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Tobin Tax Time

Tax currency transactions: reduce both speculation and poverty
Dr Sheila Killian

 

Currency speculators have been flying too close to the sun
Currency speculators have been flying too close to the sun

When the soon-to-be Nobel Laureate James Tobin first proposed his currency transaction tax (CTT) in 1972, he unleashed a movement which has taken many different tacks over the years, but whose time may have finally come. The “Tobin Tax” as it is known, is basically a tiny tax levied on all retail foreign currency transactions, worldwide. The idea is that a small tax of say, 0.1% would “throw some sand in the wheels” of the market, and help prevent the damage caused by speculative investors to vulnerable economies. Such a small rate of tax would not be a disincentive for long-term, though it might discourage some shorter-term, investment.

 

The design of the tax has evolved a little since Tobin’s original proposals. The most popular variant is a two-tier tax proposed by Paul Bernard Spahn. The idea is that the tax will be imposed at a standard low rate, unless the market in a particular currency becomes very volatile. If that happens, a higher rate will kick in temporarily, as a kind of circuit-breaker, deterring transactions at precisely the time in which speculation is likely to be the most harmful, and the most profitable. The tax would be applied to all retail transactions, and collected relatively painlessly through the electronic international payments systems.

Primarily, then, the tax was designed with a view to its economic effect rather than the revenue it might raise. Since then though, the tax has found widespread appeal among what Tobin himself described as “a non-economics constituency”, a group more interested in the money the tax would raise than the impact it would have on speculators. Estimates on how much money a Tobin Tax would raise vary woefully, but a 2007 report from the Bank of International Settlements (BIS) stated that average daily turnover in foreign exchange markets ran at $3.2 trillion in 2007. However, more than half of all currency trades are done at interbank or dealer level, to which it is generally anticipated the Tobin Tax would not apply. Still, if we assume 250 trading days in the year, on the surface, this would suggest that a tax of 0.1% would yield $320billion annually. This crude estimate completely ignores any dampening impact of the tax, but gives some idea of the worldwide revenue that could possibly be raised. The potential to address global problems such as the financial crisis, global poverty, Aids, malaria and an underfunded UN etc., is obvious.

Opponents of the Tobin Tax marshal their arguments under two main headings which are largely unchanged over time. The first is that it distorts the market; the second is that it is difficult to enforce. All taxes distort economic activity, though many aim for a neutral effect. The Tobin Tax deliberately sets out to ‘distort’, in that it aims to change the behaviour of those affected, and discourage them from short-term currency trades. Those who oppose this either oppose market distortions in general, or believe that the change will be for the worse. The first group adhere to the idea that unfettered markets will optimise economic activity. This is a key pillar of market efficiency, but one which is open to a great deal more criticism in recent years. Tobin succinctly dismissed this line of thought saying “There is no arguing with true believers in the faith”. A smaller group of scholars believe that a Tobin Tax will create a specific and damaging distortion. They argue that in certain circumstances the tax may actually increase volatility by slowing up international capital flows, and could also damage the liquidity of smaller, less dominant economies.

The enforceability of the tax is currently a bigger issue, and most of the opposition to the tax implementation centres in this question. Early writers on the subject were concerned at how cumbersome any mechanism to collect the tax might be. Technology and the integration of international payments systems have largely overcome this objection. The biggest difficulty is political. Most commentators agree that the tax should be implemented simultaneously in all countries worldwide. Failure to do this would mean that transactions in one country’s currency would cost more than in another, and this could be politically difficult in times of tax competition. It is hard to imagine Ireland, for example, introducing a Tobin Tax on a unilateral basis, as there are fears that this would make the IFSC less attractive. Tobin himself dealt with this problem by suggesting that the imposition of the tax at an internationally-uniform rate be made a precondition for membership of the IMF, thus sidelining any non-cooperating states. It could clearly also be introduced at an EU level on all Euro transactions, or in the US for dollars, if the political will were there.

Then there is the elephant in the room – derivatives are widely blamed for the market instability that triggered our recent financial crisis. Arguably, any tax that seeks to stop damaging speculation needs to apply in this area also. Derivatives are complex financial instruments whose value derives from another, underlying asset, but whose price may be very different from that of the asset concerned. A simple example is a share option. The value of the option depends on the price of the share, but the price of the option is probably far below the share price. It would be technically very difficult to apply a Tobin Tax to currency derivatives. The problem is that if derivatives are exempt, then they can easily be used to avoid the tax on retail transactions. Certainly the financial sector has in the past shown that innovation will respond to such monetary incentives.

Finally, there is the question of how the revenue will be divided between the collecting country and which international body will be charged with overseeing and implementing the tax. Tobin envisaged a system whereby the tax would be collected in the countries where the transaction was initiated, but would be surrendered to the IMF as an administering body and applied to international issues. Poorer and more vulnerable countries, however, would be allowed to retain most of the revenue they gathered, and governments of closely-related countries would have the opportunity to apply for an exemption from the tax on transactions between themselves. There is by no means universal agreement that the IMF is an appropriate body. Its often heavy-handed policies are not always welcome in developing countries. The creation of a new body seems inefficient, but some administering group is almost certainly needed.

After years in the wings, the Tobin Tax is now moving to centre stage, politically. The EU and IMF are considering it as part of a range of alternative strategies. Hundreds of NGOs support it either as a primary aim, or as a second-best alternative to a more broad-based tax on financial transactions. Partly this is reactive – global volatility and speculation is seen as having caused the financial crisis, and anything that can address this is welcome. Global poverty has also made its way towards the top of the agenda, and the funds raised by a Tobin Tax are an obvious way to address this. Thirdly, it is argued that a well-funded United Nations could greatly reduce the impact of future economic shocks by introducing a new era of stability into world relations, and minimising the economic effects of upheaval, pandemics and environmental disasters. The pace of globalisation itself is also a spur for more recent consideration of the tax. It is increasingly clear that multinational companies are more powerful than many of the countries in which they operate. In the presence of global tax-competitions, if national governments face increasing challenges in taxing international business, perhaps there is a case for a truly international tax. Finally, there is a popular drive to tax banks and financial transactions more effectively, following the impact of the financial crisis on the economies of countries worldwide. The Tobin Tax or some variant thereon is seen as a straightforward, comprehensible mechanism for making banks pay.

A Tobin Tax would certainly be a major international undertaking, and would require a shift in the way we think about taxes, and a possible re-imagining of what is meant by national sovereignty. There are obvious practical difficulties in its implementation, and some doubts over its impact. However, even at worst, a successfully-implemented Tobin Tax may not significantly reduce volatility, but it would certainly dampen short-term speculation and raise significant revenue internationally. The question of how much revenue is very unclear, and the thornier one on how the revenue would be applied, also remains open. This is unlikely to be addressed until the tax becomes a serious possibility. While debate continues about implementation issues, the main impediment to the implementation of a Tobin Tax remains political will. At the time of writing, many EU leaders support the idea of a tax, but the US has alternative ideas on taxing international banks. Nevertheless, the aftermath of the financial crisis presents the best possible international opportunity for the implementation of a currency-transaction tax. In the 1930s, JM Keynes wrote that “it is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges”. Finance ministers from the G7 wealthy nations agreed on February 6th to take a closer look at various proposals for making banks cover the cost of bailouts, past and future. The details are sketchy and ideas range from a tax on a bank’s balance sheets, proposed by U.S. President Barack Obama, to the Tobin tax. The idea of a Tobin Tax is almost forty years old, but 2010 may well be its year.

Sheila Killian is the Head of the Accounting & Finance Department at University College Limerick