Currency Transaction Tax - a Concept with a Future

Chances and Limits of Stabilising Financial Markets Through the Tobin Tax

WEED working paper by Peter Wahl & Peter Waldow

(German document in English translation)

Summary

The concept of the Tobin tax has experienced a resurgence in the discussion on reforming the international financial system. In addition to many legislative initiatives in favour of the Tobin tax in national parliaments, possible ways to introduce a Tobin-style currency transaction tax (CTT) are being scrutinised by United Nations during the preparation of the international conference on "financing for development". The Indian prime minister has recently suggested a tax on currency transactions between developed countries. A study conducted on behalf of the IMF has also favoured a variant of CTT. The German Trade Union Confederation (DGB) and the AFL-CIO in the US have shown their support for this tax as have many other civil society organisations.

While there is increasing interest in the topic with many interesting versions of the tax on the table, the phalanx of opponents is still unbroken. This indicates the massive financial and economic interests which are at stake here.

At least since the Asian financial crisis, there is widespread agreement that short term capital movements are the key cause for exchange rate volatility. Volatility fosters speculative bubbles and can cause or aggravate financial crises. Since developing countries are highly vulnerable to external shocks, they are particularly affected by financial crises. But even without a proper crisis, high volatility contributes to a very unfavourable environment for foreign trade and debt servicing. Short term capital movements must thus be limited. A currency transaction tax serves this purpose. Short term investments often speculate on small profit margins. These very short term speculations are rendered unprofitable by the tax. As a consequence, the amount and the pace of short term transactions are reduced without deterring trade, long term credits, or real investment. This is called the filter function of the tax. Tobin described this as throwing sands in the wheels without damaging the functionality of the wheels. In short, a currency transaction tax makes economic sense and is particularly attractive from a development point of view.

Of course, the Tobin tax can deter neither massive speculative attacks nor all kinds of financial crises. To this end, other instruments are needed. The Tobin tax is only one instrument in a set of different measures for regulating financial markets.

The technical implementation of the Tobin tax is facilitated by the increasing formalisation and computerisation of international payment systems. The tax could be levied at the national or the international level. The revenue from a currency transaction tax is estimated to exceed several ten billion US-$ per year. Civil society groups advocating the Tobin tax focus their suggestions for the revenue's expenditure on sustainable development projects.

There are several measures available for limiting the scope of potential tax evasion. These include political pressure on offshore tax havens to co-operate with the international supervisory or regulatory institutions and differential tax levels for transactions into or from non-co-operating regions. Tax evasion need not be more of a problem for the Tobin tax than for any other tax and can thus not be used as an argument against the tax.

The most important obstacle to the implementation of the Tobin tax is the obstinate resistance of those who take advantage from the volatile financial system, i.e. private financial market players and individual national governments, in particular the US administration.

You can download the whole document here as PDF-file: WEED-TobinTax-Englisch (337 KB)

You can order the German original as a brochure here: Orginalfassung

Bonn, April 2001