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Finally, some political support for a financial transaction tax in the EU – but a global solution is necessary (or a tax on settlements)

Commentary by Timothy Leon Misir (Policy and Programme Executive, EU Centre in Singapore)

22 Aug 2011 – As part of a plan to prevent a deepening debt crisis and restore confidence in the euro zone, France and Germany have given preliminary support for the introduction of a Financial Transaction Tax (The ‘Tobin Tax’, named after the economist James Tobin who first proposed the tax in the 1970s) in the euro zone. Most likely, this will come in the form of a 0.01 – 0.05% tax on trade on the foreign exchange market and financial instruments such as stocks, bonds and futures. While little support has been given to the introduction of joint euro bonds, moves toward closer joint governance on economic policy in the EU makes a financial transaction tax potentially feasible.

The think tank Social Europe argues that the introduction of a Tobin Tax will raise over US$700bn annually if levied on all currencies (€200bn per year on euro trading), which is enough to overcome current budget crises and prevent more austerity measures, and could finance a New Green Deal that addresses environmental concerns the globe faces (Irvin, 2010).

This measure, if implemented, is supposed to curb risky speculative dealing, which can destabilise markets, as the global financial crisis has revealed. It will also reduce trading volume and reduce liquidity in markets and reduce high-frequency trading, shifting investments away from the financial sector to physical assets. Doubts have been raised about the empirical truth to these assumptions – Areport by the Institute of Development Studies suggests that higher transaction costs are associated with higher volatility in markets.

Whether it will calm speculative financial markets or not, the introduction of a Tobin Tax will provide another source of revenue for the debt-ridden economies of the eurozone, which can then be used to finance budget deficits, improve infrastructure and tackle poverty and social inequality. The potential for improvements in the social dimension with the introduction of a Tobin Tax is one of the reasons social democratic parties have long supported this measure.

At the moment, Ireland is strongly opposed to any form of financial transaction tax that does not apply to the whole of the EU, arguing that it will prompt a migration of trading to other jurisdictions where transaction costs are lower, such as the United Kingdom, which is situated outside the euro zone. Convincing the United Kingdom, a major financial centre within the EU but out of the euro zone to agree will not be easy – its foreign exchange turnover totalled $1.8 trillion in 2010 (37.8 per cent globally).  Shares in European exchange operators have already been hit as a result of the proposal. Bankers associations and other lobby groups argue that it will raise costs, negatively affect growth and distort global markets (report).

If implemented only in the EU/euro zone, there might be short-term exchange rate volatility in other regional markets, and especially in financial centres such as Singapore and Hong Kong, due to the influx of “hot money” and the rapid movement of money in currency swap transactions.

One of the solutions to curb short-term speculation and better regulate the financial markets is for a global Tobin Tax, and not just one limited to the EU or euro zone. If France and Germany are indeed serious about the Tobin Tax, they should work with the other EU member states in the G20 (Italy and UK) and work toward having this pushed through at its next summit in November in Cannes, France.

An alternative would be a tax on settlements, proposed in 1999 by economist Rodney Schmidt, a solution that would not need the cooperation of other nations as national governments can collect a tax on trades on their currency, irrespective of where the trade happens (because it is a tax on the balance of payments, which happens after a trade is completed). This might be a way forward for the euro zone in the initial stages if it is unable to reach an EU-wide consensus.

Perhaps it is time to rethink growth priorities and look at the social dimension and the wider benefits a Tobin Tax can bring worldwide, and the impact this tax can have on liberating national governments and the EU from the hold the financial markets currently have over them.

Further reading

Brondolo, John (2011) Taxing Financial Transactions:  An Assessment of Administrative Feasibility (IMF Working Paper WP/11/185).

Link: http://www.imf.org/external/pubs/ft/wp/2011/wp11185.pdf

Institute of Development Studies (2011) The Tobin Tax – A Review of the Evidence (IDS Research Report 68).

Link: http://www.ids.ac.uk/files/dmfile/RsRr68.pdf

Irvin, George (2010) “The EU Must Act on a Tobin Tax”, Social Europe Journal (Online Columns, 2 Feb 2010).

Link: http://www.social-europe.eu/2010/02/the-eu-must-act-on-a-tobin-tax/​