Unit 2 Macro: Should the EU introduce a Tobin Tax?

AS Economics student Freddie Bickford-Smith looks at some of the argument surrounding proposals to introduce a financial transactions tax in the EU. I will post another essay on this topic from a fellow student, offering an alternative perspective from that developed here!

Following the financial crisis of the past few years, and the amassing of blame on the financial sector for it, it has come to the attention of many - including the European Commission - that there must be a way of rectifying the situation, and promoting greater economic stability.

One popular suggestion is the ‘Tobin Tax’, an idea proposed by Professor James Tobin (the Nobel prize-winning American economist) for a tax on worldwide financial transactions

His aim was twofold.

First, it was to provide a disincentive (in the form of a financial barrier) for traders to make so many instantaneous international transfers of money, about which Tobin expressed his concern in 1978: he wrote that speculation can have ‘serious and painful internal economic consequences’.

Second, it was to draw a fair contribution from the financial sector to greater government tax revenue, for spending on the poorer parts of the world (hence another name given to the Tobin Tax: the ‘Robin Hood Tax’). With the likes of George Soros, Bill Gates, and Nicolas Sarkozy all putting forward their arguments in favour of a ‘Tobin Tax’, it seems that this is an appealing way of facing the problem we have. However, if this were the true solution, all world leaders would have also agreed with the proposal. What is stopping them from supporting the Tobin Tax, and is there any way of improving Tobin’s model so that an agreement might be made?

The Tobin Tax is intended to be a disincentive for speculation. If each financial transaction costs traders marginally more than it used to, they will be less willing to trade. Therefore, with a higher price, there should be a contraction in demand and with less speculation, markets would be made less volatile.

At the same time, the extra revenue taken by the government (predicted by the European Commission to be around €57 billion/year if a tax of 0.1% is levied) could be spent on giving aid to the world’s poorest countries, funding action against climate change, or paying back some of the accumulated government debt. The losers in this situation are the commercial banks: billions of pounds of their revenue is tapped away national governments, and they stand to gain nothing tangible in return.

The Tobin Tax has a political significance also. In times when fairness (not necessarily in financial terms, rather in the way people are treated) is sought by many, this is a way of the financial sector being seen to contribute. After all, it seems fair for the industry that caused the current financial distress, and that received billions of pounds worth of taxpayers’ money in bail-outs, to give something back by being taxed a minute amount of financial transactions. This will go some way to counteracting the worsening of chief executives’ reputations by showing their ability to forsake profit for the wider public good. Indeed, popular opinion is articulated by The Times in one recent editorial: ‘[the rewards given to chief executives] offend against the idea that there must be a proper relationship between what is being received and what is being contributed’. As well as serving an economic purpose, the Tobin Tax has the potential to be a political success.

At this stage in time we can only predict the impact and effects the Tobin Tax would have if it were to be introduced. And while there is no definitive verdict upon this, the general feeling is one of scepticism towards the policy.

Professor Charles Jones of Columbia University Business School holds the view that - referring to evidence in ‘the literature’ - the Tobin Tax will have the opposite effect to what is intended: market volatility will, in fact, increase. Moreover, he does not think that the political environment is right for the introduction of the Tobin Tax. While there is general support for it within much of Western Europe, Britain and the USA are currently opposed to it for fear of the migration of financial hubs.

The UK Treasury Minister believes that the Tobin Tax ‘will only work if it is done at a global level; if it’s not done as part of a comprehensive package - then traders will find ways around it’. Many traders themselves feel that the Tobin Tax will drive activity, investment, and jobs away from London. Indeed, since the UK already imposes a stamp duty tax on trading, there is a fine balance to be struck, and 80% of Europe’s financial trading is at stake. Many hypothesise that there will be unintended consequences caused by the Tobin Tax, namely an increase in market volatility, and the migration of some leading financial corporations in order to evade it. Off-shore havens will have a field day!

That said a Tobin Tax has its fair share of influential supporters. Bill Gates is spearheading the campaign for a FTT, citing it as one of many ways to make deep cuts in absolute poverty in many of the world’s poorest countries. The French president, Nicolas Sarkozy, deems the introduction of the tax ‘possible’. Indeed, the UK government supports the principle of a FTT, if it were guaranteed to be enforced globally. There is a sense that many of the G20’s big players would have greater interest in the Tobin Tax if there was less fear of financial firms evading the tax.

Even the Archbishop of Canterbury, Dr Rowan Williams, has voiced his support for the tax, claiming it would fulfil the ‘moral agenda’ of those protesting outside St Paul’s Cathedral.

However, the inability to impose a financial transactions tax (FTT) effectively on an international scale undermines some of its merit. It is unlikely that the UK government would allow the introduction of this FTT, knowing that business would shift to an alternative location, be it New York, Shanghai, or Dubai. It is not to be forgotten that the financial industry constitutes a huge proportion of the UK economy, and to lose some of it would be damaging. It is difficult to justify the risk of the Tobin Tax in its current manifestation, and the UK government should look to improve on it before proceeding. Attention should still be focussed on finding other ways around the problems we face.

The Times argues that ‘There are four ways to address the issue sensibly’, the first of which entailing high levels of growth in the economy, since ‘arguments about the distribution of income and wealth are much easier to have when there is more income and wealth’. Second, there should be ‘public service reform’ in order to ‘ensure that taxpayers feel they are getting a fair deal’.

Third is an emphasis on businesses being ‘much more responsible about the way rewards are allocated within their own companies’; firms need to restore trust from their customers by paying employees based on their performance, rather than handing out bonuses blindly. Fourth, fiscal policy has to be revised. A 50% income tax on high earners is ‘a disincentive to economic activity’, and so should be avoided; ‘The so-called Robin Hood tax is impractical…[it] will never be introduced by all’; but taxes on ‘established wealth’ and property should be raised ‘so that greater amounts are paid by the most wealthy’. After all, why - if you are seeking to achieve fairness - should you tax a specific industry rather than the population as a whole?

It is better to reform what we currently have than to introduce policies which could have unwelcome side-effects on the economy.