The idea of taxing financial transactions has been gaining strength since 2008, when the world began to suffer one of the worst economic crises in recent history. The movement involves a revival of the so-called “Tobin Tax,” a concept that takes its name from U.S. economist James Tobin, who suggested the creation of a tax on financial transactions in 1971. The original notion held by the 1981 Nobel Prize-winner in economics was to tax foreign exchange operations to stop movements from one currency into another in order to discourage the flow of capital towards very short-term transactions; that is to say, to penalize speculation in order to give more stability to the currency exchange system. The tax had to be low — about 0.1% of the value of each transaction — in order to penalize only very short-term, purely speculative transactions, rather than penalize longer-term investments. The explanation was that the real return from each speculative transaction is very low, and that speculators will only get a good return from such transactions when they do them in large volumes and at great speed.
The original concept was rejected and it was never implemented. Even Tobin himself said that he had been misinterpreted. However, the Tobin Tax has returned to newspaper headlines recently. Its defenders see it as a way to curb and control market speculation which, they argue, is one of the causes of the current economic recession. Anti-globalization movements believe that the proceeds from this tax can be used for curbing poverty in the world. However, its detractors view the tax as an interventionist measure that hinders free trade.
From Idea to Action
Recently, France has moved beyond mere words to action, becoming the first country to implement the Tobin Tax. In February, French legislators approved a law that includes a tax on financial transactions. The bill, which was backed by French President Nicolas Sarkozy, amends the 2012 budget law. It was supported by 301 conservative and centrist deputies but rejected by 207 leftist members of the opposition.
The new rules will apply a 0.1% tax to all transactions of shares of French companies that have a market capitalization of more than one billion euros. Transactions in shares of foreign companies whose market capitalization falls below the amount will be exempt from these taxes. France’s executive branch wants to avoid the flight of foreign firms from Paris to other stock exchanges. Although the tax does not affect transactions of bonds and other derivative products, the law will impose a tax of 0.01% on high frequency trading; the practice of buying and selling of shares in microseconds using computer technology with the goal of getting higher returns. The government’s plan also includes the same tax for trading of credit default swaps. These derivatives, which cover the risk of a suspension of payments by a country or company, have been closely linked to market volatility.
According to Santiago Carbó Valverde, professor of economic theory and economic history at the University of Granada (Spain), “The tax on financial transactions creates unnecessary distortions in the financial system, and there is no theoretical basis to support it.” He adds he is not convinced that such a measure is justified. “It seems more of a response to popular indignation about the financial system, which is not easy to limit or define."
Manuel Romera, director of the finance department at IE Business School in Madrid, is equally unconvinced about the real goals of the French regulation. Romera suggests it is more of an "electioneering" measure that Sarkozy has deployed now that he is facing the next French presidential election on April 22. “The tax on financial transactions has more of political character than it has anything to do with the real economy, since its application is absurd from an economic point of view,” Romera says.
Along the same lines, Jesús Palau, professor of finance at ESADE, describesthe decision of the French president as a “populist” one. Palau asks, “Why has this never been done before? This measure could have been set up a long ago.”
Adopted Across Europe?
Francealso intends for its tax to serve as an example for the rest of Europe, so that the European Union will decide to follow suit. “This is an initial step towards a financial tax [in] the heart of the European Union or, if possible, at least inside the euro zone.We had to wait too long to put it on the calendar of the European Union to establish it for the entire bloc, so France wanted to pioneer the introduction of this tax,” said Francois Baroin, France’s finance minister, in an interview with the Financial Times on February 13.
In addition to France, Germany and Spainhave shown themselves to be in favor of imposing it. But others, such asthe U.K., have opposed it head-on. British Prime MinisterDavid Camerondescribed the tax as “madness” in his speech at the latest World Economic Forum in Davos in late January. Among other things, that’s because Cameron calculates that its introduction would mean the loss of some 500,000 jobs in the European Union as a result ofits negative economic impact, especially in the financial sector.
Meanwhile, Janusz Lewandowski, the EU’s Polish-born budget commissioner, said during a debate organized in Madrid by Europa Press that the introduction of a EU-wide Tobin Tax could bring in 57 billion euros this year. He noted that the collection of those funds could involve “partially replacing contributions made by each country” to the European Union budget. In any case, the European Commission wants to impose a very low rate — 0.01% of the value of stock and bond transactions – “because they do not want to harm the real economy,” he said.
