11 EU Countries Embrace the ‘Tobin Tax’
January 23, 2013 in Euro Zone
Not surprisingly, the crisis in the Euro zone led to renewed calls for the imposition of a financial transaction tax, principally to pay for bailing out shaky banks, reducing risky bets and provide budgetary support to cash-strapped Euro zone governments. Derivatives also magnified the fallout of the financial crisis, and therefore could be reined in through the tax.
However, there was no unanimity on the proposal, and finally, on January 22, 2013, a smaller group of 11 countries that included key states France and Germany were given the go-ahead to implement the tax by the Euro zone finance ministers during their meeting in Brussels.
The UK and 15 other EU members have not agreed to the proposal. The UK and Sweden objected on the grounds that the tax would be effective only if it could be implemented globally. Sweden has opposed the tax also on the basis of its own experience with the tax which had to be repealed. Luxembourg and Cyprus declined to participate due to their status as offshore centers.
The Financial Transactions Tax is proposed to be charged on shares and bonds at the rate of 0.1% of their value, and on derivatives at the rate of 0.01% of the contract value. It would be applied to any financial instrument transaction excepting primary market issues and bank loans, and would become payable if at least one party to the transaction is based in the implementing country.
It is estimated that the tax could garner as much as €35 billion within the 11 implementing countries.
American economist James Tobin (March 5, 1918 – March 11, 2002) served on the Board of Governors of the Federal Reserve and taught at Harvard and Yale. An exponent of Keynesian economics, he was awarded the Nobel Memorial Prize for Economic Sciences in 1981.
Tobin was critical of the speculation in international currency markets, which he thought hampered the conduct of genuine business by inducing risky and volatile currency movements. He proposed the introduction of a tax on these transactions that would make it unprofitable for speculators to indulge in speculative and short-term ‘round-tripping’ currency transactions. This so-called ‘financial transaction tax’ soon became widely known as the Tobin Tax. Tobin floated the idea of this tax in 1972 amidst the turmoil created by the end of the Bretton Woods system.
Since then, the mention of the Tobin Tax generally cropped up during times of other fiscal upheavals such as the 1994 economic crisis in Mexico, the 1997 Asian Financial Crisis, and the 1998 Russian financial crisis. In 2001, Tobin detailed his concept as follows:
The tax on foreign exchange transactions was devised to cushion exchange rate fluctuations. The idea is very simple: at each exchange of a currency into another a small tax would be levied – let’s say, 0.5% of the volume of the transaction. This dissuades speculators as many investors invest their money in foreign exchange on a very short-term basis. If this money is suddenly withdrawn, countries have to drastically increase interest rates for their currency to still be attractive. But high interest is often disastrous for a national economy, as the nineties’ crises in Mexico, Southeast Asia and Russia have proven. My tax would return some margin of manoeuvre to issuing banks in small countries and would be a measure of opposition to the dictate of the financial markets.
Objections to Tobin’s Concepts
Unfortunately, the tax has been found to be difficult to implement, principally due to the inherent tendency to avoid it through various stratagems, which make it necessary that it be in force throughout a region rather than only a few willing countries.
There are also valid objections to the almost certain loss of liquidity in the markets due to the resulting curb on speculation.
Also, with banks already facing pressures on margins, the tax would have the unintended consequences of triggering further consolidation among banks, an unpleasant thought in the ‘too-big-to-fail’ scenario.
Opponents of the move also say that the objectives of the tax might as well be achieved through other taxes already in place, and that it would place another burden on consumers and/or savers. It would be particularly hard on pensioners.
Lars Oxelheim, Professor of International Business and Finance at Sweden’s Lund University says: “A 30-year-old worker, retiring at the age of 65, having a pension fund yielding 5 per cent per annum, with a turnover of the portfolio of 1.5 times a year, will see his pension reduced by 5 per cent due to the Tobin tax.”
The tax could also lead to a fall in GDP, and according to ECB President Mario Draghi, the tax could lead to a further flight of investment capital out of Europe.