Feasibility

Tobin's original proposal for a foreign exchanges transactions tax has been criticised in recent years as being difficult to implement, easy to avoid, and ineffective in preventing financial crisis. In response, revisions to Tobin's proposal have been developed and refined by economists including Rodney Schmidt and Paul Bernd Spahn, which have not been refuted. Active debate continues on the most effective tax rate and strategies to prevent tax avoidance.

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There is virtually no formal infrastructure for trading foreign exchange. Traders in major banks around the world communicate directly with each other or through a broker. By contrast, the infrastructure for settling foreign exchange trades is increasingly formal, centralized and regulated. This is due to new technology, subject to increasing returns to scale, and to cooperation between trading and central banks to reduce settlement risk. Settling a foreign exchange trade requires at least two payments, one of each of the currencies traded. Settlement risk is eliminated when payment obligations are matched and traced to the original trade, and then payments are made simultaneously. The technology and institutions now in place to support this make it possible to identify and tax gross foreign exchange payments, whichever financial instrument is used to define the trade, wherever the parties to the trade are located, and wherever the ensuing payments are made.

The report, written by Intelligence Capital, details for the first time how the UK government can unilaterally implement a stamp duty on sterling currency transactions. The report sets out how this could be plumbed in to the current system in a cost-effective way that causes minimal disruption to sterling currency markets, but has the potential to raise significant sums for international development and could increase UK aid expenditure by 50%.

Controls on short-term capital inflows or panic-driven capital outflows may be beneficial in emerging markets with fragile financial sectors and adjustable-peg currency regimes. However, the controls seen so far are relatively easy to evade, often complex and obscure, and supported by large and rigid administrations which lend themselves to corruption. A tax on foreign-exchange payments avoids these drawbacks. It is transparent, inexpensive to set up and operate, administratively lean and easy to adjust, and effective. It can discourage short-term inflows as well as slow down mass outflows.

Tobin suggested that exchange rate volatility be controlled through a tax on international currency transactions. The analysis shows that the Tobin tax as a pure transactions tax is not viable. However, a possible alternative could be a two-tiered rate structure consisting of a low-rate transactions tax plus and exchange surcharge. The exchange rate would move freely within a “crawling” exchange rate band, but overshooting the band would trigger a tax on an “externality” – which is the discrepancy between the market exchange rate and the closest margin of the band.

Zee does not endorse a Tobin tax but proposes a Cross-Border Capital Tax that shares fundamentally the same objective – to put some sand in the wheels of the global financial markets.

The vast majority of stock trades and other financial transactions are done by short term traders who hold assets for less than a year and often less than a day. These trades are essentially a form of gambling. This paper proposes a modest tax on these trades, 0.25 percent on the sale or purchase of share of stock, along with comparable fees for other assets such as bonds, futures, options, and foreign currency. Such a tax would leave long-term investors largely unaffected, but impose a significant tax on speculators. This tax could raise more than $120 billion a year in revenue.

Paper presented at the conference: “Taxing Currency transactions. From Feasibility to Implementation”, organised by Halifax Initiative, Vancouver, October 4-6, 2001.

Recent turbulence in world financial markets has rekindled interest in the so-called Tobin tax on international financial transactions as a way to discourage speculative currency trading and reduce exchange rate volatility. A two-tier structure might be more effective than a pure transaction tax.

Financial market variability is a perennial problem for investors and policymakers alike. While attractive in some ways, a two-tier Tobin tax would not solve this problem and would have a number of undesirable side effects.