Yves here. From time to time, we’ve mentioned transaction taxes, first proposed by James Tobin in the form of a small levy on foreign exchange trades, as a very good idea that is pretty sure never to get done. The big reason, as Richard Murphy mentions below. is that the financial services industry, has done a great job of indoctrinating policymakers and the press into believing that more liquidity is beneficial and restricting it is bad. This is ridiculous. For instance, high frequency trading famously adds liquidity when no one needs it and drains it when most needed, in periods of high stock market volatility. But had anyone done the sensible thing of shooting HFT dead, say by requiring that bids and offers can’t be executed faster than say, in a second? Oh noes, can’t interfere in market operations even though the very existence of HFT is the result of perversities like allowing hedgies to co-locate servers at exchanges so as to get best access to that order flow.
Sadly, the SEC was front and center of the push for more liquidity, not just in the form of ending fixed commissions but also in lowering bid-asked spreads. Super cheap or free trades make it way too easy to play speculator rather than investor, when numerous studies have found that “investors” who trade a lot on average do less well than ones that mainly sit pat with their holdings.
Murphy also contends that a transaction tax would raise revenue. While true, and in a less elite-serving world, that might sound like a good reason to proceed, that should be only a happy side effect. A transaction tax is a type of Pigouvian tax, as in one meant to deter bad activity, here undue speculation. Its measure of success is not fundraising but raising the cost of the harmful-to-outsiders commerce to properly reflect its broader cost. From Investopedia:
A Pigovian (also spelled Pigouvian) tax is a tax on market transactions that create negative externalities, or adverse side effects, for those that are not directly involved in the transaction.
Common examples of a Pigovian tax include carbon taxes to offset the environmental pollution from using gasoline, or tobacco taxes to address the strain on public healthcare systems caused by consuming tobacco products. These taxes help to shift the burden of these externalities back to the producers and consumers who cause them. However, it can be difficult to get a reliable estimate of the economic harms caused by these activities.
Pigovian taxes were named after English economist Arthur Pigou, a significant contributor to early externality theory. Pigou also promoted the link between the balance of consumption, employment, and price, known as the Pigou effect.
Keynes famously pointed out the big cost of cheap and easy trading, that it drives capital to froth-making rather than productive activities:
Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.
It isn’t simply that, as Keynes also pointed out, that financial markets are inherently unstable and vulnerable to meltdowns:
It is of the nature of organised investment markets, under the influence of purchasers largely ignorant of what they are buying and of speculators who are more concerned with forecasting the next shift of market sentiment than with a reasonable estimate of the future yield of capital-assets, that, when disillusion falls upon an over-optimistic and over-bought market, it should fall with sudden and even catastrophic force.
But even worse, as Andrew Haldane, then the Executive Director of Financial Stability at the Bank of England, explained long-form in his seminal article, The $100 Billion Question, that financiers profit from creating instability:
The car industry is a pollutant…
The banking industry is also a pollutant. Systemic risk is a noxious by-product. Banking benefits those producing and consuming financial services – the private benefits for bank employees, depositors, borrowers and investors. But it also risks endangering innocent bystanders within the wider economy – the social costs to the general public from banking crises…
Tail risk within some systems is determined by God – in economist-speak, it is exogenous…
Tail risk within financial systems is not determined by God but by man; it is not exogenous but endogenous. This has important implications for regulatory control. Finance theory tells us that risk brings return. So there are natural incentives within the financial system to generate tail risk and to avoid regulatory control. In the run-up to this crisis, examples of such risk-hunting and regulatory arbitrage were legion. They included escalating leverage, increased trading portfolios and the design of tail-heavy financial instruments…
The history of banking is that risk expands to exhaust available resources. Tail risk is bigger in banking because it is created, not endowed. For that reason, it is possible that no amount of capital or liquidity may ever be quite enough. Profit incentives may place risk one step beyond regulation. That means banking reform may need to look beyond regulation to the underlying structure of finance if we are not to risk another sparrow toppling the dominos.
So one of the easiest things that could be done to restrict financiers creating risk for their fun and profit at the expense of the rest of us is a Tobin tax. It’s comparatively simple in design, can be applied universally (reducing controversy) and has the big advantage of hitting the big speculators the hardest. The fact that such a commonsensical idea won’t get a serious hearing is yet another proof that looters are in charge.
