Author Article by Lyric Hale: A Big New Tax You Never Heard Of – The Tobin Tax

Lyric Hale

Lyric Hale

Last week leading economic commentator and What’s Next? author Lyric Hale discussed the importance of contrasting – and often provocative – opinions in helping us to understand and shape solutions to the economic problems of the world. This week she takes a look at the Tobin Tax, as championed by Andrew Sheng, a contributor to her book. Lyric explains why the Tobin Tax – a levy on financial transactions – is probably the most important tax you’ve never heard of, and why banks don’t like it.

Article by Lyric Hughes Hale

All of our contributors are eminent, but Andrew Sheng stands out for his ability to elegantly champion contrarian ideas.  Particularly in Asia, policymakers such as Dr Sheng lean towards the conservative.  Not in his case. In our book, What’s Next? he has written a chapter that is quietly revolutionary, “The Tobin Tax: Creating a Global Fiscal System to Fund Global Public Goods”.

You might not have heard of it before, but it will be coming soon, to a theater near you. The Tobin tax, or FTT (financial transaction tax) is envisioned as a way to raise government revenues, fund global social needs, and increase international economic stability. Banks and currency traders don’t like it.

James Tobin

James Tobin (1918 - 2002)

It is not a new idea, but one that I predict will become dominant in policy discussions if things don’t get better soon. In 1972, on the heels of the demise of the Bretton Woods fixed currency exchange system, Yale economist and Nobel laureate James Tobin proposed a tax on international financial transactions to benefit for example, the United Nations, while avoiding what he called the problem of frictionless markets.  Taxation of currency trading would, he thought, curb rapid round trip speculators who might destabilize local markets. His idea, as he later admitted, “sank like a rock” but surfaced again during the Asian Financial Crisis in 1997.  Had an FTT been in place, it might have in Tobin’s words, “put sand in the wheels” of the currency speculators so that the crisis would have been avoided.

We are now facing immense global fiscal challenges, and talk about the Tobin tax has been revived in Brussels. I thought of Dr Sheng’s chapter as I read the news that the European Union is planning to implement an FTT, and so I asked him for his reaction to this development.  Dr Sheng thinks that although this new tax will begin in Europe, it will gain momentum worldwide.

“My view is that despite opposition from the financial institutions, the introduction of a global FTT is no longer if, but when.  Given high fiscal deficits, higher taxes are inevitable.  Once the EU starts the ball rolling, I see China, India and the emerging markets that are coping with huge capital inflows following.”

Andrew Sheng

Andrew Sheng - Contributor to 'What's Next?' and advocate of the Tobin Tax

Here is his reasoning, and it is compelling:

“Beginning with the EU, It Would Raise Needed Revenues— On June 30th, European Commission President Jose Manuel Barroso unveiled a budget for the seven year period from 2014-2020 totaling just under  1 trillion.  What was special was the proposal for a financial transaction tax (FTT) of 0.1% on all equity and bond trades and a 0.01% tax on derivative trades in order to raise roughly  30 billion annually.   The EU is also looking at whether a tax on currency transactions would be legally feasible, since that could raise revenues by another  20 billion annually.  Since the annual expenditure of the EU is roughly  124 billion, just the FTT including a currency trading tax would raise roughly 40% of expenditures.

It is Easy to Implement: At the national level, governments have always levied stamp duty on stock market and bond transactions and were only persuaded to reduce them to zero for derivative trades in the name of “free markets and financial innovation”.   Indeed, with the trend to centralize derivative trades to central clearing houses for market transparency and to monitor systemic risks, it should be easier to tax derivative trades and to monitor such trades for market manipulation and insider trading.  Putting an FTT tax collection mechanism is relatively easy since current exchanges and clearing houses already levy a charge to cover their operating costs.  

London Won’t Suffer. National governments have been wary of imposing FTT on currency or cross-border financial transactions for fear of losing the business to other financial centers.  This is the primary objection of the UK government to FTT since it would hurt the City of London.   However, if the FTT were applied at the same rate around the world, there would be no cause for regulatory arbitrage.    This is why the EU proposal is so crucial as the “first mover” in putting a global FTT in place. 

High Frequency Traders Unfairly Dominate the Market- Latest US industry estimates show that in 2010 and 2011, high frequency trading is roughly 53-56% of all trades.   Since retail investors are hardly in this game, it would be broadly true to say that more than half the transactions are a game between professionals for their own profits.  

To illustrate, the volume of global physical trade in 2009 was roughly $24 trillion, whereas global currency turnover according to BIS data in April 2010 was $4 trillion daily, or roughly $800 trillion annually.   This means that financial turnover is 33 times real turnover, meaning that the tail is now wagging the dog.  

A Transaction Tax will Curb Systemic Risk–Because of the highly leveraged nature of derivative trading, systemic risk has risen in faster, more leveraged and interconnected trading in the financial sector, with a big tail risk.  On May 6, 2010, a single large fundamental trader in the US initiated a sell program that triggered sharp losses of up to 15% for 8,000 stocks and as much as 60% for 300 stocks.   This prompted a worldwide study of “fast trading” to discover how automated execution of trade could quickly erode liquidity and result in disorderly markets.   High frequency trading may be profitable for the individual trader, but systemic liquidity and stability could have high cost for the market under “abnormal” conditions.

