Revisiting the Tobin Tax - Financial Transaction Taxes for Burden Sharing and as Regulatory Tools
Tobin taxes are back in circulation again. The financial crisis has highlighted the fundamental problems of financial stability as well as the costs associated with bailouts of the financial sector.
Interestingly the family of tobin taxes, better known as financial transaction taxes ot security transaction taxes are good tools which can help tackle both of these problems. Their potential and role in helping provide solutions to the challenges confronting us are discussed briefly in this policy note here. This note which was written a while back will be followed by a Re-Define Policy Paper out next week.
- Easy and cheap to collect: As an increasing number of financial transactions are done electronically and even OTC derivates and currency transactions move towards electronic settlement, financial transaction taxes are becoming cheaper and easier to collect. All that is really needed is the addition of a line of software code to existing messaging and settlement systems. In the UK, for example, the Stamp Duty is 100 times cheaper to collect than an equivalent amount of income tax.
- Progressive incidence: While it is true that institutional investors such as pension funds etc own a significant proportion of the financial markets, financial transactions are still disproportionately conduced by the richer segments of society either directly (through in house asset management) or through vehicles such as hedge funds or private equity. More than 25% of financial assets in the United States, for example, are owned by the top 1% richest population. Financial transaction taxes will have a highly progressive incidence as opposed for example to the value added taxes which are regressive in nature.
- Difficult to avoid and evade: Because financial transactions leave an electronic trail and/or are settled at a central clearing centre, financial transaction taxes are next to impossible to avoid. The other reason they are difficult to avoid is that they are collected automatically either at the point of the initiation of the transaction or at the point of their settlement. While there have been some fears of transactions moving offshore to avoid unilaterally implemented taxes, these are exaggerated. In fact, in Brazil, the information generated by the financial transaction tax was successfully used to reduce the evasion of other taxes. This evasion reducing effect could be easily replicated in other countries.
- No tangible impact on market efficiency: Despite the fact that such taxes are often labelled as market unfriendly the wide variety of successful FTT regimes that operate around the world show that they are easy for markets to bear especially when the rates are low. Low rates also mean that few financial transactions undertaken for economic reasons would be effected. For example, the rate we have proposed for currency transactions -0.1 basis point- is below the radar screen of currency traders. Compared to the transaction costs that arise from 1) brokerage fee 2) exchange fee 3) short term volatility of prices 4) market movement in response to transactions etc, the levels of taxation we propose remain negligible. In most instances, levying such taxes would take transaction costs back to the level they were at 3-4 years back at which point no one accused the financial markets of ‘being distorted’.
- Potentially market stabilizing: Being a turnover tax, the FTT will penalize shorter term trading and have hardly any impact on those with a longer term investment horizon. Consider a stock transaction tax of 0.2% for instance. A trader with a daily investment horizon would on average trade once a day and end up paying a 200*0.2%/2 = 20% (he only pays half and there are 200 trading days in a year) effective tax rate. A pension fund with a five year horizon, on the other hand, will end up paying only 0.02% or 1000th the rate of the daily trader. This would discourage the kind of very short term (computer run) financial transactions that destabilized the markets in 2007 and leave the longer investment horizon investors unaffected. Hence FTTs are likely to have a market stabilizing impact. Differential taxation of systemically risky products such as complex derivatives is also likely to enhance the stabilizing impact of FTTs
- Significant revenue generation: Financial transaction taxes levied across a broad range of financial markets can generate hundreds of billions of dollars of revenue world wide without too much of a distortion of the financial markets. Once bank debit taxes, which routinely collect as much as 2%-3% of revenue in many Latin American companies, are included, the revenue potential easily edges into the trillions of dollars territory. Stock, bond, currency and derivate market transaction taxation are likely to all produce between $50 billion and $100 billion of revenue each. Once bank debit taxes are included, the total revenue estimate easily doubles.