By Richard Murphy, Emeritus Professor of Accounting Practice at Sheffield University Management School and a director of Tax Research LLP. Originally published at Funding the Future<>James Tobin, a Nobel laureate, advisor to presidents, and one of the most respected economists of the twentieth century, proposed a simple idea with extraordinary implications: a tiny tax on foreign exchange transactions, representing just a fraction of a per cent, and so small that long-term investors would barely notice, but significant enough to discourage the rapid-fire speculation that destabilises economies and enriches speculators while creating nothing of social value.
Tobin’s proposal emerged in the early 1970s, just as financial markets were supposedly being liberated from the Bretton Woods constraints and global capital mobility was exploding. He saw what others refused to confront: that unconstrained finance was becoming an international casino, and society would end up paying the bill when the bets turned bad.
His logic was straightforward: if finance is going to extract wealth from society, society has a right, and even a responsibility, to reclaim a portion of it for public purpose.
Hence the James Tobin Question: If a small tax on financial speculation could curb destructive short-termism and fund the public good, why have governments allowed the financial sector to veto it for half a century?
Finance Without Friction
Tobin understood that markets become dangerous when transactions are too cheap to think twice about. When speculation costs almost nothing, financial actors can gamble with trillions, moving capital across borders at the speed of light, destabilising currencies, pricing fundamentals out of existence, and triggering crises that governments must clean up.
As a result, he proposed introducing minimal friction into the system via taxation, not to halt finance, but to civilise it. This very small tax would force speculation to bear part of its social cost. Finance would be nudged away from destructive churn and toward investment grounded in the real economy.
It was a modest proposal for a world facing an immodest problem.
Wall Street Declared War
From the moment Tobin proposed the tax, the financial industry recognised the existential threat that it created of accountability.
The tax was dismissed as naïve.
It was attacked as being anti-market.
It was branded a threat to liquidity, and
Condemned as a brake on so-called efficiency.
Behind the rhetoric was fear, not of economic harm, but of losing political dominance. The idea that finance should pay its way challenged the doctrine of market infallibility that underpinned deregulation and rent extraction. So the industry killed the idea, softly, relentlessly, globally.
The 2008 Crisis Proved Tobin Right
When the financial system imploded in 2008, the public paid with bailouts, unemployment, austerity, lost pensions, and shattered lives, a fate shared with many smaller businesses.
The crisis revealed that finance had grown too large, too leveraged, too unregulated and too unaccountable. It was a system that privatised gains and socialised losses, exactly as Tobin had warned.
And yet, after the dust settled, the system was rebuilt with the same architecture, the same incentives, the same political protection and still with no Tobin Tax.
The Revenue Could Transform Society
A small levy on high-frequency transactions could raise tens of billions annually in a single country like the UK, and hundreds of billions worldwide. That revenue could shift the demands for taxation to control inflation from work onto finance, and in the process would reprice finance so that it would bear the costs of its own economic externalities. A Tobin Tax would shift power from unproductive speculation to public purpose. It is no wonder that the finance industry opposed it.
The Myth of Liquidity Exposed
Critics insist that taxing speculation would reduce liquidity, which they consider essential to the survival of their chosen economic system of speculation. However, much of today’s liquidity is high-frequency noise, driven not by allocating resources efficiently but by harvesting fleeting arbitrage profits. They miss the point that liquidity that destabilises is not liquidity at all. It is systemic risk, rebranded.
What Answering the James Tobin Question Would Require
To finally adopt the Tobin Tax, in both spirit and function, would require:
Reasserting democratic control over finance, acknowledging that markets exist by public permission, and not divine right.
Exposing the myth that finance is always productive, recognising that speculation is often a form of rent extraction.
Building international cooperation, refusing to allow capital flight to blackmail governments.
Confronting concentrated power because finance will not give up privileges without resistance.
>Reframing taxation as civic responsibility, especially for those who profit most from globalisation while contributing least to the societies that enable it.
This is not a technical challenge but a political one.
Inference
The James Tobin Question reveals a stark truth: the obstacle to a fairer financial system is not complexity, but power.
A tax so small most citizens would never notice it could reduce volatility, raise significant public funds, and push finance toward serving the real economy. For half a century, we have known this, and for half a century, we have allowed the financial sector to say “no”.
To answer Tobin’s question is to ask a more fundamental one: who governs our economy? Is it public institutions accountable to citizens, or private interests accountable only to themselves?
If democracy means anything in economics, the Tobin Tax should already exist.
Its absence is the measure of how much democracy we have left to win.
