Taxing the London Whale

By :: May 15th, 2012

Now that a once-obscure J.P. Morgan Chase derivatives trader named Bruno Iksil has become infamous as the London Whale, I suppose it is time to ask whether what he does should be subject to new taxes.

The question predated Mr. Iksil’s misadventures, of course. Ever since the U.S. financial crash of 2008 and the beginnings of the pending Euro-zone financial collapse, governments have been debating whether financial services should be subject to a new tax.

Such a levy could, in theory, accomplish at least three goals: It could raise revenue for countries under great fiscal stress, assure that the financial sector (which often avoids tax) pays a “fair and substantial” share of taxes, and discourage bad behavior and thus stabilize markets.

These last two aims are especially important since the cost to governments of bailing out stupid (at least) financial institutions has run into hundreds of billions of dollars over the past four years.

Of course, such a tax could also have damaging unintended consequences that would damage financial markets.  

If they should be taxed, the really interesting question is: How? There are at least three major alternatives—and lots of variations on the theme.

The first option is a financial transactions tax (FTT) that imposes a levy on each trade without regard to profits or losses.  Thus, if I buy a share of stock for $10 and then sell the same share for $10, I’d be taxed on the value of both transactions even though I made no money. The European Commission recently proposed such a tax for the EU, and Sen. Tom Harkin (D-IA) and Rep. Peter DeFazio (D-OR) proposed one in the U.S.

The second option is a financial activities tax (known, sadly, as a FAT). This tax, which has been proposed by the International Monetary Fund staff, is levied only on net proceeds of securities transactions. You could think of it as a Value-Added Tax on financial transactions—which are normally exempt from the VAT.

Just to make things even more interesting, some versions of the FAT would not tax all profits, only those that are very high. They might, for instance, have taxed some of the big derivatives bets that Wall Street placed in the early 2000s.

The third idea, which has been proposed by the Obama Administration, is a direct tax on the balance sheets of large, financial institutions. The idea is that a firm should pay a tax that reflects its contribution to systemic risk—and, thus, its likelihood of needing a taxpayer bailout.

The differences between even the FAT and FTT can be pretty arcane. As New York University law professor Dan Shaviro, who has written a terrific paper for Tax Notes on the subject, says, “It is difficult to imagine a question that initially sounds as tedious as whether we should tax financial transactions or activities.”

But this choice is a very big deal. For instance, taxing every transaction could generate an enormous amount of money, even with a very low rate. A 0.01 percent tax would collect $16 billion Euros annually and the Harkin-DeFazio 0.03 percent tax could raise $350 billion over 9 years. Because the FAT taxes only profits, it would take a much higher rate to generate as much revenue.

And there are other questions: What is a financial transaction? How, in fact, would those derivatives that created so much unpleasantness for J.P Morgan in recent days, be taxed?

Then, there is tax competition. Even if all the world’s major developed countries adopted the levy, what would prevent financial markets from decamping to some warm Caribbean island to avoid the tax?   

If you’d like some answers to these timely questions, the Tax Policy Center is sponsoring a panel on the subject on Friday.  Panelists include Dan Shaviro, IMF Deputy Director for Fiscal Affairs Michael Keen, Tax Notes contributing editor Lee Sheppard, and AFL-CIO special counsel Damon Silvers. TPC visiting fellow Steve Rosenthal will moderate.


  1. Michael Bindner  ::  5:43 pm on May 15th, 2012:

    If taxes make it into product cost, we will pay them – which could happen, even indirectly, if traders can simply demand more from the productive sector. If a FTT is enacted, it could kill automatic trading,which may not be a bad thing, since these trades take advantage of minute price differences. If an FTT is added to the burden of programmed trading, there will be less of it and therefore less revenue from the tax than projected now. While arcana is fun to speculate on, the real issue in the tax debate is who will geek in the game of chicken going on over taxes on the highest income earners. Too many moderate Republicans retiring or losing to Tea Party members will change the calculus that donors use to back Grover Norquist in his play to drown government in the bath tub. If it looks like Obama will win with clear congressional majorities, due to GOP extremism, major donors will seek a deal while they still have their people in power.

  2. Tax Roundup, 5/16/2012: Mobile workforce act, rich hix tax trix, London whales. « Roth & Company, P.C  ::  9:26 am on May 16th, 2012:

    […] Is there anything they don’t want to tax? Taxing the London Whale (TaxVox) […]

  3. Weiwen  ::  1:43 pm on May 17th, 2012:

    I hope the panel will address this question: I get how an FTT is different from an FAT, but how is an FAT different from a capital gains tax? Do proponents intend that people CAN’T use losses to offset gains in an FAT, like they do with capital gains?

    And while obviously some would prefer that an FTT or an FAT would apply to any type of financial instrument (stocks, bonds, options, credit default swaps, etc), are there any instruments that someone could make a valid technical (i.e. not solely political) case for exempting?

    It appears that some folks in the EU have thought that other forms a FAT could take would be to tax the economic rents that accrue to banks, or to tax very high wages – there could not possibly be any simple method to determine what constitutes an economic rent, though.

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