Tax Analysts Blog

Can the Tobin Tax Help Us Sleep at Night?

Posted on Sep 11, 2009

Generally speaking, the purpose of any tax is to raise money for the government. But taxes often have important secondary consequences. People react to how they're taxed, or not taxed. Sometimes these behavioral responses are just as important as generating revenue.

I was reminded of this when I recently read that Lord Adair Turner, head of the U.K. Financial Services Authority, suggested a "Tobin tax" could be imposed on Britain's financial sector. Lord Turner's comments are typical of the cautious attitude we now see in post-crisis Europe. The Brits, French and Germans want to do everything they can to make sure the financial crisis does not repeat itself. Who can blame them?

So how does a responsible government prevent a repeat of the financial meltdown?

The first thing it should do is promulgate more stringent banking regulations. That effort is well underway and was the focus of the G-20 finance ministers earlier this week. The Tobin tax would serve as a backstop to those regulatory fixes, creating a belt-and-suspenders approach to dealing with imprudent risk-taking. The Tobin tax is unlikely to take root in the U.S. anytime soon, but we can learn much from watching how our European allies experiment with the idea.

The Tobin tax is named after American economist James Tobin who in 1972 proposed that a minuscule tax -- ranging from 0.1% to 0.25% -- be imposed on foreign currency transactions. The idea was inspired by President Nixon's decision, one year earlier, to take the U.S. dollar off the gold standard. Tobin wanted to prevent wild swings in currency exchange rates. He also suggested that revenue from the tax be used to fight poverty in developing countries or donated to the United Nations.

Just to be clear, Tobin wasn't talking about taxing average folks who come back from summer holiday and need to swap euros for dollars at the airport. He was thinking more along the lines of big time investors, like George Soros who once gambled $10 billion in a single day by short-selling the British pound. That infamous "Black Wednesday" episode is still regarded as an example of how national currencies are vulnerable to manipulation by profit-seeking speculators.

Tobin died in 2002, but his legacy lives on. So popular was his proposal in France that an anti-globalization network, ATTAC, was formed to promote adoption of the Tobin tax with all revenues dedicated to fight poverty in Africa. Based on their website, ATTAC seems more interested in taxing rich guys than in stabilizing financial markets. I suspect their world view is quite different from Lord Turner's, yet they seem to agree on the desirability of a Tobin tax.

For the purposes of this discussion, I personally don't care how the revenue from a Tobin tax would be spent. (For what it's worth, it's hard to imagine today's debt-straddled governments doing anything with the proceeds other than keeping it for their coffers.) The larger point is that the tax is as much about curbing reckless financial behavior as it is about raising money.

Critics say the Tobin tax is too radical, or that it smacks of socialism, or that Lord Turner has lost his marbles. The issue could make for some fine political theater in the British Parliament as next year's elections approach.

Here in the U.S., it's clear that our banking sector was equally entrenched in an overly leveraged casino mentality. Our tax laws routinely encourage long-term investment -- which helps create jobs and benefits society as a whole -- without rewarding myopic speculation that benefits nobody but the guy looking to make a quick buck. This dim view of speculation is reflected in the favorable treatment of long-term capital gains over short-term capital gains. Viewed in this light, the Tobin tax isn't so different.

Maybe what Lord Turner suggested wasn't so radical after all.

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