The Financial Sector Should Fund Its Own Cleanup– The purpose of the FTT is to redress the subsidy element of financial sector, so that the government has revenue to compensate for its rescue of the financial sector.   In the last 40 years, financial crises costs have varied between 5-50% of GDP, depending on their severity.  A tax collection system also enables the financial markets to be monitored for oversight against market manipulation.

China and India May Follow the EU’s Lead– Ironically, Countries with exchange controls, such as China and India, are perhaps in the best position to introduce FTT before they fully liberalize their capital accounts.   The Asian financial crisis demonstrated that market manipulation exists in all markets, especially in thinly traded emerging market currencies, as most foreign exchange transactions are traded over-the-counter (OTC) and offshore.”

Dr Sheng’s analysis raises excellent questions. Has the too-easy flow of money across national boundaries, enabled by deregulation and technology, resulted in too much volatility and a redistribution of wealth that is flowing to an unproductive sector of the economy? Are fiscal deficits worldwide the result not of too much spending, but too little revenue?   Has taxation policy lagged behind the forces of globalization and the power of financial institutions? Is the Tobin tax part of the solution for what ails us?

What's Next?

What's Next?

Most economists I talk to dismiss the Tobin tax.  But political will is important.  France and Germany stand behind EC President Barroso.  The UK government is opposed for the moment, but according to a Eurobarometer opinion poll, about 2two-thirds of EU citizens, including the British public, support an FTT.  In the US, where the idea was born, the discussion is just beginning.

What’s Next? Unconventional Wisdom on the Future of the World Economy by David Hale and Lyric Hale is available now from Yale University Press.

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6 Comments

  • July 16, 2011

    shen

    Banks and currency traders don’t like it and here is why – When an institution buys 1000 currency contracts at say just the tiny tax of 0.5% – with the shorting of one currency and going long in another that one transaction makes them liable for to a £1 000 000 financial transaction tax.

    When they close that position they are liable for a one million pound financial transaction tax again and when the position they are holding is rolled over every night? They are liable for a one million pound financial transaction tax. Where as an institution used to hold a position for the quarter aiming for there percentage gain if all goes well, in this new world of financial transaction taxes it will cost them ninety two million to buy one thousand contracts and sell them ninety days later.

    They now need to make ninety two percent on the position before they start to make a profit.
    This does not put “put sand in the wheels”, rather it absolutely stops the wheels of finance from turning so in the same breath you put an end to speculation and long term investment.

    Without speculators in the market to provide liquidity the market maker will widen his spread, accumulating and closing large positions in the markets will now have a direct effect on market price because the speculators are no longer there to absorb selling pressure and create a balanced supply. The May 6 2010 flash crash was an Accident,if you introduce such heavy supply into a market without enough demand to absorb it that is exactly what happens and will happen if a financial transaction tax has sent the speculators abroad…..

    And that is exactly where they will go because this will never be global,all it takes is one country to refuse,Sweden lost revenue with such a tax because as taxable trading volumes fell so did revenues from capital gains taxes,entirely offsetting revenues from the financial transaction tax.

    During the first week of the tax the volume of bond trading fell by 85% even though the tax rate on five year bonds was only 0.003%. The volume of futures trading fell by 98% and the options trading market disappeared, that was 20 years ago at a time relocation was much harder.

    The revenue has been calculated using volumes that wont exist:

    High frequency trading firms profit potential = one tenth of a cent per share transacted – result of tax = left market place – tax is many times larger than possible profit

    Day traders and Position traders – profit potential = varies – result of tax = left the market place- being taxed on a percentage basis of the entire position makes it impossible for them to make it through draw down, unlike capital gains tax a financial transaction tax can not be written off against a loss.The trader no longer pays a tax only if he is profitable he pays it despite the out come.

    Large institutions – profit potential = hundreds of millions a year – result of tax = left the market place. Due to the huge amounts of capital these institution’s deal with on a daily basis and the phenomenal return required on any investment to break even its no longer possible to function in that market place.

    Sadly corporations who rely on the markets to raise funds,or are forced to exchange billions per annum to conduct business or are in any other way connected to the markets will not be able to avoid these costs which will be handed directly to the end consumer. London will be destroyed – billions upon billions flow through there per day creating thousands of directly and indirectly connected jobs.

    I cant see any benefit of this tax even if implemented on a global level it destroys the markets, a high turn over rate is NOT an issue if anything markets traded in low volume are the problem.

    And if this is introduced in the UK all firms will leave London, the banks will stay to service the needs of the public, charging a financial transaction tax on a persons mortgage every night when the bank lends from the interbank market to balance the books and handing that substantial cost directly to the home owner does not effect the banks,loans, products, import all these things can be worked out so the cost is handed to the consumer, stocks, Forex and exchanges will take place else where because they would have no choice.

