IN classic European fashion the French and German governments are in agreement, but what they agree about is not absolutely clear. It seems Nicolas Sarkozy and Angela Merkel want the G20 to introduce a levy on all assets of banks and to tax financial transactions at a very modest rate. But it appears they will settle for the bank levy because they know that a tax on wholesale financial transactions is more ambitious and difficult to achieve.
This is a pity, for the world needs both. And if only one is available, we need a financial transactions tax more. Puzzlingly, the Australian government seems to want neither.
One of the challenges of discussing these options is that different people mean different things when they call for a “levy” on banks. In essence, this is a very low tax, probably imposed on all financial institutions – not just on banks – and calculated according to the assets of individual institutions. The International Monetary Fund is calling for two levies of this type: a Financial Stability Contribution, which would be levied on assets and put aside to fund future bailouts; and a Financial Activities Tax, to be levied on financial institutions’ profits and staff remuneration. The IMF suggests that countries set the rate for the second of these, which has the delightful acronym FAT, so that it raises between 0.2 per cent and 0.4 per cent of gross domestic product annually.
A financial transactions tax, on the other hand, is a tiny tax on all wholesale financial transactions, set at perhaps 0.05 per cent, or one-twentieth of 1 per cent. Levied on transactions entered into for the medium to long term, it would be an insignificant amount, but on transactions entered into for seconds or minutes it would be more onerous.
The French and German governments plan to put the bank assets levy, and perhaps the transactions tax, on the agenda of the G20 leaders meeting later this week in Toronto. The need for both a levy and a tax is made clear by the balance sheets of most rich nations, which are in tatters. According to the IMF, the G7 nations alone owe US$30 trillion in debt. The levy is needed to build up reserves so that if banks require rescuing again, as they most certainly will at some point, the next bailout will be funded by the financial sector, not taxpayers.
As the IMF has put it, “Expecting taxpayers to support the sector during bad times while allowing owners, managers and/or creditors of financial institutions to enjoy the gains of good times misallocates resources and undermines long-term growth.” And the managers of financial institutions are indeed enjoying the gains again. In the year to 30 April 2010, reports the New York Times, the twenty-five top US hedge fund managers “earned” US$25 billion.
At the rates being discussed, the levies are sufficient to fund future bailouts but are inadequate to plug the massive holes in national balance sheets, holes created by the need to bail out banks while stimulating national economies to counter the damage done by the financial crisis. This is one reason why we need a financial transactions tax: it would raise many times more than a levy, and the funds would be used to repair national balance sheets and address the massive remaining problems of global poverty and climate change adaptation in poor countries.
But there is another, even more pressing, reason for a transactions tax. It might seem like a paradox, but we need the tax because we need efficient markets. Markets determine prices and allocate resources far better than any other mechanism. Capitalism relies on markets working. As the global financial crisis has proven dramatically, global financial markets are less regulated, and work less well, than in decades past.
They also work much more quickly. Many French hedge funds recently moved their trading computers to London because the time it took electronic messages to travel from Paris was placing them at a disadvantage. Across the Atlantic, Goldman Sachs has moved its computers right beside those of NASDAQ, the online exchange, and each millisecond gained, by Goldman’s own admission, is worth at least US$100 million. Assets are often bought, held and sold in under a second. No human mind is brought to bear on these individual trades and the economic fundamentals, including the value of the asset, are not factored into the algorithms that direct the computers.
Lord Turner, head of Britain’s Financial Services Agency, has described this type of trading as “socially useless,” but it’s worse than that. Super-brief trades move prices a little. Momentum programs then come into play and trade on these micro-movements, reading them as the beginning of a trend. The net result is that for long periods prices can deviate substantially from what they would be if based on economic fundamentals. This is a major source of inefficiency; and it isn’t the only one.
Hedge funds pay very little tax and investment banks pay less than their fair share. This matters on equity grounds, but it matters more on efficiency grounds. If there is a sector of the economy that pays too little tax, resources will logically flow into it. And this is what we have seen. The assets under the management of hedge funds in Australia increased thirty-fold in five years earlier this decade. Savings that could be put to productive use are in large measure going into socially useless and purely speculative trading. The standard counter-argument is that these trades provide liquidity to the market and arbitrage out price differences; in fact, most markets have excess liquidity and these trades are far more likely to generate price inaccuracies than iron out differences.
Financial markets are out of kilter with the real economy. Australia’s financial markets turnover is eighty-one times greater than our real economic turnover (our gross domestic product). Before the global financial crisis the ratio was ninety-eight times. Speculation has become the dominant form of market activity and works against productive investment. Short-term speculation distorts and damages the critical price-setting function of markets, and it consumes financial assets that could be invested long-term in the real economy.
THE IDEA that we need to reweight our markets in favour of longer-term investment and away from rewarding short-term speculation is not a radical one. Last year the Aspen Institute in the United States issued a paper, “Overcoming Short-termism,” signed by a who’s who of corporate America, including Warren Buffett and Peter Peterson, together with the former chairs of IBM and Goldman Sachs, and others.
As Warren Buffet has pointed out, the globalisation of finance has benefited the financial markets far more than anyone else. The incredible rise in profitability of investment banks, hedge funds and private equity funds has translated into enormous political power, opposed to any regulation of the markets from which they profit so handsomely. We need to reclaim those markets for their real functions, to serve the real economy that provides our livelihoods.
The fact is that a transactions tax, or other measures designed to get markets trading on fundamentals, will only be introduced when there’s a strong groundswell of public opinion in favour of action. At the moment, I suspect, global public opinion is not yet sufficiently strong for the G20 nations to act.
The politics of the bank levy are different, however, and relatively clear. Although European Union nations are divided when it comes to a transactions tax, they all support a bank levy. Britain is reportedly drafting bank levy legislation but the coalition government appears to have dropped the idea of a transactions tax, which was part of the Liberal Democrats’ policy platform before the election. The US administration supports a bank levy but is silent on a transactions tax. Indeed, if international media reports are correct, the only voices consistently raised against a bank levy are those of Canada, Russia and Australia, which argue it would penalise the banks of nations who came through the financial crisis unscathed.
If our government is arguing against the bank levy in international fora, it is wrong to do so. It indicates the political influence of the big four banks, rather than good policy. The bank guarantee charge earned the government a large amount of money, far more than Treasury had anticipated, although it will not disclose exactly how much. As the banks wean themselves off using the formal guarantee of their borrowings, that revenue is declining, rapidly. But an informal guarantee remains in place, as it is manifestly clear that no Australian federal government, of either persuasion, would allow a major bank to fail in this country. If Australian taxpayers are, in effect, going to stand behind the banks, strengthening the sector’s credibility in the marketplace, they should be compensated for doing so.
The issue is not whether a levy would penalise banks that navigated the shoals of the financial crisis. The issue is that we, through our governments, confer an extraordinary benefit on a company when we grant it a banking licence. We confer an even greater benefit when we imply that the public purse will be a backstop if the bank should fail. And so we are entitled to ask for fair compensation for these massive benefits conferred upon one sector of industry. A bank levy would be that compensation. The Australian government needs to reverse its opposition to the idea, and now. And then it should throw its weight behind the campaign for a financial transactions tax. •