Taxing the Speculators

Paul Krugman, a Nobel prize winning economist, wrote an interesting commentary that was recently published in the New York Times (access it by clicking here). He suggested that financial speculation on the exchange of currencies creates negative externalities that disrupts the world economy. One way that these externalities can be reduced is by imposing a small tax on the exchange of currencies. He argues that the tax would be easy to impose due to the centralized nature of trading and generate revenue that is much needed by the United States government. While it is not a cure-all, it would help banks and other organizations to become less reliant on "ultra-short-run financing" and may help prevent future crises similar to the one our country is currently experiencing.

I find the idea of taxing negative externalities intriguing. Governments already do this through taxing the creation and disposal of pollution and other destructive elements. Almost all taxes create a degree of deadweight loss, so the benefits may not be worth the costs. I'm not sure if the same concept of taxing these externalities could be applied to financial speculation the way Mr. Krugman is suggesting; nevertheless, it is an interesting thought.


Deric said...

I am not so sure that taxing currency exchange is a great idea. I think that by doing this it is going to create more negative externalities within the stockmarket and its participants while not really solving the problem.

Dr. Tufte said...

This is an area of ongoing research in international finance.

Theoretically, taxing currency transactions is a form of capital control. There is not a lot of basis for thinking that they work. The effects are a lot deeper than externalities and deadweight losses.

But, empirically, the evidence is not so clear cut. The best example is Malaysia, which introduced fairly strict capital controls about 10 years ago, and has done OK with them.

As a revenue raising tool, I can't call Krugman's suggestions anything other than bizarre. Yes, this would raise some revenue. But this is a virtual business, so it would probably just move somewhere where it isn't taxed.

Krugman seems to have a lot of problems with the "if you're so smart why aren't you rich" argument. I'm not sure that I see much other than a soak the rich philosophy underlying his suggestion.