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.
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.”
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?
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.