Tobin Tax Now?
The plea of 1000 economists from 53 countries – among them celebrities such as Jeffrey Sachs and Dani Rodrik – for G20 finance ministers to tax “speculators” in order to help the poor in the Guardian of Wednesday 13 April 2011 impressed by the sheer extent of expertise gathered. The great public appeal of the two main variants, the Tobin Tax and the Robin Hood Tax, cannot hide the fact that both concepts have severe drawbacks. The time is right for action, but before agreeing on a strategy the international community has to come to grips with some open questions.
The initial proposal
The idea to tax international financial activities comes in two main variants. The initial proposal made by Nobel-laureate James Tobin in the 1970s was intended to slow foreign currency speculation by imposing a tax on forex transactions. This seems appealing for three reasons:
The first is volume: The foreign exchange market is by far the biggest international financial market with an estimated daily turnover of 3,981bn US dollar in April 2010. By comparison: Total issue of international debt securities such as bonds and notes amount to $26,751 bn.
The second reason is leverage: In this wholesale market due to established customs, when a currency is bought or sold spot in the interbank segment (which is the largest one), no accounts are debited or credited, that is no money actually changes hands, until settlement, and it is only the difference, i.e. the gain or loss, that has to be paid and settled.
The third reason is impact: Financial crises often start with rumours in the foreign exchange markets and traders testing the currency, and they are reinforced by renewed rumours and tests in each successive wave of instability.
Further, this tax variant would be lucrative: Estimates by the European Commission several years ago indicated that a turnover tax of 0.01 per cent to 0.1 per cent would generate between $20bn and $200bn a year. This was at a time when official development finance was about $66bn.
The disadvantages of this proposal are less obvious. The first is availability of data. The only coherent source of information on market volumes is a survey conducted every three years by central banks and monetary authorities of countries with large and medium-sized foreign exchange markets under the auspices of the Bank for International Settlements.
The results represent only a fraction of aggregated foreign exchange business worldwide. They provide limited information of a market which is permanently in motion with actors, amounts, and types of transactions varying considerably from one point in time to another.
There is no basis for tracking individual positions in order to tax them. In contrast to an often used argument even the big real-time-gross-settlement (RTGS) payment systems are of no help in this case: For leveraged positions it is not the amounts settled via a payment system that matter, but the much higher traded volumes behind. They reflect supply and demand in the market which in turn affect prices and trigger instability. As a consequence, taxing positions settled via these systems would mean a much smaller burden than intended and yield much lower revenues than the ones tax proponents hope for.
Robin Hood Tax
At first view, the second variant, the Robin Hood Tax, a tax on exchange-traded financial securities and/or bank loans, would avoid these obstacles. Securities trades and loans are well-documented.
However, there are several drawbacks, too: Markets are much smaller than those for currencies. In addition, in some of them only parts are actively traded. As a result, they are easier to manipulate but less lucrative for the tax collector. Above all, they are by no means an alternative when it comes to halting the free fall of a currency or changing its direction.
Another drawback of the Robin Hood Tax is that, in contrast to currency markets, the markets concerned are to a much smaller extent wholesale markets. In the securities and loan business much more non-financial players are involved. As a consequence, in these markets distortions from taxing would have more undesirable repercussions on the real economy.
The most serious deficiency, however, in my view is the recent shift in targets in public debates: As a reaction to the latest financial crisis the focus seems moving gradually from emerging market economies to advanced economies and, at least in countries with large and deep financial markets, to a more inward-looking approach apparently driven by the wish to stabilize national systems and get some compensation for experienced losses. Furthermore, for tax proponents who in the past tried to cope with the complexities of feasibility and data problems, to deal with securities and bond markets which appear more tractable and transparent must come as a relief. But with this advantage, of course, they are moving farther and farther away from the solution initially sought.
All proposals to tax international financial activities bear the risk that in trying to find a balance between desirability and feasibility the finally chosen strategy will prove inappropriate and ineffective.
Accordingly, before coming to a decision answers should be found to three basic questions:
- What is the aim to be pursued? Is it to reduce vulnerability of emerging market economies to financial instability? Or is it to make money in order to fund international initiatives against poverty? Or is it to make banks in advanced economies safer? Or is it to make banks pay for the damage they did and compensate taxpayers and governments for the losses? These aims are not necessarily mutually compatible and mixing motives and strategies will most certainly result in inadequate outcomes.
- How can this aim be reached? What kinds of transactions, positions or states are to be taxed? How can related data problems be solved? How can “good” financial flows be distinguished from “bad” ones in order to avoid distortions and negative side effects?
- What shall happen with tax revenues? If the idea of taking from the banks and giving to the poor “works” huge amounts will have to be distributed to economies which currently struggle to digest much smaller inflows. How can those revenues be used without provoking further distortions and creating new imbalances and sources of instability?
As soon as satisfying answers to these questions are found, the right moment has come to deal with the aspects of how to obtain international consensus and avoid tax and regulatory arbitrage. At this stage, however, this would seem premature. Regarding the range and variety of existing concepts and proposals, so far economists apparently have no unequivocal and unanimous answers beyond the general call for a tax. Under these circumstances, however, the world would be better advised to proceed in small steps and look for more modest but feasible and effective alternatives. For instance, there is only a handful of banks dominating trade in emerging market currencies. Draw the world’s attention to the question how to regulate their activities in times of crisis and much will be won.