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Debate: Tax on currency trading across borders (Tobin Tax)

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Should a global tax be waged on foreign exchange dealings (i.e. the Tobin tax)?

Background and context

James Tobin, a Nobel Prize winner for economics, first presented his plan for a tax on currency transactions in 1978. His plan was to slightly increase the cost of trading in currencies, by introducing a currency transactions tax (proposals range from 0.003% to 0.5%). The tax was intended to discourage the speculations that are blamed for large exchange rate fluctuations and serious damage to economies. The idea was not accepted with enthusiasm at that time. In 1990s two additional factors came to the international arena that triggered the interest in Tobin’s proposal again. Firstly, the seventies and eighties' confidence in floating exchange rates diminished, as currency instability led to several crises (Mexican, East-Asian, Brazilian, Russian). As the tax could also generate considerable amounts of money, the idea attracted the attention of those concerned with the public financing of development. Proponents argue that a Tobin tax would help reduce financial instability and is feasible. Opponents counter that it is infeasible, and could even worsen instability. The arguments stated below do not go into specifics, as there are several different and complex proposals being discussed at the moment. Various proposals directly answer one criticism or another but at the same time raise other questions. Below you will find the most typical advocacy and criticism of the plan to introduce a currency transactions tax.

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Argument #1

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Yes

A Tobin tax would reduce speculative trading and facilitate real trade and investment. More than 1.8 trillion dollars changes hands every day on global foreign exchange markets. More than 80% of this trading is buying and selling money for profit’s sake. This speculation has played a crucial role in 1990s financial crises. In a crisis situation, currency trade swiftly increases and dealers often act as a “herd” and cause a rapid economic breakdown. A minimal tax would not hold back productive business transactions for trade and investment, but speculative transactions would be hit harder because the greater the frequency of transactions, the higher the tax charge.

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No

There is little evidence that such taxes reduce market instability and they will certainly not stop speculative attacks. However, even a small tax on each transaction could be sufficient to reduce liquidity in financial markets and do exactly the opposite - lead to an increase in instability. Because the tax can’t distinguish between speculative activities and dealings to finance trade, all market participants would be subject to the tax and as trade is welfare enhancing, public welfare is reduced to the extent that trade is reduced. The motivations of different traders in financial markets are not well understood, and there is no way to target only destabilising traders.

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Argument #2

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Yes

A Tobin tax protects the most vulnerable economies. Recent crises have unevenly hit the poor, mostly affecting the most helpless in those societies. Because of the East-Asian crisis in 1997-98 more than 10 million people lost their jobs. These economies are less flexible and adjust more slowly to huge shocks; moreover their thinner financial sectors absorb financial shocks with more difficulty. A Tobin tax does not prevent bad outcomes resulting from bad policy; instead it is intended to prevent groundless speculations.

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No

A Tobin tax is of little use in the worst cases of speculations that usually hit the poorest economies. In the emerging market world of extremely high currency risks, investors who expect a short-term devaluation of as little as 3% or 4% would not be deterred by a low Tobin tax. Indeed, given the scale of recent emerging market devaluations (50% in Thailand and Indonesia, 40% in Brazil), the tax would be totally irrelevant.

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Argument #3

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Yes

The revenue generating potential of a tax is tremendous. It has been estimated that a tax of 0.1% could raise $50 - $300 billion a year. Even if we take the smaller amount, this would match existing levels of official aid. The UN and World Bank estimated in 1997 that the cost of wiping out the worst forms of poverty and providing basic environmental protection would be about $225 billion per year. For comparison, the total annual UN budget is about $10 billion.

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No

All these sums of money do seem a tempting solution but what they actually cause is an effect of “moral hazard”. Countries that would receive huge amounts of financial aid would get used to international institutions solving their problems and would not learn to build efficient economies. That is of course if we presume that rich countries (they would collect most of the tax) would be willing to allocate all this money to international institutions. Industrialised countries may want to keep it for themselves.

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Argument #4

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Yes

There are several studies that address administrative problems and find adequate answers to administrative problems. A recent policy paper on the Tobin Tax, published with the support of the German Development Ministry concludes that the tax is technically feasible.

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No

Huge administrative problems exist in implementing the tax. Should this tax be collected by central banks, the UN itself, the IMF or even quotation agencies? The proper use of the tax would require a level of co-operation between monetary and fiscal authorities that does not exist in reality. It is doubtful that monetary authorities would have the ability and independence to administer such a tax wisely.

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Argument #5

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Yes

If international development organisations had their own source of money, they would be less dependent on the good will of industrialised nations and less influenced by the day-to-day politics of major powers and their selfish calculations. That would provide a more long term approach and help to focus on the real problems.

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No

The reality is that countries don’t want more independent international organisations. A huge challenge would be to persuade the rich to accept the loss of influence that would occur once these organisations gained a more independent income. The idea that revenues could fund the United Nations, for instance, has received an icy reception from the US. Sheer self-interest apart, there is an issue of democratic accountability at stake here, as independent international organisations are not subject to the same democratic control and scrutiny as most of the governments which would lose influence as a result of this proposal.

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Argument #6

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Yes

Presently 84% of all foreign exchange transactions occur in just nine countries. A tax introduced in these nine would initially provide a workable regime that could be gradually expanded further.

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No

The tax would need to be introduced globally and at the same rate, or transactions would move offshore to tax-free or lower tax jurisdictions (as happened with the eurobond market in the 1980s). Unless a world-wide uniform tax is imposed on all instruments for transacting in foreign currency, the tax will be largely ineffective.

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Argument #7

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Yes

Evasion should not be decisive in determining whether a tax is warranted. Every tax system is subject to some evasion and avoidance, and the extent of such behaviours is an appropriate concern. In any case, the very low level at which individual transactions would be taxed would be lower than the cost (or risk) of using other instruments instead. The argument that offshore financial centres are autonomous states and thus cannot be forced to cooperate is nonsense – their very existence depends on the protection of a G7 member.

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No

Tax on foreign exchange dealings could easily be evaded by shifting activity offshore or by using derivatives and other financial instruments to disguise trades in foreign exchange.

See also

External links and resources

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