It’s time for a new financial transactions tax if it’s fiscal policy that’s going to control inflation in the future

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I have an article on the Social Europe website this morning in which I argue that the time has come for a new financial transactions tax, which I see as important now to the role of tax within modern monetary theory. This is what I said (with minor edits):

Five decades on, a ‘Tobin tax’ is no longer fit for purpose. Now what should be taxed, progressively, is all financial flows.

There are reasons for saying now is not a good time to discuss tax. In a great many countries demand is already weak and most taxes reduce demand. Increasing them would, in that case, reduce economic activity and so increase unemployment and corporate failures, favouring recession rather than recovery.

That, though, is precisely why we need to think about a new role for financial-transactions taxes (FTT). It may just be that this is the tax which, in contrast to all others, managing the coronavirus crisis requires.

All governments must currently run deficits to support their economies and this will remain so for a long time. Meanwhile, interest rates have ceased to be a tool for economic management: when they are already close to zero they cease to have an impact on behaviour. Both concerns, however, provide reasons why we might need an FTT.

Revenue-raising instruments

FTTs have traditionally been designed as very specific taxes on a very narrow range of financial transactions, including trades in financial commodities and currencies. The rates proposed have often been small. This has been because—oddly given the political perspective of many of those proposing them—they have been seen as revenue-raising instruments and not as Pigovian taxes designed to change behaviour significantly.

Pigovian taxes are placed on products, such as alcohol and tobacco, which generate ‘negative externalities’ (in those examples for public health). They are primarily intended to reduce demand, rather than to raise revenue—even if they do that too. But it would seem that the proposed social use of FTT revenues has been the primary purpose of these taxes in the eyes of their proponents, which implies that their rates and impacts must be limited. The uncomfortable truth which modern monetary theory has exposed—that tax revenue is not a precondition for social spending to take place—has not helped their cause.

The FTT we now need is very different. Precisely because monetary policy has ceased to be effective, because the use of tax in conventional fiscal policies is an extremely blunt instrument and because rapid fiscal intervention in any economy is now essential to control demand, employment and inflation—in an environment where there will be persistent government deficits—new instruments of fiscal management are required. An FTT can fulfil this role.

Financial flows

This would, however, be an FTT of a type previously very rarely used. It would be imposed on financial flows through all bank accounts in an economy, without exception. The charge would be on both debits and credits, with the deliberate intent of reducing the scope for evasion. And the tax should be designed to be significant in overall amount, acting as a possible replacement for other taxes such as payroll and social-security charges, for example, which are such an impediment to employment now.

This FTT should be significantly progressive. As the flows through the bank accounts under the control of a person increased, so would the charge. Those with average or low incomes would expect very low rates to be levied upon them. It would even be simple to make the rate negative for some, as a means of delivering income support. In contrast, those with very large financial flows would expect significant charges.

It would be appropriate for any individual to link all the accounts they had under common control for the purposes of their charge being assessed. So, for example, a person should not have to pay an FTT charge when making a payment to their mortgage account, transferring savings or paying a credit card bill. Instead, the charge should arise when real interaction with third parties took place.

Deciding how a person and their household were related might be an issue for this purpose; equally it could be an instrument for delivering social support. Transfers into and out of the country, even to related accounts, would however always be charged. Put all this together and this would become an effective and progressive tax on consumption.

The charge would also need to be applied to business accounts, and again some progressivity could be appropriate: support for smaller businesses could be implicit in rates charged. And businesses should not object, especially if they were relieved of some of their social-security costs. The issue of cash usage would have to be considered: it would be a legal necessity to require that cash sales and purchases were declared for tax purposes, to prevent abuse.

This one aspect apart, administratively this tax would be easy: all the software to create the charge should already exist, even if some accounts are linked and even if multiple banks are involved. Since the charge would be a simple percentage of flows into and out of accounts, the calculation would be simple, as would annual aggregation to avoid unfairness if the charge in any month were excessive on a ‘pay as you go’ basis.

Fiscal control

This would be a progressive consumption tax—which value-added tax is not—and it would extend the tax base to financial services and transactions, which are the preserve of the wealthiest and beyond the reach of VAT. It could, therefore, be a significant tool for tackling income and wealth inequality.

But the most important element of this tax might well be the opportunity it would provide for fiscal control. It could be finessed to promote or restrain demand very rapidly, without requiring anything more than changing the rates in a relatively small number of banks’ charging algorithms.

So if there were, for example, a desire to provide an immediate stimulus, rates could be reduced at short notice. Most especially, those rate changes could be targeted at particular income groups—even rendered negative for some, if desired.

Equally, if there were a need to target inflation, then FTT rates could be quickly increased to dampen demand. This is important, particularly to proponents of modern monetary theory, since it is often claimed taxes cannot be used for this purpose.

Finally, the tax could still be used to control excesses in the financial-services sector, although special rates might be required. The Spahn variation on such a tax, as it was originally recommended by James Tobin in the 1970s, has automatic stabilisers built in—increasing rates automatically in the event of financial crisis in a way that increases the costs of transactions, so as to calm markets in panicked financial situations. The rate increase would induce calm precisely when that might be most required.

I see little point now in promoting for its own sake an FTT of the type proposed over the last five decades, when neither the economy nor economic understanding demands it. In contrast, an FTT that promotes employment, reduces inequality, can be used to deliver income support and enhances fiscal management is a tax for this moment. It is a genuinely 21st-century tax, which is needed now and in favour of which a coalition of the willing should be created.