To cover the costs of the ongoing economic crisis, a Tobin-type financial transactions tax (FTT) on bonds and shares has been proposed for the European Union to be introduced not later than 2014. “The financial sector must make a contribution,” argued Jose Manuel Durao Barroso, president of the European Commission in his State of the Union 2011 speech. Billionaire Bill Gates, too, has backed an FTT on financial transactions to raise “substantial resources” for developing countries.
The four-decade-old proposal by the late Nobel prize-winning economist James Tobin was originally intended to dampen speculation in the foreign exchange market. There were no takers for this idea till the anti-globalisation movement resurrected it to raise resources for causes like the war on poverty. It again became fashionable after the 2008 global economic crisis. Earlier this year, a group of 1,000 economists urged the G20 to adopt an FTT to tackle global problems like health, education and climate change.
The Tobin tax was never meant to rein in the financial sector or raise resources for development. All that it entailed was a one per cent tax on foreign exchange transactions to make many cross-border transactions unprofitable. But this idea has shown remarkable resilience by resurfacing every now and then as a solution for the ills of the world — exemplifying what John Maynard Keynes said of the ideas of economists being more powerful than is commonly understood; that the world is ruled by little else!
The European Commission’s FTT proposal is only a broader version of a Tobin tax since it includes the whole gamut of transactions in securities — equity, debt and their derivatives. Such a tax cannot be dismissed on the grounds of administrative practicality since most G20 countries tax financial transactions. India has a securities transaction tax that raised resources amounting to 0.09 per cent of GDP in 2010-11. Britain, the biggest opponent of the FTT, levies a 0.5 per cent stamp duty on locally-registered shares.
Concern over the possible negative effects of an FTT has led advocates to propose a much lower tax than was proposed by Tobin. The European Commission’s proposed tax rate is 0.1 per cent on shares and 0.01 per cent on derivatives. Even such modest rates can raise enormous amounts of money. For example, a tax of one basis point or one-hundredths of a percentage point on stocks, bonds and derivatives can raise $200 billion annually on a global basis according to a report “Financial Sector Taxation: IMF’s Report to the G-20 and Background Material”, September 2010 and Thornton Matheson “Taxing Financial Transactions: Issues and Evidence” IMF Working Paper, March 2011.
The European Commission intends to push for agreement on this FTT at the forthcoming meeting of G20 leaders in France next month. It bears mention that this powerful grouping is far from unified on such a proposal. But Barroso thinks it is the right time to create a “new momentum globally” with this initiative and his allies are the German Chancellor Angela Merkel and French President Nicolas Sarkozy. However, the US, the UK and Canada feel that such a measure will only add fresh burdens on financial institutions.
For such reasons, the prospects of a globally-administered FTT appear daunting. Despite these dissensions among the world’s most powerful economies, if the European Commission is unfazed and goes ahead with its proposal by 2014 there are significant risks of what is called delocalisation — business shifting to other tax jurisdictions and offshore centres. There will also be some negative effects on the overall economic activity and a significant reduction in the market volume of transactions due to this tax.
Barroso, for his part, has factored in such risks and is determined to impose the FTT. His argument is that European taxpayers have granted aid and provided guarantees amounting to ¤4.6 trillion to the financial sector during the last three years. It is payback time now with a tax on stocks, bonds and their derivatives that can raise ¤55 billion a year and defray some of the costs in coping with the economic crisis. The billion-euro question is whether haute finance is on board with this idea.
The upshot is that it is difficult to hazard a view on whether this Tobin-type tax is an idea whose time has come. To be sure, the FTT definitely can be implemented, as many as 40 such taxes have been put in place around the world. The IMF report noted above mentions that implementation difficulties are not unique to this proposal and that sufficient basis exists for practical implementation of at least some form of FTT to focus on the central question of whether such a tax would be desirable in principle.
Considering the role that financial institutions have played in the global economic crisis, there is no question regarding the desirability of an FTT. However, the best chances of its successful implementation lie in a coordinated approach globally by the G20 grouping.
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