In the evolving discussion of economic reform, the idea of transaction taxes has surfaced as a noteworthy solution. Originally suggested by economist James Tobin as a minor levy on foreign exchange trades, the transaction tax remains a promising yet unlikely strategy. Richard Murphy highlights a critical barrier: the financial services industry has successfully convinced both policymakers and the media that increased market liquidity is inherently good and that any restrictions are detrimental. This misconception is sorely misguided. High-frequency trading (HFT), for instance, adds liquidity at times when it is not needed and withdraws it during periods of market turmoil. Advocates for reform have proposed that measures could be taken, such as limiting the speed of trades, but this would be seen as interference in the market, despite the real issues HFT creates.
The SEC has historically promoted the concept of liquidity, supporting initiatives to end fixed commissions and lower bid-ask spreads. The prevalence of super cheap or free trades has made it too easy for people to engage in speculative trading rather than sound investing. Research consistently shows that active traders often perform worse than those who hold their investments for extended periods.
Murphy argues that a transaction tax could generate revenue, which, while true, should be seen only as a beneficial byproduct. The principal aim of a transaction tax is to act as a Pigouvian tax, designed to deter undesirable behaviors—specifically, excessive speculation. Its effectiveness should be measured not by how much money it raises, but by the extent to which it raises the cost of harmful trading to reflect its broader societal impacts. According to Investopedia:
A Pigovian tax is levied on market transactions that generate negative externalities, affecting those not directly involved. Common examples include carbon taxes for environmental pollution from gasoline and tobacco taxes addressing the public healthcare costs of tobacco consumption. These taxes aim to shift the burden back to the producers and consumers who create these externalities. However, accurately estimating the economic harms caused by such activities can often be challenging.
This tax is named after English economist Arthur Pigou, a seminal figure in externality theory who also explored the relationship between consumption, employment, and pricing known as the Pigou effect.
John Maynard Keynes famously noted that the cheap and accessible nature of trading incentivizes capital to flow into speculative pursuits rather than productive endeavors:
Speculators may do no harm as bubbles on a steady stream of enterprise. However, the situation becomes critical when enterprise itself transforms into just another bubble in a whirlpool of speculation. When a country’s capital development becomes a by-product of gambling, the results are likely to be poor.
Keynes also observed that financial markets, by nature, carry an inherent instability and are susceptible to crashes:
Organized markets, influenced by uninformed purchasers and speculators focused solely on predicting shifts in market sentiment rather than reasonable forecasts of asset yields, often experience disillusion when an overly optimistic market suddenly reevaluates. Such corrections can occur with dramatic, even catastrophic, consequences.
The situation worsens as Andrew Haldane, former Executive Director for Financial Stability at the Bank of England, articulated comprehensively in his landmark speech, The $100 Billion Question. Haldane pointed out that the financial sector profits from the instability it creates:
While the car industry is undeniably a pollutant, the banking sector also generates toxicity. Systemic risk is a harmful side effect; banking serves those engaged in financial services, bringing private benefits to employees, depositors, borrowers, and investors, yet it poses risks to innocent bystanders within the broader economy through social costs stemming from banking crises. Tail risk in some industries might be influenced by divine will, but in finance, it is a human construct, subject to manipulation. Historical trends show that risk expands to consume available resources, and within banking, generated risks frequently exceed regulatory controls. Therefore, genuine banking reform must delve beyond regulation into the fundamental structures of finance to avert future crises.
Implementing a Tobin tax is one straightforward approach to mitigate the risk financiers create for their benefit at the expense of society. Its design is relatively simple, can be universally applied (minimizing controversy), and would predominantly target large-scale speculators. The fact that such a practical suggestion lacks serious consideration highlights the power that certain interests have within the financial landscape.
By Richard Murphy, Emeritus Professor of Accounting Practice at Sheffield University Management School and director at Tax Research LLP. Found originally at Funding the Future
James Tobin, a Nobel laureate and advisor to various presidents, proposed a simple yet profound idea: a minimal tax on foreign exchange transactions, marginal enough that long-term investors would hardly notice, but significant enough to deter rapid speculation that destabilizes ecosystems and enriches those who create no societal value.
