Tobin Tax

Definition of Tobin Tax

• A Tobin tax is the name given to a specific tax placed on currency transactions.
• It was proposed by economist, James Tobin, as a way of stabilising currency markets.
• The idea is that by increasing the marginal cost of currency transactions it reduces the incentive to speculate on currency movements. In theory, this prevents destabilising swings in currencies.
• Tobin initially proposed a tax of 1% on all currency trades. This has subsequently been reduced to lower figures such as 0.25%. One UK proposal suggested a Tobin tax as low as 0.01%

Advantages of a Tobin Tax

1. By placing a tax on currency trades, it makes currency trading slightly less attractive. By marginally increasing the cost of currency trading there should be a reduction in speculative trading, leading to greater exchange rate stability in floating exchange rate systems.
2. Raises Revenue. The global trade in currencies has grown at a very rapid rate. In 2007, the global currency market was worth $3,200 billion a day in 2007, or £400,000 billion per annum. Of this, trade in Pound Sterling as £34,000 bn a year.
3. A tax set at 0.01% on just Sterling trades would raise £2bn a year. A tax on global currency trades could raise significant sums.
   
4. Redistribution from Financial Sector to Developing World. The idea of a Tobin Tax is often seen as a good way to redistribute income from developed world to the developing world. The idea has been seized upon by many aid charities and anti-globalisation protesters. Though James Tobin has often stated that the main purpose of the tax is not about raising revenue and redistributing wealth, but its impact on reducing speculation.
5. After damage created by speculative investments such as derivatives and futures trading. There has been greater support for intervention to reduce speculative buying in financial markets.

The famous investor George Soros has stated, though it would harm him personally, he thinks a variation of the Tobin Tax could be beneficial for the world economy.

Arguments Against Tobin Tax

• Difficult to tax all transactions, it may encourage investors to find ways around the tax.
• Decline in currency flows may harm functioning of markets and lead to poor liquidity in currency markets.
• Tax may be insufficient to prevent speculative flows and currency movements which are driven by economic fundamentals.
• A tax may discourage 'hedging' which is a way of insuring against currency movements rather than discouraging speculation.
  
• If it was introduced unilaterally in one country, e.g. UK then it would lead to loss of financial business as firms trade in other currencies / countries
• There may be better ways to deal with speculation e.g. placing lump sum insurance schemes on financial firms who invest in speculative markets.

At the G20 Support finance ministers in US and Canada were quick to condemn the tax, proposed by Gordon Brown, on the grounds of 'we are not in business of raising taxes'. But, the arguments against a Tobin tax are weak. Why do we happily accept a VAT Rate of 15% on basic goods yet, feel a tax of 0.01% on currency would be damaging and unfair?

A Tobin tax is more than just a measure to tax 'undeserving financial speculators' It is not going to undermine the world economy as some of the more extravagant claims may suggest. On balance, it is a sensible policy with many benefits - both economic and social.