The primary aim of Tobin tax, unlike most taxes, is not to raise revenue, but to discourage short-term speculation, particularly in the foreign exchange markets.
In the currency markets, enormous amounts of money are traded daily, as traders attempt to make profits from small discrepancies between the relative values of currencies (arbitrage). For example, in April 2009, the volume of foreign exchange trade reported by the north American Foreign Exchange Committee was USD 11,590,858,000,000.
Tobin himself highlighted the fact that 80% of foreign exchange transactions involved round trips of less than a week (1). This high volume of short-term trade performs no useful social value, and is detrimental to managing national economies. While trade is of course necessary to adjust the exchange rates of currencies in a floating system to reflect the differences between the ways that nations conduct their economies, the volume is out of all proportion to what is necessary to achieve this.
What is a Tobin Tax?
This would be a tax of a small percentage (typically proposed at about 0.1%), enough to cause friction in speculation, because of the massive volumes churned over short periods which realise small gains. However, for trades that reflect changes in market fundamentals, the tax is not a significant percentage of the trade; it throws some sand in the wheels of speculation without hurting the main purpose of the financial markets, which is to allow the values of national currencies to adjust relative to each other.
The proposal was first made the year after Nixon took US dollar off the gold standard in August 1971, ending the Bretton Woods system of fixed exchange rates that had been formulated after the war. Over the next five years governments had to surrender their control of the exchange rate between their currencies and other currencies to the foreign exchange markets. This used to be a tool of national economic policy, whereas it now reflects the market opinion of that nation's wealth relative to others.
What Problem Is the Tobin Tax Trying To Solve?
With no fixed exchange rate mechanism between currencies it is up to a large number of economic entities to determine the relative values of currencies in the marketplace. In itself this is no bad thing, but short-term currency speculation where large amounts of money are shifted between currencies with different interest rates make it difficult for countries to implement monetary policy. In the 1990s the Asian monetary crisis highlighted the negative aspects of currency speculation as it limited the effectiveness of countries response to the crisis, bringing the idea of the Tobin tax to prominence again.
Disadvantages of the Tobin Tax
Like any attempt to regulate vested interests, the potential losers raise a hue and cry that such a tax would drive financial transactions to tax havens like the cayman Islands. Implementing such a tax would be difficult, and transaction costs would have to be kept low. It would at the very least need co-operation between US, Asian and European regulators.
The Credit Crunch and The Tobin Tax
Although foreign exchange speculation was not the cause of the credit crunch, it hampers countries ability to implement economic policy, and the idea has been revived by President Nicolas Sarkozy of France, and the chairman of the UK's banking watchdog, Adair Turner.
The Tobin Tax and the G20 Summit
Sarkozy's proposal for the G20 summit extended the remit to any financial transaction - it is unlikely that he will be able to carry this proposal in that form, but the credit crunch has made some unthinkable solutions thinkable. perhaps the Tobin Tax will be one of them, an idea whose time has come.
References
- The Tobin tax: coping with financial volatility, Mahbub ul Haq, Inge Kaul, Isabelle Grunberg, OUP 1996, ISBN 9780195111804
- Sarkozy to Press For Tobin Tax, BBC News
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