Tobin’s proposal surfaced in the early 1970s, during a time when financial markets were purportedly being liberated from the constraints of Bretton Woods and global capital movement was surging. He recognized that unchecked finance risked becoming an international gambling venue, leading to costly repercussions for society when those bets failed.
The rationale was clear: if finance siphons wealth from society, then society has both the right and the duty to reclaim a portion of that wealth for public good.
Thus emerged the James Tobin Question: If a small tax on financial speculation could mitigate destructive short-termism while funding the public good, why have governments permitted the financial sector to reject this idea for fifty years?
Finance Without Friction
Tobin comprehended that markets become perilous when transactions are inexpensive enough that individuals don’t think critically. When speculation incurs minimal costs, financial actors can gamble extensively, shifting capital at lightning speed, destabilizing currencies, disregarding fundamental values and causing crises that the government is then forced to address.
Thus, he proposed the introduction of minimal friction through taxation, not to hinder finance, but to regulate it. This modest tax would direct speculation to incorporate part of its social costs. In doing so, finance would shift from unproductive churn to investments rooted in the real economy.
It was a reasonable proposition for a world grappling with considerable issues.
Wall Street Declared War
From the moment Tobin floated the tax idea, the financial industry recognized it as a serious threat to their dominance and retaliated vehemently:
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The tax was dismissed as unrealistic.
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It was branded anti-market.
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It was deemed a threat to liquidity.
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And condemned as a limitation on so-called efficiency.
Beneath the surface rhetoric lay a fear—not of real economic harm, but of losing political sway. The notion that finance should contribute equitably to society directly contradicted the prevailing belief in market infallibility that undergirded deregulation and wealth extraction. The industry systematically extinguished the idea, quashing it globally.
The 2008 Crisis Proved Tobin Right
When the financial system collapsed in 2008, the repercussions devastated the public, resulting in bailouts, unemployment, austerity, lost pensions, and shattered lives—a fate also shared by numerous small businesses.
The crisis exposed the financial sector’s reckless expansion—too large, too leveraged, and too unregulated. The system privatized profits while socializing losses, just as Tobin had warned.
Yet, after the aftermath, the structure was reestablished with the same incentives, the same protections, and still no Tobin Tax.
The Revenue Could Transform Society
A small charge on high-frequency transactions could potentially generate tens of billions annually in a nation like the UK, and hundreds of billions globally. Such revenue could redirect the demands for taxation, easing the burden on individual workers while facilitating financial accountability for its economic impacts. A Tobin Tax would empower public interests over unproductive speculation, hence the financial sector’s resistance to it.
The Myth of Liquidity Exposed
Detractors maintain that taxing speculation would reduce liquidity, claiming it is vital to their preferred speculative economy. However, much of contemporary liquidity constitutes high-frequency trading noise, driven by fleeting arbitrage profits rather than efficient resource allocation. They overlook that unstable liquidity is not truly liquidity; rather, it represents systemic risk in disguise.
What Answering the James Tobin Question Would Require
To genuinely implement the Tobin Tax, in both essence and operation, we must:
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Reassert democratic authority over finance, acknowledging that markets exist by public permission rather than divine right.
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Expose the myth that finance is perpetually productive, recognizing that speculation can often equate to rent extraction.
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Foster international cooperation, combating capital flight as a means of coercing governments.
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Confront concentrated financial power, as the financial sector won’t yield its privileges without opposition.
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> Reframing the concept of taxation as a civic duty, especially for those who profited most from globalization yet contributed the least to the societies enabling it.
This challenge is not merely technical; it is fundamentally political.
Inference
The James Tobin Question underscores a sobering reality: the impediment to establishing a fairer financial system stems not from complexity, but from entrenched power. A negligible tax that most citizens might not even notice has the potential to diminish volatility, generate substantial public funds, and encourage finance to focus on serving the real economy. For fifty years, we have recognized this potential, yet we have allowed the financial sector to dictate its refusal.
Addressing Tobin’s question leads to a deeper inquiry: who governs our economy? Are public institutions answerable to the citizens they preside over, or are private interests solely accountable to themselves?
If democracy carries any weight in economics, the Tobin Tax ought to already be a reality. Its absence is a reflection of how much more democracy we have yet to achieve.
