FAQs - Tobin Tax

Revised 1999

What
What’s the difference between the Tobin tax and the currency transactions tax?

What is the Tobin tax?
What would the tax rate be?
What is the difference between speculative and legitimate trade transactions?
What would be taxed?
What is the biggest barrier to the adoption of CT taxes?

How

How do CT taxes work?

How should the revenue be distributed?
Who
Who would be taxed?

Who collects the tax?

Why

Why are CT taxes necessary?
Why CT taxes now?

Other

Won’t speculators find ways to evade the tax?

Would CT taxes have prevented the crisis in SEAsia?
Can political barriers be overcome?

Answers

What’s the difference between the Tobin tax and the currency transactions tax?
The Tobin tax is a currency transactions (CT) tax, but it is not the only one. Recent proposals by economists including Rodney Schmidt and Paul-Bernd Spahn are based on Tobin’s original concept but respond to changing times and conditions. In his proposal, Schmidt addresses concerns that Tobin’s proposal was too difficult to adopt and too easy to avoid. Spahn responds to criticisms that Tobin’s tax would be useless during financial crises.

The terms “Tobin tax”, “CT tax”, “Tobin-type tax” are often used interchangeably. The terms “Tobin” and “Tobin-type” tax are more widely recognized by the public and the “CT tax” or “CT taxes” are more frequently used in academic and political spheres.


[ Back to Top ]

What is the Tobin tax?
In 1972, Nobel prize-winning economist James Tobin proposed that major countries levy a small tariff on all foreign exchange transactions. This tax would reduce or eliminate the small margins currency speculators profit from thereby reducing the volume of speculative capital flows. By reducing the flow volume, the tax is designed to help stabilize exchange rates and increase the fiscal and monetary policy autonomy of national governments.

[ Back to Top ]

What would the tax rate be?
The rate would be determined by each country enacting the tax, but the tax range recommended to produce moderate market calming and revenue-raising outcomes is between .1 and .25%. While this may seem very small to consumers paying up to 20% taxes on goods and services, the impact on the margins of currency speculators would be enough to curb their activities.

[ Back to Top ]

What is the difference between speculative and legitimate trade transactions?
The primary difference is the speed at which they occur. Investors in the productive economy have medium to long time horizons. Speculators, on the other hand, are profiting by the daily, hourly and minute-to-minute fluctuations in interest rates, currency values and bond markets. Over 80% of all speculative transactions occur within 7 days or less - 40% occur in two days or less.

The brilliance of Tobin’s original (and all subsequent) proposals is that it automatically penalizes the short-horizon exchanges, while negligibly affecting the incentives for commodity trading and long-term capital investments. A .2% tax on a round trip in another currency costs 48% a year if transacted every business day, 10% if every week, 2.4 % every month and so on. A CT tax at a rate of between .1% and .25% is a trivial charge on a long-term investment.

One of the beneficiaries of CT taxes will be long-term investors due to reduced exchange rate risk. Reduced exchange-rate volatility means that businesses need to spend less money hedging, thus freeing capital for new investments.

In the new “casino” economy, money has ceased to be a means of exchange and has become a commodity.


[ Back to Top ]

What would be taxed?
The scope of CT taxes varies. Tobin would have taxed all purchases of financial instruments denominated in another currency. Schmidt broadened the tax to include all foreign exchange transactions. These would include simple exchanges of one currency for another (spot transactions) as well as complex derivative financial instruments including forwards, swaps, futures and options if they involve two currencies.

[ Back to Top ]

What is the biggest barrier to the adoption of CT taxes?
The biggest barrier is not technical or administrative, as critics claim, but political. CT taxes are taxes on the most powerful banks and investment institutions in the world. These taxes are viewed as a threat to financial community privilege and have been met with resistance by a sector with massive political clout. The very idea of putting peoples’ needs ahead of market whims challenges the dominant economic paradigm of our times.

Only sustained public pressure will ensure continued debate and successful implementation. See Public Pressure for a look at the growing global public debate on CT taxes.


[ Back to Top ]

How do CT taxes work?
All currency transactions taxes are designed to help stabilise exchange rates by reducing and eliminating the small margins speculators profit from. For a currency transaction to be profitable, the change in value of the currency must be greater than the proposed tax. A CT tax would reduce or eliminate profits and therefore, the incentive to speculate. See also What is the difference between speculative and legitimate trade transactions?

