What Is A tobin Tax And Why Does China Want One?

Finally, a levy of this kind will facilitate the harmonization of the national legislative frameworks and, in this way, reduce the fragmentation of internal markets. At the UN September 2001 World Conference against Racism, when the issue of compensation for colonialism and slavery arose in the agenda, Fidel Castro, the President of Cuba, advocated the Tobin Tax to address that issue.

Chinese authorities are considering imposing a so-called Tobin tax on currency transactions in an effort to curb speculation against the yuan currency, according to a report by Bloomberg. The market inefficiency can be corrected by inducing traders to moderate their response to their private signals, and by making the price less sensitive to surprises in fundamentals. If properly designed and calibrated, a transaction tax makes informed traders internalise the pecuniary externality in the use of private information. The end result is a price that contains less information, and possibly even a deeper market. A potential problem is that the regulator typically cannot distinguish between informed and uninformed trade. Fortunately, the tax can be calibrated to apply to all traders to induce an efficient result.

It Is Meant To Help Curb Short

At the same time, even in the case of stock transaction taxes, where some empirical evidence is available, researchers warn that “it is hazardous to generalize limited evidence when debating important policy issues such as the transaction taxes”. In 1978, James Tobin proposed a worldwide tax on all foreign exchange transactions. First, he argued that it would reduce exchange rate volatility and improve macroeconomic performance. Second, he argued that the tax could bring in a lot of revenue to support international development efforts.

It simplified the two-tier tax in favour of a mechanism designed solely as a means for raising development revenue. Theories of multiple equilibria are based on the concept of self-fulfilling beliefs, i.e., that speculators base their investment decisions on beliefs about the future which their own decisions bring about. (This idea provides a counter-argument to Friedman’s contention that destabilizing speculators must lose money.) Perhaps the most persuasive example was put forth by Obstfeld . He showed that when government policies themselves react to the exchange rate, then speculators’ beliefs can elicit government responses that justify those beliefs. This view of exchange rate determination is in marked contrast to traditional views, which typically assume government policies are formulated independently of the exchange rate. There are also fears that the cost of the tax to banks could be passed on to customers. This could take the form of increased fees, lower long-term rates, greater spread between lending and borrowing rates, or higher service charges.

Sweden’s Experience With Financial Transaction Taxes

In this context, we may suspect that traders will rely too much on public information. The reason is that traders do not consider that their reaction to private information affects how informative public statistics and general welfare would be. In other words, traders do not internalise an information externality. This type of externality will make agents insufficiently responsive to their private information and, in the limit, to disregard it (Banerjee 1992, Bikhchandani et al. 1992). As an example, Morris and Shin point to the paradox that, by publishing aggregate statistics, a central bank makes them less reliable because it induces agents in the economy to rely less on their private signals. The de facto aim of the proposed tax is more about raising revenue (to recover public money spend during the Global Crisis by collecting annually about 0.4% of GDP of member states) than correcting a malfunctioning market.

The G20 was established in September, 1999, and Canada was part of the original G7. There was no Canadian election between the March 23, 1999 Canadian adoption of the Tobin tax resolution, and the September 1999 formation of the G20, so the government remained the same. SDRT is a broadly equivalent tax on the transfers of uncertificated stock. Although Tobin had said his own tax idea was unfeasible in practice, Joseph Stiglitz, former Senior Vice President and Chief Economist of the World Bank, said, on October 5, 2009, that modern technology meant that was no longer the case. Stiglitz said, the tax is “much more feasible today” than a few decades ago, when Tobin recanted.

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But today Italy is implementing the tax on its own in a very different context. Its problems include a debt crisis, an uncompetitive economy and a weak banking sector, rather than exchange rate instability.

An experimental study in 2010 by researchers at the University of Innsbruck suggested that a global Tobin tax would have little impact on volatility. And there is not much evidence at all that unilateral Tobin taxes work.

Cepr Policy Research

The European Commission’s proposed financial transaction tax , would be imposed in 10 EU countries . It is popularly known as the Tobin tax, as it is similar to the one advocated in 1972 by the US economist, James Tobin, although it has a broader scope and serves a different purpose than the original. The FTT aims to levy all financial asset transactions carried out in the secondary market. Hot money—money that moves regularly between financial markets in search of high short-term interest rates. The shorter the investment cycle (i.e., the time between buying and selling a currency), the higher the effective rate of tax—thus providing market-based incentives for lengthening the term structure of investments.

Modern financial engineering is based on replicating one asset with combinations of other assets. At a minimum, the tax would have to be applied to forward, futures, and swap transactions in addition to spot transactions, since a spot transaction can be replicated easily by a combination of debt and forwards, futures, or swaps. Spot transactions could also be approximated by exchanging liquid securities (like T-Bills) denominated in different currencies. Consequently, the tax would likely spread and eventually come to envelop large segments of what is traditionally regarded as the domestic capital market. On September 1, 1998, Malaysia announced that it was imposing a range of capital controls designed to prevent foreign investors from taking their money out of the country . These restrictions enabled the Malaysian central bank to cut interest rates without having to fear a run on its currency. It’s too soon to say what the long-term consequences of these controls will be, but the relatively favorable performance of the Malaysian economy since they were imposed has certainly caught the eye of its distressed neighbors.

Angela Merkel Warns Us Over Surveillance In First Speech Of Third Term

Otherwise, foreign exchange business could gravitate quickly to any country that did not enforce the tax. Currency trading is a highly paid job and would yield spillover benefits to other businesses.

