Over the weekend, the idea of a tax on financial transactions gained significant momentum when UK Prime Minister Gordon Brown announced his support for the measure.
Fortunately, the tax will probably remain nothing more than an idea since Tim Geithner continues to oppose it.
The UK’s support for the tax came as a surprise to many. Brown announced it at a meeting in Scotland of G-20 representatives. The tax has broad support in Europe, especially from France and Germany. Until this weekend, however, the UK was thought to side with the US, Canada and Russia in opposing the tax.
Among its supporters, the tax is seen as pre-funding future bailouts of financial institutions. The idea would be to somehow impose a tax on financial transactions and use that money for some sort of financial security fund. The finance ministers who support it want it imposed in accordance with an international agreement to prevent financial institutions from fleeing to tax haven countries that do not impose the tax.
Geithner made it very clear that the U.S. would not support a bank-transaction tax. This is absolutely the right position because the financial transaction tax is based on dangerous nonsense.
Here are the three main problems:
- Low cost index funds would be hurt. Far from discouraging excessive risk taking, the tax would discourage long term index fund investing in favour of riskier strategies. The Vanguard 500 Index fund, as Mike Santoli pointed out in Barrons, would have paid $34 million on a financial transaction tax of 0.25% in 2007 because it bought and sold a total of $13.6 billion of securities that year. This would double the expenses of the fund, punishing conservative investors and encouraging them to seek greater returns through more risk.
- Banks would respond by becoming riskier. The bailout fund created by the tax would discourage appropriate risk management by the firms who pay the tax and disincentivize creditors from monitoring the risk at those firms.
- Taxpayers would still be on the hook. The bailout fund would be a fiction. All money collected would be spent by politicians for current spending programs. It wouldn’t be “saved” for future expenditures in any real sense. This means that future bailouts would be funded by taxpayers despite the existence of the tax.
So we’re giving Geithner a big “Boo-ya” for holding fast against the transaction tax.