Global Policy Forum

By Robin Round

On 23 March 1999 the Canadian Parliament voted to 'enact a Tobin Tax in concert with the international community'. For three intense months people from across the country had written letters, signed petitions, penned newspaper articles and spoken out at public meetings. And now we had won. Canada had become the first country in the world to declare that currency speculators must be stopped.

During that time campaigners ran into the same basic questions from ordinary people who were just beginning to hear about global currency speculation and to get some sense of its dangers. Here are some of the key concerns raised and our responses to them.

So what is currency speculation and why is it a problem?
The world of international finance has become a global casino where investors seeking quick profits bet huge sums around the clock. Unlike investments in goods or services, speculators make money from money alone. No jobs are created, no services provided, no factories built and no widgets produced.

Investors play the bond and currency markets profiting from the minute-to-minute, hourly or daily fluctuations in prices around the world. And the game is big: $1.5 trillion ($1,500,000,000,000) is traded every day, 95 per cent of which is bet on whether currency values and interest rates will rise or fall. Traders make money either way and they thrive when markets are highly unstable, as they were in Southeast Asia in 1997.

International investment banks are the big winners, but the game has far-reaching impacts on the losers. As the Mexican, Southeast Asian, Russian and Brazilian financial crises demonstrated, an enormous human toll is extracted from the citizens of these countries when investors panic and run for the exits.

As national economies become more liberalized and integrated, future financial crises are inevitable unless changes are made.

What is the Tobin Tax?
In 1978 Nobel Prize-winning economist James Tobin proposed that a small worldwide tariff (less than half of one per cent) be levied by all major countries on foreign-exchange transactions in order to 'throw some sand in the wheels' of speculative flows. For a currency transaction to be profitable, the change in value of the currency must be greater than the proposed tax. Since speculative currency trades occur on much smaller margins, the Tobin Tax would reduce or eliminate the profits and, logically, the incentive to speculate. The tax is designed to help stabilize exchange rates by reducing the volume of speculation. And it is set deliberately low so as not to have an adverse effect on trade in goods and services or long-term investments.

How would a Tobin Tax benefit the global economy?
It could boost world trade by helping to stabilize exchange rates. Wildly fluctuating rates play havoc with businesses dependent on foreign exchange as prices and profits move up and down, depending on the relative value of the currencies being used. When importers and exporters can't be certain from one day to the next what their money is worth, economic planning – including job creation – goes out the window. Reduced exchange-rate volatility means that businesses would need to spend less money 'hedging' (buying currencies in anticipation of future price changes), thus freeing up capital for investment in new production.

Tobin's proposed tax would not have stopped the crisis in Southeast Asia, but it could help prevent future crises by reducing overall speculative volume and the volatility that feeds speculative attack.

How would the Tobin Tax benefit national governments?
It is designed to reduce the power financial markets have to determine the economic policies of national governments. Traditionally, a country's central bank buys and sells its own currency on international markets to keep its value relatively stable. The bank buys back its currency when a 'glut' caused by an investor selloff threatens to reduce the currency's value. In the past, most central banks had enough cash in reserve to offset any selloff or 'attack'. Not any longer. Speculators now have more cash than all the world's central banks put together. Official global reserves are less than half the value of one day of global foreign-exchange turnover. Many countries are simply unable to protect their currencies from speculative attack.

By cutting down on the overall volume of foreign-exchange transactions, a Tobin Tax would mean that central banks would not need as much reserve money to defend their currency. The tax 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 according to demands of fickle financial markets.

How would the Tobin Tax benefit people?
By making crises less likely, the tax would help avoid the social devastation that occurs in the wake of a financial crisis. It could also be a significant source of global revenue at a time when foreign aid is decreasing and strong domestic anti-tax sentiments are reducing the ability of governments to raise revenue. In the face of increasing income disparity and social inequity, the Tobin Tax represents a rare opportunity to capture the enormous wealth of an untaxed sector and redirect it towards the public good.

Conservative estimates show the tax could yield from $150-300 billion annually. The UN estimates that the cost of wiping out the worst forms of poverty and environmental destruction globally would be around $225 billion per year.

Who will be taxed?
The majority of foreign-exchange dealing is by 100 of the world's largest banks. The top 10 control 52 per cent of the market and are mostly American, German and British. Citigroup tops the list with a 7.75-per-cent market share and a 1998 volume of foreign exchange transactions which, at $8.5 trillion, exceeded the GDP of the US. These banks operate in their own interest and on behalf of large corporate and private investors, insurance companies, hedge funds, mutual funds and pension funds.

