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Why a financial transaction tax will miss the target

French President Nicolas Sarkozy has been trying to get U.S. President Barack Obama on board his renewed push for a global financial transaction tax.

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Kevin Milligan is Associate Professor of Economics at the University of British Columbia. His recent Economy Lab posts and Twitterfeed can be found here.

Calls for a worldwide tax on financial transactions are strengthening. President Sarkozy of France is pushing such a levy, and has been joined by German Finance Minister Wolfgang Schaeuble, who wants a linguistically efficient one-word Finanztransaktionssteuer. Since 2010 a coalition of NGOs in the UK has advocated a ' Robin Hood Tax'(Canada too), and this advocacy has been echoed by the 'occupy' movement in the last six weeks. For economists, the idea is most familiar as the ' Tobin tax', named after the Nobel Laureate James Tobin.

While the idea goes by many names, the various financial transaction tax proposals draw their essence from the same well. Three goals appear in most proposals: removing speculation to improve the social impact of financial markets, raising big revenue for governments, and making the rich pay. Each of these three features deserves scrutiny.

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Some want a financial transactions tax to curb 'speculation.' Is this desirable? From the traditional view, financial transactions represent a trade of assets between two willing parties, based on different information or different views on the same information. It is not obvious how the world is made better off by inhibiting such productive trades. On the other hand, an argument can be made that much of the volume of financial transactions is ' noise'. If trading is noise, less trading might improve the value the economy gets from the financial sector. It isn't clear how a financial transactions tax curbs the 'noise' without affecting the 'productive' trades.

The second feature of financial transaction tax proposals is the potential for big revenue -- tens if not hundreds of billions of dollars. In the most naive of these proposals, the total volume of current financial transactions is multiplied by the proposed tax rate to calculate the expected revenue. This is naive because it ignores the behavioural response to the tax that surely will follow. The tax base will shrink, as some trades will no longer be made. Also, unless the reach of the tax extends to every inch of the planet, trading is very likely to migrate to jurisdictions not covered by the tax. Any serious proposal must account for the behavioural response.

Finally, many want to change the tax burden toward the top one per cent that has done very well over the last thirty years. Steepening the tax burdens for the top one per cent may or may not be a worthy goal, but it is hard to see how a financial transactions tax even achieves this goal. Increasing the cost of making trades will lead to an increase in fees charged by bankers. These fees are paid by clients. The biggest financial organizations in Canada are pension funds like the Canada Pension Plan Investment Board, the beneficiaries of which include the entire Canadian middle class. If the goal is to raise the tax burden on high income individuals, we should just tax their incomes more. Why complicate the matter by imposing a levy on transactions bankers conduct on behalf of their clients?

It is hard to deny that the events since 2008 have uncovered serious shortcomings in the functioning of global financial markets. Measures to protect the national interest from the risks of the financial sector seem warranted, and we should not necessarily shy away from measures that make bankers squirm. However, a financial transactions tax is a distraction from the real regulatory improvements that need to be enacted.

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