behaviour of a sufficiently large number of states or maybe even levying the tax itself. But which new actor could we trust with issues traditionally at the heart of national sovereignty and as important as taxation?

This is where the European Union comes in. It is not just the case that an international financial transaction tax should be introduced, but that the European Union should introduce it! The European Union is big enough and powerful enough to act as a first mover. Even if other actors do not in the end follow the European Union’s example, the EU market of half a billion relatively affluent customers simply is too attractive and too important for financial firms to abandon it. They simply cannot afford to give up doing business in the European Union. Moreover, the European Union possesses the right credentials to qualify as an actor with the right to tax. Even if it does not yet fully meet in theory (and rarely fully meets in practice) the standards of democratic legitimacy traditionally associated with tax-levying nation-states, the EU clearly has the potential to develop into an actor fit for greater fiscal power and authority.

Pessimists may worry that developing the political institutions of the European Union is too high a price to pay for the introduction of a financial transaction tax. If anyone, they argue, nation-states have the right to tax, and one should resist any change that would come with more power for unaccountable bureaucrats at levels far removed from ordinary citizens. Wouldn’t the right to levy taxes not be yet another step towards a European leviathan? Optimists should respond that increasing the pressure to turn the European Union into a full-fledged democracy is another of the tax’s advantages. The power to tax will go hand in hand with greater demands for democratic legitimacy, rejuvenating the slogan familiar from the period of the American Revolution: No taxation without representation! Just like taxes on fuel, income, and beer made the democratic nation-state, a tax on financial transactions may make a democratic European Union.

Online Debate

On 8 June 2018, Gabriel Wollner defended his proposal in the Twelve Stars debate. The main objections are presented below. Rebuttals can be followed in the online debate.

Background Research

Read up on current initiatives and proposals concerning this topic in our background briefing.

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