Last Friday, I participated in a Special Briefing on Capitol Hill in support of the Financial Transactions Tax (FTT). I came as a seasoned practitioner speaking on behalf of the real economy, not for the interests of the Wall Street trading community. What I tried to convey was that what the US and World needs is enhanced capital market function, and that an FTT can help bring it through a feedback loop, rather than complex regulation. The $50 billion-plus of annual deficit reduction is a bonus. The session was standing room only, a big change from the Washington press briefing I participated in over a year ago. Is change afoot? Tim Geithner effectively vetoed the FTT in the US without a logical reason, and the thoughtful and highly respected former chief economist of the IMF, Harvard Economist Ken Rogoff, has now weighed in with a piece on the FTT titled “The Wrong Tax for Europe”. In September 2009, the Aspen Institute gathered a group of prominent businesspeople (including Warren Buffett, Felix Rohatyn, John Whitehead, Former Chairman of Goldman Sachs, and Peter Peterson, Founder of the Blackstone Group and the deficit hawk Peterson Institute) who signed on to a document that decried “high rates of portfolio turnover” by fund managers with little concern for long-term corporate performance or externalities, emphasizing that this all puts corporations and the interests of shareholders seeking long-term growth at risk. The Aspen group went on to propose tax reform to encourage “patient capital” as its top recommendation, including the imposition of an FTT. What do these distinguished business leaders (and yours truly) from the financial sector, experienced in the actual practice of finance, understand that the elite economists are missing? Plenty. Professor Rogoff is right to say the FTT has become “the darling of some leading liberal economic commentators such as Paul Krugman and Dean Baker (a fellow panel member last Friday, as was the highly articulate Damian Silvers of the AFL-CIO). I think liberals do a disservice to the tax by promoting their favorite liberal causes as the beneficiaries of the tax. Even Bill Gates’ recent support of the tax is linked to his desire to increase third world aid. In reality, money is fungible. Leon Panetta should have as much interest in the tax for his threatened defense budget. Rogoff is also right to say an FTT will not provide justice to a world ransacked by financial irresponsibility, greed, and fraud. It will not. However, it is his common sense and, remarkably, his economics, that are flawed. Rogoff’s argument rests on three criticisms and an over-reliance on the analysis of economic research – the same economic research that has been so horribly discredited for missing the financial collapse. His first argument is the well-worn liquidity argument. To this I repeat, yes, at the margin, liquidity will be reduced. I will even concede that “with fewer trades, the information content of prices is arguably reduced.” However, with that modest reduction of marginal liquidity also comes enhanced market resiliency (as any systems scientist understands empirically, not theoretically), and restored trust. These qualities don’t fit into the economists’ models – the same flaw that blind-sided the economists to the crash – so are not “valued”, but are certainly valued by the common sense of seasoned professionals like the group that gathered in Aspen. There are decreasing returns to liquidity, and there can be uneconomic and at times destructive excessive market liquidity, as we see today. Rogoff’s second argument is the tax collection problem, and he sights Sweden’s (unrepresentative) experience. This is sloppy thinking, not worthy of Ken Rogoff. He must know that the UK has had an effective FTT in place (the stamp duty) for over a century on UK stock trades, and equity trading never moved to Sweden or anywhere else. The SEC already imposes a trading fee in the US to fund its budget, and all stock trading has not left the shores of America. And how do we explain the very successful FTTs in place in Switzerland, Hong Kong, and Singapore, as Larry Summers conceded when I asked him the question. As if to attempt a crushing blow, Rogoff then invokes the growth question, suggesting that a transactions tax would raise the cost of capital. The entire paragraph needs highlighting because it is so flawed: Worse still, over the long run, the tax burden would shift. Higher transactions taxes increase the cost of capital, ultimately lowering investment. With a lower capital stock, output would trend downward, reducing government revenues and substantially offsetting the direct gain from the tax. In the long run, wages would fall, and ordinary workers would end up bearing a significant share of the cost. More broadly, FTTs violate the general public-finance principle that it is inefficient to tax intermediate factors of production, particularly ones that are highly mobile and fluid in their response. Higher transactions costs on secondary trading of securities do not, in fact, increase the cost of capital. The European proposal rightly suggests omitting the tax on all primary issuance of securities that channel real investment into the real economy. Problem solved Professor, without the frightening implications for “ordinary workers”. Furthermore, as Dean Baker observes, where is the evidence, much less even a discussion, that the decades-long decline in transactions costs has contributed one basis point to economic growth? Surely it must work both ways? And finally, while real investment is a factor of production, mobile and fluid as you say, secondary trading of securities and derivatives is not a “factor of production” at all! Ask any CEO or CFO that question if you have any doubt. So no Professor Rogoff, this is not “all well known and ignored by prominent opinion leaders, politicians, and philanthropists” (a clear tag on Gates). And I’m quite surprised the distinguished professor raises the important lessons of “Inside Job” which was hardly kind to the economics profession. The time is now for thoughtful Financial Transactions Tax legislation to be presented in the United States Congress, following the lead of the European Commission that seems more willing to take on the powerful interests of Wall Street. The time is now for the Supercommittee to take up the task, embracing the leadership of Senator Harkin and Representative DeFazio who I hope will reintroduce their Bill. This is your issue Secretary Panetta, as much is it is Bill Gates’ and every citizen of America who is for restoring proper function to the capital markets and healing the real economy.
“Overcoming Short-Termism: A Call for a More Responsible Approach to Investment and Business Management” Aspen Institute, September 9, 2009