Lewandowski added, "We have to find an additional source of income for the financial sector that is the least aggressive possible one for the real economy." At the same time, he made it very clear that in no case will the EU impose such a tax on any member state; instead, it will respect "fiscal sovereignty." It will be up to the various European parliaments to decide whether or not to introduce such a tax
Helpful or Harmful?
Carbó Valverde is skeptical about the usefulness of such a measure. He believes that it would create unnecessary distortions in any financial system where it is imposed. “Markets are governed by equilibriums, and price formation and regulation should not lead to opportunities for arbitrage. That is to say, some institutions have advantages in some countries but do not have them in other countries. In addition, the tax puts added pressure on any sector that must restructure, rebuild and provide loans, so this sort of measure is not going to help,” he notes.
Moreover, he adds, “if France is the only country that implements it, French banking will be damaged, and the pressure is going to be on its financial sector. If these measures are applied by everyone, it would create further distortions because financial flows would be concentrated even more in those places where regulations are less stringent, thus creating even more uncertainty about the control of systemic risk.”
Romera also opposes the Tobin Tax, which he considers negative for the economy in general. "It would make it harder to move money and it would greatly restrict the free movement of capital, which is what generates wealth and the ability to create jobs,” he says. Harm would be caused by imposing a financial transaction tax on an activity known as cash pooling; a very common practice in the U.S. that is beneficial for companies. Cash pooling is the centralized management of cash for companies that have many local branches. It enables capital from these small branches to move to a single, centralized account of the head office, improving the flow of information and reducing costs.
Romera argues that such a tax makes no sense. “We shouldn’t be paying according to how much wealth is transferred, but according to how much wealth is generated.” In addition, “this [tax] involves imposing a levy on banks for making deposits. It's like saying that the banks have to foot the bill for the crisis.” He is certain that the tax “would be harmful because it would make it harder for Europe to achieve liquidity in the real economy,now that loans are in themselves very restricted.” This added cost for the banks “would make loans more expensive and harder to get. The cost for such a tax would wind up being paid by those citizens who ask their financial institutions for loans.”
Palautakes the completely opposite position. Not only does he support the French measure and its adoption by the other countries of the European Union, but he also believes that the tax on financial transactions should be higher in some specific cases, such as movements of derivatives. “It's a very good measure because it creates obstacles in an economy that is excessively speculative,” he says. “To a great extent, the excessive speculation that exists in today's economy has been the cause of the current crisis in which we find ourselves.” In his view, “Financial transactions do not generate wealth, but simply enable it to change hands.” That is why “economies must have more resources used for productive investments, and must limit a financial sector that is oversized — and the Tobin Tax will contribute to that.”
According to Palau, “This tax will be beneficial for [EU member] states because it will enable them to raise more money at a sensitive time for their budgets. It is better to balance their accounts that way, rather than by cutting such items as education or health.”
Hard to Implement
One of the central problems about introducing the Tobin Tax involves the international consensus for implementing it. Many people argue that the tax would be useful only if it is imposed around the world in a coordinated way. Otherwise, financial intermediaries would clearly look for and find ways to avoid paying the tax.
Carbó Valverde argues that the universal application of the tax among the G-20 nations “is not feasible or practical and, in any case, is not justifiable. A well-functioning and well-supervised financial system can make a very significant social and economic contribution, but these sorts of taxes do not make such a contribution; on the contrary, they make it harder and they slow things down.” As a result, he does not expect other European countries to eventually follow in the footsteps of France, “even less so in the United Kingdom or other countries such as Holland [where the financial sector does not carry so much weight].” He adds that “making things harder for the financial sector is not the most suitable approach to take at this time.”
According to Romera, “The French government would raise much more money if the tax were established around the globe.” But he does not expect that this will ever take place. “The banks are one of the biggest global lobbies, and they are going to exert pressure so this tax does not win out. In France, [the banks] don’t have as much power, but in countries like the U.K. and the U.S. they do have a lot of power.” Elsewhere in Europe, he adds, whether or not the tax is adopted will depend on the size of each country’s financial sector. “At the root of this question is the concept of ??how each government wants to manage its own country, and whether or not itbelieves in economic freedom.”
Palau believes that the Tobin Tax can be effective in a single country such asFrance, but he recognizes it will be more effective if a larger number of countries adopt it. Nevertheless, he agrees with thosecolleagues who expect the tax to remain a mere scrap of paper. “I do not believe that the nations of the European Union will agree to establish such a tax,” says Palau. “The banks have a lot of power, and they are the ones who manage the world economy. The politicians won’t dare to confront them.”