What will be taxed?
Only specialized financial transactions known as 'spots', 'swaps', 'futures' and 'forwards' will be taxed. With the exception of spot transactions, these instruments are known as 'derivatives' because their value is derived from the value of an underlying asset which is not bought or sold in the transaction.

Tourists exchanging dollars to pay for their holidays abroad would not be subject to a Tobin Tax. Debate continues as to whether the tax should apply to any transaction less than a million dollars.

How does the Tobin Tax work?
The tax would target only speculative currency transactions. Because it is not easy to determine which types of transactions are speculative and which are associated with legitimate trade in goods and services, the tax hinges on the speed of a transaction. Speed is the primary difference between speculative and legitimate trade. Productive investment works on the medium to long term while speculators flip investments like pancakes, profiting by the daily, hourly and minute-to-minute fluctuations in interest rates and currency values. Eighty per cent of all speculative transactions occur within seven days or less – 40 per cent occur in two days or less.

A Tobin Tax would automatically penalize short-term exchanges, while barely affecting the incentives for commodity trading and long-term capital investments.

Won't speculators find ways to evade the tax?
Inevitably. However, this has never dissuaded governments from collecting taxes, particularly 'sin taxes' designed to stem unacceptable behavior. The real question is, how do you minimize evasion?

A Tobin Tax could be difficult to evade. Because currency transactions are tracked electronically, in theory the tax would be easy to collect through the computer systems that record each trade. While the amount of money is enormous, the number of centres where trading occurs and the number of traders is not. Eighty per cent of foreign-exchange trading takes place in just seven cities. Agreement by London, New York and Tokyo alone would capture 58 per cent of speculative trading.

Won't speculators shift operations to offshore tax havens?
Agreement between nations could help avoid the relocation threat, particularly if the tax were charged at the site where dealers or banks are physically located or at the sites where payments are settled or 'netted'. The relocation of Chase Manhattan Bank to an offshore site would be expensive, risky and highly unlikely – particularly to avoid a small tax. Globally, the move towards a centralized trading system means transactions are being tracked by fewer and fewer institutions. Hiding trades is becoming increasingly difficult. Transfers to tax havens like the Cayman Islands could be penalized at double the agreed rate or more. Citizens of participating countries would also be taxed regardless of where the transaction was carried out.

What is the biggest barrier to the Tobin Tax?
It's not technical or administrative. It's political. The tax is seen as a threat by the financial community and has met with stiff resistance by a sector with massive political clout. The very idea of putting people ahead of markets challenges the foundations of the current global economic model and those who control it.

Can the opposition be overcome?
In the wake of recent global financial crises governments everywhere are examining their faith in free markets. Even the World Bank and the International Monetary Fund recently praised Malaysia's use of capital controls to jump-start its battered economy. This is a fundamental shift in attitude, unimaginable only a year ago.

The political appeal of this tax to cash-strapped governments and multilateral agencies worldwide can't be underestimated. And voters will likely respond well to a campaign to tax big banks, which are widely viewed as under-taxed.

Who supports the Tobin Tax?
The international trade union movement, the Canadian Parliament, the Finnish Government and a growing number of academics and elected representatives. In Brazil politicians recently launched the 'Parliamentary Front for the Tobin Tax'. And citizens' movements for a Tobin Tax are active around the world, including CIDSE in Europe, Attac in France, the Halifax Initiative in Canada, KEPA in Finland and War on Want in Britain. These and other groups have established the International Tobin Tax Network to share information and co-ordinate actions as they work to build public and political support for the tax.

This is only one aspect of the fundamental reform of the global financial system and is not a panacea for the world's financial ills and development woes. The democratization of economic decision-making and the equitable redistribution of wealth must become the central principles upon which governments act in the new millennium.

The victory in Canada is an important first step, but the real work has just begun. Citizens and politicians around the world must not let the powerful forces who oppose the Tobin Tax stifle, manipulate and ultimately undermine an essential public debate on controlling global financial markets.

The Tobin Tax deserves a fair hearing. Only widespread popular support and public pressure can ensure it.

Robin Round is with the Halifax Initiative, a coalition of Canadian NGOs working for the democratization of economic decision-making. She heads up their Tobin Tax campaign.

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