Transcript Slide 1

Zombie Taxes:
Why They Are So Hard To Kill
Joseph A Grundfest
Stanford Law School
Rock Center for Corporate Governance
June 6, 2012
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Zombies and Zombie Taxes
Zombies are “typically depicted as mindless, re-animated corpses with a
hunger for human flesh, and particularly for human brains.” (see, Wikipedia.
Where else?)
Zombie taxes are mindless, re-animated tax proposals driven by populist
appeal and that must defy rational thought in order to survive.
 Financial transactions taxes are among the great zombie tax proposals of
all time.
This is not to suggest that the financial services sector or that financial
market activity cannot, or should not, be differentially taxed. It is, however, to
suggest that a transactions tax is a uniquely poor method of taxing financial
sector activity.
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How to Kill a Zombie
This is hard to do: “The undead are notoriously difficult to kill, the base reason
being that they are already dead.” (See Yahoo!. Wikipedia did not know this.)
Apparently, to kill a zombie, you must attack its brain, and the top ten
techniques for achieving this result are (again, according to Yahoo!):
10. Crow bar to the skull (use both hands)
9. Drop an Egyptian obelisk on the head (not sure if other obelisks work)
8. Light the zombie on fire (gasoline is the fuel of choice)
7. Smash head in convection oven (preheat to 350 degrees)
6. Run it over with a car (bigger is better)
5. .308 Winchester to the head (important to split the skull in two)
4. Chain saw (wear goggles)
3. Starve the zombies out (takes 2-3 years. Bring lunch.)
2. Trap zombie in concrete (use qwik-set)
1. Put zombie in wood chipper (another pair of goggles)
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How to Kill a Zombie Tax
Easier to kill a zombie. Zombie tax proposals have eternal life and survive
even if attacked at their microscopically small brains.
As soon as you persuade one person that a zombie-tax idea doesn’t work,
or is harmful, another bozo across the room independently re-invents the
same zombie-tax idea. Think Whack-A-Mole.
Best possible approach: All persons who propose or who are known to
support zombie tax ideas could be fed into wood chippers.
•Do we have enough wood chippers?
•This doesn’t stop the idea from spreading. It only stops people
from talking about it. But maybe that’s good enough.
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A Noble, but Failed Effort at Zombie-Tax-Icide
Grundfest and Shoven, Adverse Implications of a Securities Transaction
Excise Tax, J. Acct., Auditing & Fin. 409-442 (1992).
Reaction to 1990 proposal by Bush Administration to impose a 0.5 percent
excise tax on all sales of financial instruments other than treasury bonds.
Note: Treasury bonds are commonly exempted from questionable regulatory
regimes, such as the Dodd-Frank Act. Why is that? Should there be a rule that
no market can be subject to a regulation unless the Treasury market is also
subject to the same regulation? By how much would that help clean up the
regulatory structure in financial markets?
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Arguments Against a Financial Transactions Tax
1. Capital market transactions typically have ready substitutes, and are therefore
easy to avoid through legal means and through off-shoring. Economic theory
suggests that optimal taxes are inversely related to the elasticity of substitution.
A financial transactions tax is therefore quite sub-optional.
2. Because the tax is easy to avoid, it will not raise the anticipated revenues,
especially if estimates are based on static projections.
3. Part of the substitution effect will drive financial transactions offshore, thereby
hollowing out domestic financial markets.
4. To the extent the tax is effective and raises revenue, the tax increases effective
transaction costs (i.e., the after-tax bid-ask spread) and must therefore be
reflected in lower asset prices. In other words, the greater the revenue raised,
the larger the hit to financial asset values.
• The CBO in 1990 estimated that a 0.5 percent transactions tax would
cause a 7.7 percent decline in the Dow Jones index.
• Amihud and Mendelson estimated a 13.8 percent decline.
5. The financial transactions tax would therefore increase the cost of capital in
U.S. markets as the value of financial instruments fell.
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Arguments Against a Financial Transactions Tax
6. Costs will also be incurred as the financial markets evolve new transactions and
instruments expressly designed to minimize the effective transaction tax rates,
including deadweight losses as lawyers, accountants, and other intermediaries
charge additional fees.
7. There will be a discriminatory negative effect on the valuation of short term assets
and assets that are more likely to be traded.
8. The cost of marketmaking and of risk hedging can increase dramatically:
exceptions for these activities would be difficult to monitor.
9. There is no evidence that such taxes would reduce market volatility, a major
benefit claimed by many adherents:
• Markets with high transactions costs also experience high volatility (see,
e.g. the U.S. housing market and many foreign equity markets)
• Arguments in support of this thesis are entirely theoretical and rely on
unsubstantiated assumptions. Equally plausible models generate
increased volatility as a result of the transactions tax.
• Volatility also spreads through correlations that would be unaffected by
transactions taxes.
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Why the Tax Proposal Persists
Most people don’t understand the underlying economics:
•To the extent that the tax raises revenue it can only do so by
reducing asset values.
•Huge incentives to establish avoidance mechanisms
•It won’t promote long-term investing or reduce volatility.
It appears to fall primarily on “fat cat” capitalists and active traders – hardly
the most popular constituencies – when, in fact, the tax will be broadly borne
by investors and by the economy at large.
It is easy to demagogue.
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The Financial Activity Tax: An Alternative
A Financial Activity Tax (“FAT”) targets the profits generated by intermediation
activity in general, while the transactions tax targets some variant of turnover.
The IMF staff has proposed three variants of a FAT.
FAT 1: Roughly speaking, a VAT on the financial sector (a tax on the sum of
financial sector wages and profits defined in cash flow terms).
FAT 2: Same as FAT 1, but excludes reasonable wages from the tax base, with
the goal of taxing rents, as best as they can be estimated.
FAT 3: Same as FAT 2, but excludes a “normal” or “fair” return on capital, so
that the tax falls on returns that are more likely characterized as rents.
FATs are strongly preferable to transactions taxes on economic and operational
grounds. See Shaviro, The Transactions Tax versus the Financial Activities Tax
(NYU Law & Economics. Working paper No. 12-04, March 2012).
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