Why the “Tobin tax” makes sense in today’s world

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Investors, Wall Street executives and market makers in the United States have debated the impending introduction of a currency transaction tax, or “Tobin tax,” in recent months, following statements to this topic from officials in the Biden administration. The debate over whether or not to lift the Tobin tax has raged for decades and has been a point of contention between some liberal economists and policymakers on one side and Wall Street participants on the other.

James Tobin, the American economist and Nobel laureate in economics in 1981 proposed the currency transaction tax in 1978. It was intended to discourage short-term speculation in currency markets that caused erratic rate fluctuations. exchange rate, causing significant damage to economies.

When Richard Nixon suspended the convertibility of the US dollar into gold in 1971, he effectively ended the fixed exchange rate system established under the Bretton Woods system and signaled the move to a flexible exchange rate system. As a result, there was a massive movement of funds between different currencies that threatened to destabilize the economies of many countries. Having become accustomed to the floating exchange rate system and the volatility associated with it, Wall Street scoffed at the idea of ​​a Tobin tax aimed at curbing speculation. As someone put it succinctly, “most participants have a vested interest in volatility in the currency markets, as a high turnover rate tends to occur only when the markets are volatile.” Salomon Brothers analysts have hit the nail on the head by asserting that “logically, the most destabilizing environment for an institutional house is a relatively stagnant interest rate environment”.

Tobin had suggested a rate of 0.5% on short-term currency transactions and argued that the tax would only be effective if all countries adopted it and the revenues flowed back to developing economies, as these are those who are most affected by exchange rate and capital volatility. exits. Although the rate offered by Tobin is low, substantial income could be earned as foreign exchange transactions between countries have increased, thanks to globalization.

Proponents say the tax would help stabilize the currency and interest rates and provide relief to central banks in economies that lack the reserves needed to stop a massive sell-off of currency. The attraction of the Tobin tax is to discourage short-term transactions without hampering normal international trade. Tobin argued that market instability was caused by asymmetric information and herd behavior among speculators.

Although the original purpose of the tax was to curb speculation in short-term currency transactions, different countries that implement it have used it to their advantage to justify the tax. Many European countries have imposed a tax on transactions in financial assets like stocks and bonds. India also has a kind of Tobin tax called Securities Transaction Tax (STT), which is levied on the buying and selling of securities such as stocks, bonds, and mutual fund shares. The government has raised substantial amounts through STT due to the higher participation of retailers thanks to the stock markets reaching new highs. The government collected a STT of Rs 5,178 crore for the first quarter of fiscal year 2021-22 compared to the annual target of Rs 12,000 crore. Incidentally, the amount collected was Rs 2,408 crore during the corresponding period of last year. These taxes have helped governments around the world to use the revenues to tackle issues like environmental pollution and poverty, which is why it is sometimes also referred to as the Robinhood Tax. Some countries, like Chile, require a 30 percent deposit on the inflow of capital held for a year, and this policy has been used as a deterrent and has ensured short-term exchange rate stability.

Opponents of the Tobin tax argue that the motivations of different traders in financial markets are not well understood and that it is difficult to tax all short-term transactions because they provide liquidity to the currency markets. They say the tax would wipe out profits for traders and reduce the volume of transactions. They also argue that there is little evidence to suggest that the Tobin tax can reduce market volatility and prevent speculative currency attacks. There is also the problem of getting countries to agree on a flat tax rate. Another controversial issue will be revenue sharing between countries and the United Nations.

To quote an article written for Oxfam, “Any proposal on the distribution of tax revenues can be expected to meet strong opposition from one neighborhood or another. Countries that are currency exchange hubs will want to keep the money to themselves, developing countries will want resources for development, and major industrialized countries will not want to give up the purse strings of multilateral organizations. That pretty much sums up why there is no global Tobin tax today. Let’s see if Biden succeeds.

(The writer is CFA and former banker. He currently teaches at Manipal Academy of BFSI, Bengaluru)


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