Controversial as the proposals in it are, I got generally positive feedback from the recent publication of “A New Tax Policy for the 21st Century”.
The most productive suggestion was from my friend Bill Stillinger, who suggested that along with taxing fossil fuels, we should also be taxing financial transactions. That got me thinking about an article I read in the Wall Street Journal, “Derivatives – Trading Tally: $700 Trillion (or so)”, which suggests that the global financial derivatives market has a nominal valuation on the order of $700 trillion with an annual turnover of $3.7 quadrillion. Numbers like that will make your head spin.
For perspective, at Market Watch, Paul Farrell suggested some numbers back in early 2008 to get a sense of how big these derivatives market numbers really are:
U.S. annual gross domestic product is about $15 trillion
World’s GDPs for all nations is approximately $50 trillion
Total value of world’s stock and bond markets is more than $100 trillion.
Farrell also quotes Warren Buffett from his Berkshire Hathaway Annual shareholder letter back in 2002 with some prescient wisdom on derivatives markets:
“We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
Note that Buffett recognized the danger well before the financial collapse of 2008 precipitated by the collapse of the mortgage derivatives market.
Its hard to get a sense of how much of the global derivatives market involves US transactions or at least US parties to transactions. But if we had a tiny tax on the nominal value of derivatives transactions, and as a wild guess presume that a US party is on one side or another of about one quarter of the worlds financial derivatives transactions, we could replace every current source of government revenue with a tax on such financial transactions of less than a quarter of one percent. If we included every other form of financial transaction including stock and bond trades, bank transactions, etc. then the tax could be lower.
Perhaps nominal value isn’t the right metric to tax. Farrell suggests:
Also, keep in mind that while the $516 trillion “notional” value (maximum in case of a meltdown) of the deals is a good measure of the market’s size, the 2007 BIS study notes that the $11 trillion “gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets.”
(Note that Farrell was writing three years ago and the derivatives markets have apparently added another $200 trillion or so in deals since being responsible for the market crash of 2008 – which should probably tell us something about true effectiveness of the so called financial market reforms Congress has put in place.)
Perhaps it is the actual cash value of transactions backing these deals that should be taxed at a higher rate. The fundamental point is that such transactions don’t appear to be providing much public good in their current formulation relative to the huge public risks and problems they entail. We should tax them both to garner some public value and to discourage risky and unproductive financial speculation.
I’d be glad to have a small tax on my credit card transactions and mortgage payments, if by doing so we could replace the counterproductive drag on our economy that our current tax system entails and help discourage some of the speculative churning of the financial derivatives market. Rather than having the vast majority of transactions merely enriching bankers and traders, it would be great to have the nation gain some actual value from Wall Street.
Shifting away from taxing productive work and investment and instead taxing waste and unproductive activities can take many forms. Combining the fossil fuel taxes suggested in “A New Tax Policy for the 21st Century” with a very small financial transactions tax could likely pay all the costs of government, wipe out the federal deficit and return us to a prosperous economy with lower energy prices than Europe and no other forms of taxation.
Discouraging the speculation and risk that Warren Buffett clearly recognized the derivatives markets both represent and encourage, would also be a worthy goal of public tax policy.
Significant change is inevitable. Our current government funding model is clearly not sustainable. The politics of enacting change like this will be a serious challenge. But we should at least begin debating sensible and fundamental changes to get our economy and our society back on track.