22 Dec 2011

The Golden Rule for Fiscal Policy and the Variable FTT

Many governments have been pushing to implement a Golden Rule for fiscal policy - namely, the idea that government expenditure should not be allowed to exceed revenue. With the current tax systems, based largely on Income tax, VAT, and taxes on company profits, it is very difficult (impossible?) to ensure that this happens without having tax levels fixed at levels that generate surpluses. As soon as there is a global recesssion, tax revenues drop, and governments have to resort to borrowing to cover their costs. Interest rates spiral, and we end up in the calamitous situation that now faces us.

I would argue that implementing a Financial Transaction Tax with a variable rate is a solution to this dilemma. It might even be the only practical solution.

The idea is simple. The government just has to set the FTT rate to whatever value is necessary to provide the required level of revenue, month by month. Like a well regulated thermostat on a heating system, adjustments can be made continously so that the total revenue reaches the required amount at the end of each month.

At first, the introduction of a Flat Rate FTT across all transactions would no doubt lead to considerable reduction in the level of certain types of transaction. For example, if the rate was initially fixed at 0.1%, anyone involved in High-Frequency Trading where the net gain per operation was less than 0.1% would rapidly find that they were losing money. They would either stop making such trades (something that would probably be beneficial for everyone else), or maybe move their operations to some other location. Some commentators have claimed that this would kill off the City of London. But the simple fact is that these sorts of activities depend completely on being able to make operations with delays of microseconds. This could not be done efficiently from an offshore site such as the Caymans. I doubt that this would have any serious consequences for the economy.

But the fact is that even if the level of certain types of transactions drop, or even collapse completely, this would not be a problem. There will always be a very large volume of financial transactions that would persist. Firstly, any speculation that allowed profits to be made that exceeded the FTT value would continue. Indeed, an FTT does not prevent people speculating - just high volume speculation that has very low returns. But, more importantly, there are very substantial parts of the economy that involve transactions that are essential. People have to pay for food, energy, housing, transport. Businesses need to pay salaries and buy raw materials. These transactions would continue whatever the FTT value. Applying VAT at 20% doesn't stop people buying goods. It simply means that they buy less of them. And even the outrageous 2.99% FTT that credit card companies charge holiday makers when they are abroad will not stop them going to restaurants, buying souvenirs and so forth. They simply buy less of them.

In other words, it is extremely unlikely that the fluctuations in rate that would occur once the tax has been introduced would produce any significant pertubation. Frankly, if at the end of the month, the FTT has gone up from 0.1% to 0.11% because of a 10% drop in total transactions, no-one would even notice. Someone being paid a salary of £2000 a month, and who spent everything would see that the FTT costs on their bank statement would increase from £2 to £2.20. Big deal.

The most imporant feature is that this continously varying FTT mechanism would guarantee that the Golden Rule can really work. Of course, given that virtually all governments are massively in debt to the banks, there may well be a need to have an initial period where the FTT is higher until the debt has been paid off. But even this can be planned in detail.

For example, the UK government currently has debts of around £900 billion. With transactions currently running at around £1000 trillion a year, this could potentially be paid off in around 12 months with an FTT set at 0.1%, or over 10 years with a tax rate of 0.01%.  One option would be to start with the very low rate, and increase it progressively if it transpired that the tax did not lead to serious collapse in the transactions.

All of this just seems to make so much sense. I frankly can see no advantage whatsoever in maintaining the current tax schemes centered on Income tax at a basic rate of 20%, VAT at a basic rate of 20% and Corporation tax at a basic rate of 20%. They are all full of anomalies, rife with evasion, and expensive to collect.

I say scrap them all. We should have a 0-0-0-0.X% system with 0% Income tax, 0% VAT, 0% Corporation tax, and a variable rate FTT which would almost certainly only need to be set at a fraction of 1%.

All I want for Christmas is an FTT, an FTT, just an FTT....

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