    • This tax is only feasible in the year 2,500 when every country in the world has a middle class that makes enough money to trade. There would have to be another 100 currency pairs added and the volume of the forex market would need to be 100 trillion. This way, the spreads would be less than 1 pip, so that even with the addition of this tax people could trade. Still, the tax is waaaaay too high and should only be .0000001% because if implemented on a global scale will still make plenty of money. Plus a tax will not stop the irresponsible reckless government spending and idiocy that is causing the USA to be in debt 14 trillion, and the EU to be in massive debt. This tax will end whatever hope someone has of ever making enough money to retire or survive if they don’t have a regular 9-5 job. Plus, I;m sure that as the gov’t implements it they will spend recklessly, and raise the tax, and as usual give special privledges to Goldman Sachs and Morgan Stanley so that they only have to pay .000000000000000000000000000000000000000000000000000000001% compared to us who pay .0005%. IM SICK OF THIS!!!!!!!!!!!!!!

  • July 16, 2011

    shen

    ” according to a Eurobarometer opinion poll, about 2two-thirds of EU citizens, including the British public, support an FTT. In the US, where the idea was born, the discussion is just beginning.
    …”

    Also is that Really a fair assessment of public opinion? What number of these people use there knowledge to successfully make a living from the markets? What number of people even understand the markets?

    Do they understand how much a financial transaction tax would push up the cost of goods and services including there own mortgage payments, do they understand the implications of harming London as a financial center in this way?

    Or do they just hear “tax the banks” and assume “the banks are not me”, followed by ” tiny tax ”
    and assess that “tiny tax” in terms of numbers that are relevant to them?

  • July 16, 2011

    Tom

    Support for the Financial Transactions Tax (FTT) comes primarily from Europe. However, they’ve been unable to enact the FTT because unanimous consent is required to legislate a tax across the entire EU. Sweden is against the FTT because of their bad experience when they tried it back in the 1980s (see Note #1). The UK is against it because, as Europe’s largest financial center, they have the most to lose. (see Note #2). Other countries (Poland, the Czech Republic, the Netherlands and Denmark) have said they will only support the FTT if it’s imposed world-wide.

    ECB (European Central Bank) president Jean-Claude Trichet, and his apparent successor Mario Draghi, had similar reactions to the FTT proposal. Draghi said, “A financial transaction tax would not work unless it was introduced on a global level.” Trichet told the European Parliament that introducing such a measure in the EU would “drive out investors.” The Danish Finance Minister echoed that criticism, saying that an EU-only FTT would result in an exodus of financial expertise and investment capital to non-FTT countries. Canada, though not an EU member, showed an early interest in supporting the tax. After conducting an extensive study, Canada now opposes the FTT saying that it would irreparably damage their financial centers.

    Switzerland, Singapore, Hong Kong, Bermuda, Dubai and a dozen other countries have stated that they won’t impose the broad FTT and would welcome the business from taxed jurisdictions.
    …………………………..

    Note #1: Sweden enacted a Financial Trading Tax (FTT) in 1984. Futures trading volume fell 98%, options trading fell to zero, bond trading fell 70%, and most other markets’ trading volume fell by at least 50%. A large segment of the Swedish financial industry either left the country or went out of business. Total tax collections (both capital gains and related income taxes) fell so dramatically that those tax losses wiped out all the gains from the FTT. The total FTT taxes collected were only 3% of what the Swedish Finance Ministry had originally projected (a source of considerable embarrassment), and what was promoted as a way to raise billions in taxes to support social services ended up being a net loss to the Swedish Treasury. The FTT was repealed in 1991. Sweden cites this experience as their reason for opposing the FTT.

    Note #2: The UK currently has a transaction tax (aka, “stamp tax”) and it doesn’t seem to have harmed their huge financial market. However, government data shows that over 75% of all UK financial transactions are exempt from the tax. Many large banking and investment firms are fully or partially exempt, and many London traders do their business on US or other exchanges to avoid the tax entirely. If capital flees Europe, London is projected to lose thousands of financial jobs, tens of billions in economic activity, and billions more in taxes (both income and capital gains taxes). The UK cites these projected losses as their reason for opposing the FTT.

  • July 16, 2011

    ftfsos

    Even the proponents of a financial transaction tax know that it won’t work.

    James Tobin himself dismissed his own Tobin tax later in life saying that it would not work.

    IMF states in the Final Report For The G-20, June 2010 about the financial transaction tax, “Its real burden may fall largely on final consumers rather than, as often seems to be supposed, earnings in the financial sector…A tax levied on transactions at one stage ‘cascades’ into prices at all further stages of production.”

    Sweden’s six year experiment with their FTT produced negative revenues.

    The Tobin Tax-FTT and its true purpose: let’s let Hitler’s 1922 Munich speech speak for the proponents: “Capitalism as a whole will now be destroyed, the whole people will now be free. We are not fighting Jewish or Christian capitalism, we are fighting every capitalism: we are making the people completely free.”

  • July 16, 2011

    0x101

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