Wednesday, December 2, 2009

A brief aside regarding tax policy, fiscal crisis and why taxing Wall Street to pay for infrastructure is not quite right...

By Ariel

I think it is fair to say that our current financial crisis was caused by the legalization and utilization of financial products whose risk was not properly appreciated. The failure of these products has cost the United States, and the world, dearly.

One might suppose that it is not surprising that Democratic representatives are looking to tax Wall Street to fund key initiatives. Recently Rep. Ed Perlmutter (D-Colo.) has argued that the US should levy a tax upon financial transactions to fund a jobs bill and Rep. Pete DeFazio (D-OR) would like to impose a small per-trade tax on the Wall Street oil futures market.

When James Surowiecki of the New Yorker writes about similar attempts to regulate the financial markets (as opposed to imposing the above mentioned taxes with very tenuous nexus) he characterizes the reaction against such initiatives as veritable chastisements of attempts to “stifle innovation.” Surowiecki argues that indeed, that is precisely the point: that we want only so much innovation, that such potential (and now actualized) risk is externalized to the public and not born only by the investors. I buy that argument. I’m not just indulging in a little populism when I say that I find it hard to argue that the any of these financial instrument portfolio managers (or whatever) who received six figure bonuses really suffered the effect of the damage they caused.

However, tax policy must be refined and not blatantly spread about taxes should be based upon some sort of nexus. I am highly ambivalent about the above-mentioned proposals, while they smell like bad policy I would love to get my hands on that tax revenue to build better transit service in Philadelphia.

An appropriate tax would integrate an assessment of the risk any given financial instrument has to our overall economy. HMO’s determine your monthly payments based upon your potential to cost them a lot of money. I would argue we need to tax financial products similarly. If you want to engage in risky home mortgage derivatives, you should pay for it with a transaction tax.

Not only does that discourage risky products (not risky for the investor, rather risky for the economy as a whole) from proliferating but we could use the generated revenue to either invest a hedge against such damage, or to invest in necessary reforms, etc.

This argument has its limits, I am uneasy with the parallels to the tobacco industry, and various states’ reliance on cigarette taxes to plug budget deficits and I am not sure how on earth you would even begin to measure such risk on the outset, none the less, I believe that is an avenue worth exploring.

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