[ Back to Top ]

How should the revenue be distributed?
One of the most devastating negative externalities or costs of financial crisis is a human one. When currency values collapse in the wake of speculative attack, prices skyrocket, wages fall, companies unable to pay debts denominated in foreign currencies go bankrupt and joblessness soars. Three decades of poverty reduction and economic growth was wiped out in the SEAsia financial crises of 1997/8. The responsibility for preventing financial crisis is a global one; the responsibility for repairing the damage wrought is also a global one.

Thus, while CT tax revenues will accrue to individual participating nations through its central bank, a portion would be targeted to assist the most vulnerable nations in preventing speculative attack and ensuring social development. An international agreement between participating nations would be negotiated under the aegis of the United Nations. Tax levels as well as the formulae and terms of revenue redistribution would be negotiated by treaty signatories. The UN would receive agreed revenue levels from participating countries and administer the tax in co-operation with other multilateral institutions or a new agency could be established. Broad participation in the treaty would be encouraged by the prospect of revenue sharing. See Primary Research - Implementation for select papers.

Several factors make tax administration less cumbersome than critics claim. While the amount of money moving around the globe in speculative activities is enormous, the number of centres in which trading occurs and the number of traders is not. 80% of all global foreign exchange trading takes place in only 7 financial centres (London, New York, Tokyo, Singapore, Hong Kong, Frankfurt, Bern) between less than one hundred large international banks and investment houses. The relatively few locations, limited number of players and a clear electronic "paper trail" would help reduce the administrative burden and cost of tax collection.

The inevitability of future crises makes the re-regulation of capital a global imperative.


[ Back to Top ]

Who would be taxed?
CT taxes are progressive ones, designed to target only those profiting from currency speculation. The majority of foreign exchange dealing is done by 100 of the world’s largest commercial and investment banks. The top 10 control 52% of the market and include Citibank/Salomon Smith Barney (US), Deutche Bank (Germany), Chase Manhattan Bank (US), Warburg Dillon Read (US), Goldman Sachs (US), Bank of America (US), JP Morgan (US), HSBC (UK), ABN Amro (Netherlands) and Merill Lynch (US). Citibank is at the top of the list with a 7.75% market share and a 1998 foreign exchange transaction volume that exceeded the GDP of the US at US$ 8.5 trillion. These banks operate in their own interest and on behalf of clients including large corporate and private investors, insurance companies, hedge funds, mutual funds and pension funds.

[ Back to Top ]

Who collects the tax?
Under Schmidt’s proposal, any country with the authority to tax could adopt a currency transactions tax unilaterally. Collection of the tax would then be the responsibility of the national central bank and subject to all the tax laws of the implementing nation. Once adopted, the CT tax would then automatically apply to every transaction involving the taxed currency, anywhere in the world.

Critics falsely claim that CT taxes represents “global taxation” and an “unwelcome infringement on sovereignty”. CT taxes cannot be imposed upon any country.


[ Back to Top ]

Why are CT taxes necessary?
Currency transactions taxes can help:
  • Prevent financial crisis
    The deregulation of financial markets, coupled with a dramatically increased volume of financial transactions, has increased the inherent volatility of financial markets and contributed to the financial crises in Mexico, Russia, SouthEast Asia and Latin America. These crises are not isolated but reveal the systemic instability of financial markets. Investors can never obtain sufficient information about future prices and costs to enable them to estimate risk vs. return accurately – these are inherently subjective judgements. As a result, markets behave irrationally, driven by panic selling and herd behaviour. Speculators have a vested interest in creating and maintaining these severe fluctuations as profit potential increases in volatile markets. Yet it is these same swings that have dramatic adverse effects on an economy, often resulting in severe economic contraction and social upheaval.

    The taxing of currency transactions represent one means by which countries can reassert control over their increasingly unstable financial markets by reducing the volatility speculators thrive in.
     

  • Restore economic sovereignty
    Financial liberalization has meant that governments have largely surrendered their ability to control global capital flows. Historically, a central bank’s cash reserve was sufficient to offset any speculative selloff or “attack” and maintain relative exchange rate stability. Global official reserves, however, are now less than half the value of one day of global foreign exchange turnover. This means that many countries do not have the ability to intervene to protect their currencies from speculative attack. When a country cannot defend the value of its currency effectively, it loses control of its monetary policy and ultimately, its economy.

