It's not time for Tobin

In The Guardian, Larry Elliott argues that it's time to introduce a tax on international currency transactions. As he explains, the idea is far from new. It is particularly associated with the late Nobel laureate James Tobin, who first expounded it in 1978, in a paper called "A Proposal for International Monetary Reform". The idea is that governments should impose a modest tax on foreign-exchange transactions in order to dampen speculative activity and enhance national control over monetary policy. Elliott argues:

"In the past, any efforts at cracking down on tax havens, for example, has been stymied by the knowledge that the US and the UK were reluctant to play ball. One of the unintended consequences of the crisis is that it has legitimised coordinated global intervention. There is the chance to make finance once again the servant of the public, which is as it should be.

"One obvious reform is to introduce a tax on international currency transactions. This idea has been knocking around since US economist James Tobin first suggested it in the early 70s, but the lack of interest in Washington and London has meant it never gained traction.

"Set at a lower level it would raise considerable sums of money. If a levy of just one basis point (one hundreth of 1%) was placed on all currency deals, governments would find themselves with an additional $70bn a year. At a time when they are chucking vast amounts of taxpayers' money at the banks, that would be a nice little earner, and might help assuage the concerns that the public are going to pay for the folly of financiers."

I accept that a tax of just one basis point (or indeed five, or ten, as is the usual proposal) is unlikely to disrupt financial markets. (Unlikely, but possible. It's not the same type of tax, but there was a proposal in the Senate in 1989 to tax securities trading, under the tendentious title "The Excessive Churning and Speculation Act". In opposing it, the Chicago economist Merton Miller - who became a Nobel laureate in 1990 - made the point that transactions taxes, even at apparently low rates, can have far-reaching consequences. He cited a type of security known as a "letter stock", which traded 20 or even 30 per cent below ordinary shares in the same company.)

But my fundamental objection to Elliott's proposal is that it won't work. Taxes that don't work are not, on the whole, worth introducing. Elliott's reference to tax havens indicates that he knows exactly what the first potential problem is. Traders could evade the tax by booking the transaction in another jurisdiction, not covered by the tax. The tax would need to be implemented and enforced internationally - and that isn't going to happen.

The reason it won't happen is that while you can imagine a situation where every leading centre of forex trading signs up, there would still be offshore financial centres that would then develop their own forex trading facilities. The temptation to be a free rider is always there. And it's by no means inconceivable that an important financial centre could grow up as a result of ill-judged regulation elsewhere. (One of the reasons that London is so prominent a financial centre dates back to US regulations adopted in the 1960s that limited the amount of interest that banks could pay on deposits. US banks moved to London to get round them, and the hugely important eurobond market developed here as a result.)

The second potential problem, even supposing the first one is soluble, is that traders would label the transaction as something other than a currency transaction, and thereby avoid the tax. This isn't particularly difficult to do. Barry Eichengreen gives a good example in his book, written after the Asian currency crisis a decade ago, Toward a New International Financial Architecture, 1999, p. 89:

"Traders betting on changes in the exchange rate don't merely trade national currencies; they trade any one of a number of assets denominated in different currencies. If currency transactions were defined for tax purposes as the exchange of bank deposits in different currencies, traders could substitute the exchange of treasury bills denominated in those currencies and then sell those treasury bills for deposits."

Eichengreen acknowledges that tax avoidance is always a problem with any tax - but this one is different. Bankers are accustomed to financial engineering; they are likely to find ways round anything the authorities devise. The main purpose of the tax would thus be symbolic - and while I'm not opposed to gesture politics in all cases, I prefer the principle of simplicity in the tax system.

Comments

[Tony Francis]

The political winds have changed. Bush II has given the Republican brand such a bad name they will lose everywhere. McCain is an awful candidate. Anyway, Republicans have been big government liberals for at least a generation. Why vote for an ersatz liberal when you can get the real thing by voting Democrat? So here come the new taxes (of all kinds), the "create jobs" spending programs, the regulation, the micro-managing - its all in the offing. By winning big, the Dems will think they have a mandate to do it. I don't have any particular objection with their plans, other than they probably won't work. They never have. But we shall see. In the mean time, expect a return to the New Deal:
http://www.politico.com/news/stories/1008/14569.html
Nancy Pelosi is still blaming Republicans, which is astonishing since the Dems have controlled both houses for two years.
http://www.speaker.gov/legislation?id=0053
"George Bush caused this, and John McCain is senile" are not economic plans. The other day, Obama said, "We are going to eliminate capital gains taxes on money invested in small business - to create new jobs." Sounds like he is at the top of his game, and better yet, cares about the little folks. One problem: there is no capital gains on small business to begin with. So either Obama or the people who are writing his script have no clue. Pelosi says she has reduced the price of college by pumping billions of dollars into them. Usually, this kind of thing inflates college price. Expect more taxes, everywhere. We shall see if it works.

[Marc]

Oliver,

There are at least two other reasons to oppose the tax:

First, it's not just speculators who write forex swaps, but ordinary businesses hedging their forex exposure.

Second, as I think you've raised in previous columns: the idea that speculation is the cause (rather than a symptom) of financial crises is populist nonsense.

Marc