However, this kind of calculation is misleading in the context of speculative attacks against pegged exchange rates, since it ignores the fact that anticipated annualized gains can themselves be quite large. For example, a 10% devaluation on a single day translates into an annualized return of over 300% for short-sellers. So even if speculators assign relatively low probabilities to such events on any given day, it may still be worthwhile to make the bet. In other words, Tobin taxes would do little to extend the lives of unsustainable currency regimes. No one doubts the potential benefits of international capital mobility.

• The first nation in the G20 group to formally accept the Tobin tax was Canada.
• One of the main economic hypotheses raised in favor of financial transaction taxes is that such taxes reduce return volatility, leading to an increase of long-term investor utility or more predictable levels of exchange rates.
• The effects of stamp duty on equity transactions and prices in the UK Stock Exchange.
• Stiglitz said, the tax is “much more feasible today” than a few decades ago, when Tobin recanted.
• However, these benefits are predicated on the efficient functioning of markets, and many have argued that the foreign exchange market in particular is subject to distortions that may justify government intervention.
• If properly designed and calibrated, a transaction tax makes informed traders internalise the pecuniary externality in the use of private information.

Tobin originally put forward his idea in a very different context to that faced by the Italian government today. He promoted it as a way of stabilising currency markets after the Bretton Woods system of fixed exchange rates collapsed in 1971. His proposed tax on currency exchanges was intended to curb de-stabilising capital flows across borders. Tobin envisaged a global tax, which was impossible to avoid by moving financial markets offshore.

Financials

He estimates that any financial tax should be at most one basis point so as to have negligible effect on hedging. When James Tobin was interviewed by Der Spiegel in 2001, the tax rate he suggested was 0.5%. His use of the phrase “let’s say” (“sagen wir”) indicated that he was not, at that point, in an interview setting, trying to be precise. Others have tried to be more precise or practical in their search for the Tobin tax rate. On November 7, 2009, prime minister Gordon Brown said that G-20 should consider a tax on speculation, although did not specify that it should be on currency trading alone. The BBC reported that there was a negative response to the plan among the G20.

• The aim of the FTT is to levy all financial asset transactions carried out in the secondary market.
• It is popularly known as the Tobin tax, as it is similar to the one advocated in 1972 by the US economist, James Tobin, although it has a broader scope and serves a different purpose than the original.
• The representatives of APEC’s national trade unions centers also met with the Japanese Prime Minister, Naoto Kan, the host Leader of APEC for 2010, and called for the Prime Minister’s support on the Tobin Tax.
• Tobin’s more specific concept of a “currency transaction tax” from 1972 lay dormant for more than 20 years but was revived by the advent of the 1997 Asian Financial Crisis.
• Although Tobin suggested a rate of 0.5%, other economists have put forward rates ranging from 0.1% to 1%.
• This “R plus I” solution means the EU-FTT would cover all transactions that involve a single European firm, no matter if these transactions are carried out in the EU or elsewhere in the world.

An existing example of a Financial Transaction Tax is Stamp Duty Reserve Tax and stamp duty. Stamp duty was introduced as an ad valorem tax on share purchases in 1808, preceding by over 150 years the Tobin tax on currency transactions.

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Although large markets might see a fall in volatility, smaller markets would see a rise due to a fall in liquidity. Even Barry Eichengreen, a supporter of Tobin’s original proposals, now argues that a European Tobin tax may prove a “distraction” that allows systemic risks and instability to increase in other areas. For instance, according to Harald Hau, an economist at the Swiss Finance Institute and the University of Geneva, “credit misallocation” in the economy as the result of distorting equity and bond prices may make life difficult for small and medium sized business that cannot raise finance from abroad. In practice Tobin taxes imposed unilaterally have proved unsuccessful as markets have moved abroad to avoid them. Sweden’s experiments in the 1980s with a transaction tax on shares, equity derivatives and fixed-income securities ended in failure as activity moved offshore to avoid the levies. In the first week of the fixed-income tax bond trading volumes fell by 85%; the amount eventually raised from the tax averaged only about 3% of what was predicted. However, neither of these were Tobin’s reason for supporting the imposition of a currency transactions tax.

In a new paper, I argue that a rationale for a Tobin tax exists, even if markets are competitive and informationally efficient, and traders do not suffer from behavioural biases and extract information from prices in the rational expectations tradition . The key conditions for this result are that traders have private information, and conditioning on prices – two standard features of financial markets. Financial transaction tax rates of the magnitude of 0.1%-1% have been proposed by normative economists, without addressing the practicability of implementing a tax at these levels. In positive economics studies however, where due reference was paid to the prevailing market conditions, the resulting tax rates have been significantly lower.

The Sterling Stamp Duty, as it became known, was to be set at a rate 200 times lower than Tobin had envisaged in 2001, which “pro Tobin tax” supporters claim wouldn’t have affected currency markets and could still raise large sums of money. The global currency market grew to $3,200 billion a day in 2007, or £400,000 billion per annum with the trade in sterling, the fourth most traded currency in the world, worth £34,000 billion a year. A sterling stamp duty set at 0.005% as some claim would have raised in the region of £2 billion a year in 2007. Tobin had suggested a rate of 0.5 per cent on short-term currency transactions and had argued that the tax would be effective only if all countries adopted it and the revenues were donated to developing economies since they were affected the most by volatile exchange rates and capital outflows. Although the rate proposed by Tobin was low, substantial revenues could be garnered as forex transactions between countries have grown multifold, thanks to globalisation. James Tobin, the American economist and winner of the Nobel Prize for Economics in 1981 proposed the tax on currency transactions in 1978.