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The Return of the Tobin Tax?

by | March 12th, 2013 | 10:24 am
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Algirdas Semeta, EU Commissioner for Taxation, recently toured Washington touting the decision by eleven of the 17 members of the euro area to adopt a common financial transactions tax (FTT).  In his public remarks, Commissioner Semeta invoked the name of Nobel-prize-winning, Yale economist James Tobin, who advocated such a tax in the 1970s to discourage foreign exchange market speculation.  The rationale for the EU-proposed FTT is much broader than that for the Tobin tax, and it is an intellectual distortion to suggest otherwise.

An FTT might be imposed for many reasons:  to limit financial market speculation (in specific markets or more broadly) or as a sin tax on something that is socially frowned upon and has an inelastic demand (higher taxes and prices do not substantially reduce demand). Another rationale for the tax is to punish the financial sector for its excessive profits or other reasons, or to raise revenue for a general or specific purpose.   In his remarks in Washington at the Center for American Progress (CAP) on February 25, Commissioner Semeta suggested that the European Union’s motivation was all of the above. Unfortunately, as a general rule, a policy instrument directed at multiple objectives is unlikely to be efficient or effective in achieving any one of them.

Shortly before Tobin died in 2002, he wrote in the Financial Times and gave an interview with Der Spiegel saying that the objective of the Tobin Tax, as he envisaged it, was solely to limit foreign exchange market speculation that undercuts domestic macroeconomic stabilization efforts.  He decried the practice of associating his name with a tax intended to raise revenues for various causes, regardless of how worthy they might be, such as economic development.  He also was upset that, in addition, his name had been hijacked by the anti-globalization movement merely because he favored a tax on speculation.

Commissioner Semeta did not honor Tobin’s request.  At the CAP, he invoked the name of Tobin while advancing his argument in a form that Tobin probably would have criticized, that the proposed FTT should “deter the ‘casino-type’ trading that contributed to this [global financial and European debt] crisis.”  Most analysts think that to have any substantial deterrence effect on financial market behavior, a Tobin tax would have to be set higher than the proposed 0.1 percent on all financial instruments except derivatives, which would be taxed at a minimum 0.01 percent of their notional (face) value, and the tax would have to be near global in application. Tobin’s concept was to put sand in the wheels of the foreign exchange market.  He suggested tax rates that are five times those in the EU proposed approach, and many scholars have concluded that much higher rates would be necessary to have much of a deterrence effect on those seeking quick profits on a weakening, or strengthening, currency for periods as short as a day or a week.  The granularity of the EU plan is closer to powder. 

Commissioner Semeta argued, moreover, that to be effective, an FFT does not have to be global in scope.  He contradicted himself by saying that the EU proposal is intended to apply to “any transaction with an established economic link to the eleven Member States,” which amounts to an extraterritorial application of the tax to increase its effectiveness in raising revenue and to project the franchises of financial institutions in the countries imposing the tax.  Moreover, Commissioner Semeta’s  purpose in Washington was to drum up support for the United States to join the parade so that “a global FTT will also be a reality some day.”

He contended, as well, that the EU’s proposed FFT has “carefully ring-fenced the real economy” so that it would not be harmed.  It would be a neat trick if this were the case, but how can one be sure? The commissioner’s contention suggests that, in fact, the proposal is a sin tax, and we know that the world would be uniformly better off with less sin.  He qualified his assertion: EU “analysis shows a positive growth effect if the revenues are intelligently recycled.”

Consequently, one might ask how the revenues from the proposed tax will be spent or allocated.  The European Union expects to raise €30 billion to €35 billion ($40 billion to 45 billion) per year for the members participating in this rare example of “enhanced cooperation” among a subset of euro-area and EU member states.  However, neither the European Union nor any of the member states has indicated how the funds will be used, aside from Commissioner Semeta’s comment that “nowadays every government needs new sources of public funding.”

As a final point, Commissioner Semeta justified the European Union’s proposed FFT on the grounds of fairness and the balancing of contributions by various subsets of economic agents to the public purse, saying, “Currently the financial sector is under-taxed, both in Europe and worldwide, compared with other sectors.”

Commissioner Semeta is right that many governments need more revenues, and it is appealing if countries, in fact, can magically raise more revenues with no adverse effects on their real economies. He may be right that the financial sector is under-taxed; that is a complicated calculation infused with assumptions and judgments that can be challenged.  He may also be right that the financial sector needs to be punished.  But he engaged in hyperbole when he argued that the European Union’s proposed FFT is all good (the economist’s dream, a perfect lump sum tax) with no adverse side effects on economic or financial incentives.  Given the proposed rates of taxation, the EU FFT is unlikely to deter speculation significantly—James Tobin’s original motivation.  The Tobin tax has returned, but informed public debate has not returned with it.