    By cutting down on the overall volume of foreign exchange transactions, CT taxes would reduce the volume of reserves necessary for countries to defend their currency. CT taxes would allow governments the freedom to act in the best interests of their own economic development, rather than being forced to shape fiscal and monetary policies in accordance with the perceived “demands” of fickle markets.
     

  • Generate significant public finance
    CT taxes would yield anywhere from US$ 100 - 300 billion annually at rates discussed below and with widespread participation. Faced with large debts and deficits, governments are looking for new sources of revenue. Given the declining commitment to bilateral and multilateral aid around the world, these taxes could generate important new resources to alleviate poverty and enhance development. The cost of eliminating the worst forms of poverty worldwide is estimated at US$ 40 billion per year for ten years, according to the United Nations Development Programme.

[ Back to Top ]

Why CT taxes now?
Financial crises are becoming more frequent and more devastating, revealing the extent to which financial markets are under-governed in the global economy. Recent trends to liberalize financial flows globally have increased not only the volume of transactions, but volatility in recent years, inviting destabilizing speculation and abrupt capital flow reversals. From 3.5 times the level of dollar value of exports in 1977, foreign exchange transactions rose to 68 times the value of world exports by 1998. The global daily foreign exchange turnover is now $US 1.2 trillion per day. The ease with which enormous quantities of capital, unconnected to productive in investment, move around the globe threatens the national economic security of all nations.

Attempts by industrialized nations to address the problems are woefully inadequate. Assumptions that the crises were caused by the inadequate provision of information to investors and inappropriate developing country policies fail to address the systemic nature of the problem. The solutions proposed to date including increased transparency and data reporting, as well as IMF surveillance and control of developing country financial systems, are therefore fundamentally flawed. Markets will remain volatile and crises, inevitable, until the incentive for speculation is removed.


How much is a TRILLION?
A million dollar pile of stacked $100 dollar bills would be 2 metres tall; a one trillion dollar pile would be 20 times the height of Mt. Everest.
[ Back to Top ]

Won’t speculators find ways to evade the tax?
Yes, they will. All taxes are evaded to some extent and never capture the entire revenue stream they target. These arguments, however, never dissuaded governments from collecting taxes. The real question is how do you minimize evasion and create mechanisms to revise the tax as necessary?

CT taxes could be quite difficult to evade and easy to collect. The proposal by Canadian economist Rodney Schmidt would utilize an existing centralized and regulated structure through with major banks exchange balances on the wholesale market. All transactions are already tracked electronically. Monitoring systems are already in place and all major currencies participate. Because the tax will be collected at centres controlled by the central bank, non-cooperating tax havens could be refused the right to utilize the taxed currency.


[ Back to Top ]

Would CT taxes have prevented the crisis in SEAsia?
The proposed CT tax level would have been too low to have stopped the crisis in Southeast Asia once exchange rates began to plummet, but it could help prevent future crises by reducing overall speculative volume and the volatility that feeds speculative attack. By making crises less likely, CT taxes would help avoid the social devastation that occurs in their wake.

A “circuit-breaker” variation of the CT tax by German economist Paul Bernd Spahn would address crisis situations by raising the tax to prohibitive levels for short periods, thereby stopping all trading. Once the panic had passed, the tax would be reduced to a lower standard level.


[ Back to Top ]

Can political barriers be overcome?
Yes, if the conditions are right for change. We are at a time when economic necessity coincides with social justice. The risk of future financial, economic and social crisis, coupled with the revenue potential for a currency transactions tax, are providing political incentives and opportunities unimaginable in the mid-90’s.

As the frequency of financial crises increases, the ability of the world to ignore the problem declines. Nations can ill-afford the economic devastation, political turmoil and untold human suffering of the last few years. In the wake of recent financial crises governments around the world are examining their former faith in unfettered free markets. See Governments Respond for a detailed analysis of what countries are doing.

In the face of increasing income disparity and social inequity, CT taxes represents a rare opportunity to capture the enormous wealth of an untaxed sector and redirect it towards the public good.


[ Back to Top ]