Tyler Cowan argues against Krugman and makes several good points, most notably, that capital requirements are more effective than a Tobin tax to deal with excessive risk taking.
As Gary Gorton and Andrew Metrick of Yale have shown, by 2007 the United States banking system had become crucially dependent on “repo” transactions, in which financial institutions sell assets to investors while promising to buy them back after a short period — often a single day. Losses in subprime and other assets triggered a banking crisis because they undermined this system — there was a “run on repo.”
And a financial transactions tax, by discouraging reliance on ultra-short-run financing, would have made such a run much less likely. So contrary to what the skeptics say, such a tax would have helped prevent the current crisis — and could help us avoid a future replay.
Would a Tobin tax solve all our problems? Of course not. But it could be part of the process of shrinking our bloated financial sector. On this, as on other issues, the Obama administration needs to free its mind from Wall Street’s thrall.
It seems to me that one big problem with a Tobin tax is that it is a tax on arbitrage transactions, and in particular, on short selling. It seems to me that asset bubbles are caused by the difficulties of arbitrage and short selling. If we had more of it then skepticism about bubbles could be priced and this would be valuable. Taxing financial transactions raises the cost of an already costly activity. So the unintended consequence could be severe.