The Tobin Tax:
An International Tax on Foreign Currency Exchange
 
What is the Tobin tax?
 
In 1978, James Tobin, a Nobel-Prize-winning economist, first proposed the idea of a tax on foreign exchange transactions that would be applied uniformly by all major countries. A small amount (less than 0.5%) would be levied on all foreign currency exchange transactions to deter speculation on currency fluctuation. While the rate would be low enough not to have a significant effect on longer term investment where yield is higher, it would cut into the yields of speculators moving massive amounts of currency around the globe as they seek to profit from minute differentials in currency fluctuations.
 
Why is support growing for such a tax? 
 
Interest has grown rapidly in such a mechanism, as the place of foreign exchange transactions and financial deregulation has accelerated over the past decade. Today approximately US$1.5 trillion worth of currency is traded every day in unregulated financial markets. Less than 5% of this activity is related to trade in goods and services. The other 95% is simply speculative activity as traders take advantage of exchange rate fluctuations and international interest rate differentials. This kind of financial speculation plays havoc with national budgets, economic planning and allocation of resources. Governments and citizen are becoming increasingly frustrated by the whimsical and often irrational activities in global financial markets that have such an influence over national economies and are seeking some means to curb damaging, and unproductive, speculative activity.
 
What effect would an international currency tax have on the global economy? 
 
1. Reduce the volatility of exchange rates.
A uniform tax on foreign exchange transactions would deter speculation by imposing a small tax on such activity. This would reduce the volatility of exchange rate fluctuations and provide exporters, importers and long-term investors a more stable exchange rate in return for paying the tax.
 
2. Reduce the power that financial markets have over national governments to determine fiscal and monetary policies
The tax would give more autonomy to governments to set national fiscal and monetary policies by making possible greater differences between short-term interest rates in different currencies. Such a tax would also reinvigorate the capacity of central banks to alter exchange rate trends by intervening in currency markets. By cutting down on the overall volume of foreign exchange transactions, central banks would not need as much financial clout to intervene.
 
3. Raise revenue
This tax would yield enormous sums in receipts. Assumptions vary about the actual rate of the tax, the decline in volume of trade, the amount of trade circumventing the tax and transactions which would be exempt. However, just for illustrations, assuming a conservative tax rate of 0.2% and an effective tax base of $75 trillion annually, the tax would yield $150 billion annually in receipts. Given the declining commitments to bilateral development assistance around the world, the tax could generate important resources to support sustainable human development.
 
This sounds good, but is it politically possible to implement? 
There are two key political issues involved with putting such a tax in place. First, it would be necessary to forge agreement amongst the major countries to implement a uniform tax, and second, there would have to be agreement on the collection and distribution of the tax revenue.
 
Developing countries have always been much more vulnerable to exchange rate volatility, but there is for the first time a convergence of interest between industrialized and developing countries as they all seek stronger government autonomy and more effective central bank intervention.
 
At present, the government of Australia and France have spoken out in favour of a currency exchange tax. The Prime Minister of Malaysia has declared that currency trading is "unnecessary, unproductive, and totally immoral," adding, "it should be stopped." The Canadian government appears divided on the question as cabinet ministers debate the issue publicly. The eighteen member countries of the Asia-Pacific Economic Cooperation are reviewing the proposal.
 
Pressure is building on national governments and international institutions to support this measure from coalitions of non-governmental organizations representing labour, church, environment, women, youth, seniors and poverty groups as they seek to restore democratic control of their national economies.
 
Perhaps more significant is the fact that many governments face large deficits and strong anti-tax populism among the electorate and are looking for new sources of tax revenue that are not politically suicidal. Such a minimal tax will not hit "Main Street", but rather "Bay Street/Wall Street speculators". The promise of a new source of revenue will likely be the primary motivation for reaching agreements to implement the tax.
 
Collection and distribution of the tax revenue is a much trickier question. The tax would have to be applied worldwide at the same rate in all markets. There would also have to be agreement on precisely which transactions would be subject to the tax. Compliance would depend on the banking and market institutions. Tracking the activity would certainly be possible as the financial industry has the sophisticated technology required to do this but enforcement would rest with the major economic powers and the international financial institutions. There would certainly be some strong resistance from members of the financial sector some of whom have already begun to speak out against the proposal.
 
It is possible that some members of the financial community might support this tax. The pace and the volumes traded in the markets has added a level of risk to doing business, for as much as great profits can result from speculation so can great losses as in the Barings Bank fiasco. Some experienced business people may see the value of the limited risk of more stable markets, suggesting if not the Tobin proposal, other strategies to limit the volatility of the current global money system.
 
Recommendations:

• 1. A tax to curb speculation in foreign currency exchange is an innovative and fair proposal that will contribute to restoring democratic control over our national economies and generate substantial revenue to build a sustainable future.
• 2. Governments around the world, the United Nations, the International Monetary Fund and World Bank should take the steps necessary to implement a tax to curb currency speculation as soon as possible.
• 3. The tax should be administered by an accountable democratic structure such as could be found within the UN system, with the revenue collected used for genuine social development.