Tobin Trouble

CAMBRIDGE – European leaders are seriously considering a Tobin tax, which would put a small levy on financial transactions, thereby dampening trading. But will the tax do as much as its proponents hope?

The popularity of the tax (named for the late Nobel laureate economist James Tobin, for whom its aim was to reduce exchange-rate volatility in currency markets) reflects widespread animus directed at the financial sector, but it far exceeds any real benefits that the tax would deliver. Nonetheless, elected officials find a Tobin tax highly appealing, because it could blunt criticism and divert attention from fundamental, but politically paralyzing, problems surrounding economic policy, particularly budgets, debt, and slow growth.

A Tobin tax does have benefits, even if it cannot address enough of the problems that afflict financial markets today. A tax on stock transactions encourages longer-term holdings. It taxes liquidity, which many believe is overly abundant. It encourages fundamental analysis of a company’s operations, and some advocates hope that a Tobin tax would push firms themselves to focus even more on long-term value.

Moreover, a Tobin tax moves financial traders – talented people with strong work habits – into other activities, which (policymakers hope) will benefit the economy more. And, if financial innovations like derivatives and short-term repurchase agreements have made markets more volatile and fragile, a Tobin tax could help to stabilize and strengthen them.