Germany's leaders agreed earlier this week that financial markets need to be taxed, but exactly how such a tax should be implemented is still up for debate.

Some experts say a "financial transaction tax" on each trade would slow markets down to a point where they better reflect economic realities. Others say a "financial activity tax" on profits, salaries and bonuses is a way to clamp down on the most aggressive speculators without stifling the market.

If the tax were only to be implemented in Germany or Europe, it could result in capital being drained into less-regulated foreign markets, others warn.

Tax could damage comeback

Volker Treier, chief economist of the German Chambers of Industry and Commerce (DIHK), said the global economy is still in a state of crisis, making it impossible to know if another credit crunch is coming.

"Anyone who says now is the time to heavily regulate financial markets needs to keep in mind that well-functioning financial and credit markets are preconditions for investment opportunities in the real economy, and therefore can also create jobs," Treier told Deutsche Welle. "At the moment, that is being overlooked."

A financial tax would make it difficult for companies to obtain credit, hedge against currency fluctuations or compensate for changes in raw materials prices, the DIHK said.

"There is only one exceptional reason to not be against this: if it is implemented internationally," Treier said. Otherwise "investors will steer well clear of Germany and Europe, meaning less capital flowing into Europe."

Markets increasingly abstract

But Pedro Morazan of the Suedwind Institute for Economics and Ecumenism sees a financial transaction tax as a tool for stabilizing financial systems so they serve the interests of the general public rather than those of speculators.

Current conditions present an "unparalleled opportunity," he said. "To claim a tax will bring about a situation which already exists because of the absence of that tax is an argument we consider very strange."

A financial transaction tax could help reduce Germany's national debt, bolster struggling local governments and support relief efforts in poor countries, according to Morazan.

However the additional income generated by a financial tax might also discourage governments from making politically painful budget cuts, Treier said. "It would be a good excuse for them to avoid making important cutbacks in their expenditures."

Morazan pointed out global and computerized trading has lent unprecedented volatility and speed to financial markets. Because of this, market values often fail to accurately reflect the basic balance between supply and demand, he said.

"Financial transactions no longer react to price signals coming from the market, and these transactions are sometimes conducted within nanoseconds," he said. "The main problem we have is a massive number of financial transactions."

A financial transaction tax would make profitable high-volume trading difficult or impossible.

Markets need reality check

Michael Schroeder, head of International Finance and Financial Management at the Center for European Economic Research, said he believes a transaction tax could "bring market rates back to their fundamental values and lessen the volatility around those values."

"In principle I believe it makes sense that those who carry the greatest risk are pushed from the market. In part because their activity might generate false signals and one function of capital markets is to indicate when there is a scarcity of capital," he told Deutsche Welle.

Schroeder said that if a transaction tax is only implemented in Europe, the potential loss of European markets' value and significance could be avoided by finding "mechanisms which make it difficult to circumvent the tax."

The possibilities of a "financial transaction tax" and "financial activity tax" are not mutually exclusive and "could also be implemented together," he said.

Author: Gerhard Schneibel
Editor: Sam Edmonds