By Bart Bode
(CISDE)November 6, 2000
1. What kind of Currency Transaction Tax (CTT) are we talking about?
The original proposal
Most of the discussions on a currency transaction tax are based on the original proposal introduced by James Tobin in 1972.
This proposal consisted of levying a tax on short-term speculation, with the aim of reining it back and channelling the majority of capital into long-term investments. Tobin proposed introducing a tax of 0.5% (which boiled down to 50 base points) on all speculative transactions. It had to be a worldwide tax that was the same everywhere. Tobin also believed that this system would give governments greater autonomy to implement a good monetary policy, without denying the economic reality.
More than twenty years later, most of the arguments against any form of a currency transaction tax are still based on the old Tobin proposal. They deny the evidence and expertise that have been elaborated since 1972 and the answers that are given on the shortcomings of the original Tobin tax.
A two-rate tax system
In 1994, Paul-Bernd Spahn, professor of economics at the university of Frankfurt-am-Main, and at that time an IMF-expert, wrote a memo about taxing financial speculation, based on the original proposals of James Tobin.
Spahn developed a proposal on the basis of a double taxation system:
The Spahn variant offers a number of advantages: the small tax (0.01%) does not disrupt normal market movements and provides a guarantee of constant revenue (albeit smaller). The heavy tax is an effective tool for hindering excessive speculation and thus avoiding the risk of crises as in South-East Asia in 1997.
Taking the point of view that we want both to generate revenue and avoid crises, the Spahn variant provides the best guarantees.
Furthermore, this option is much more feasible politically, because both market economists and policy-makers alike see it as a realistic position. Even with the small tax at a very low rate (0.001 % or 0.0001 %), the monitoring device of this tax provides an instrument to follow the market movements and gives governments the possibility to take the necessary measures to avoid a major crisis. It is the ideal instrument to create time to act, the time that governments lacked during the financial crises in the past decade.
2. This is a feasible tax
A few years ago, the economist, Rodney Schmidt, was commissioned by the Canadian ministry of finance to examine how a currency transaction tax could be applied and monitored. According to him, on the basis of the electronic networks and daily settlements between the national banks, a currency transaction tax could be applied and monitored perfectly. Thus far, no-one has demonstrated the opposite and most people agree that Rodney Schmidt's application study could in fact be implemented effectively.
On October 22th 1999, CIDSE organized an international expert meeting on this particular issue. During that meeting, strong cases were made for the three following assertions:
In fact, even taking into account that some small problems remain (e.g. on some very complicated derivate products), one can state that this currency transaction tax is far more easy to implement than existing income taxes or the systems of a value added tax (VAT) that are common instruments in Europe and other Western countries.
3. This is mainly a domestic instrument
In debates on the old Tobin proposal, an argument that is often given is that at the present time, we do not have an international institution that has the legal power to levy an international tax. In the new proposal, we don't need this at all. It has to be stated very clearly that this is a tax that can be raised by each individual government, provided it has the legal authority to levy taxes.
Furthermore, we have two examples of states that have already introduced a similar tax system:
4. Some global aspects of this domestic instrument.
In principle the money markets are highly concentrated into a few major markets. This means that if a tax on financial speculation were to be introduced, those countries where these markets are located (United Kingdom, the US and Japan) would suddenly have a whole heap of extra revenue, while countries with small financial markets would generate very little revenue.
To avoid this situation some sort of redistribution mechanism has to be established.
Part of the revenue in these markets could be allocated to domestic purposes. For industrialized countries, the proposal is to allocate 20% of the revenue raised from the tax for social purposes in each individual country. The remaining 80% could be dedicated to development cooperation. Based on a simulation, a tax of 0.01% would double current official development allocations (ODA).
For the countries in the South, it can be said that 100% of the revenue could be used for their own development. Their needs are big enough, while resources are scarce.
The international institutions, in particular the United Nations, the IMF and the World Bank could establish an international agreement on redistributive measures if such a currency transaction tax were to be introduced.
This agreement could feature the exact methods to be used regarding the application, monitoring, possible sanctions and the way in which the revenue from this tax could be spent and redistributed. The collection of the tax comes under the judicial responsibility of each member state, but the conditions of the international agreement can provide for it to be carried out globally in the same way at the same rate, and as such avoid new tax competition between nation-states.
5. Some other relevant arguments
The monitoring device of a very low tax is an instrument for prudential regulation
Even at a rate of 0 %, the low tax in the Spahn proposal functions as a monitoring device. This guarantees transparency in financial markets, which are now very "opaque" since they are decentralized. Transparency is the first condition to introduce a global prudential regulation by central bank authorities. Since the recent financial crises also affected Western markets, most of the central bank authorities are convinced that a prudential regulation of financial markets is necessary for medium and long term economic policy-making.
Nonetheless, in the Spahn proposal it is still the market who decides, since currency rates are based on average trade positions. One can state that the CTT is a good compromise between existing market mechanisms and a prudential policy. And as stated above, it gives governments time to take adequate measures without the fear of a sudden major crisis.
Effective protection and using national bank reserves for domestic development
Most of the small economies lack the capacity to build up national bank reserves that are sufficient to counter a major attack on their national currency. Most of these reserves are often low return investments in one of the "hard" currencies. This is "immobile capital" until it is needed to protect the currency. With the high tax (the circuit breaker) in the Spahn proposal, those small economies don't need a big amount of useless capital, because their currency is protected by this system. The trade will slow down automatically without intervention from a central bank. This gives governments the possibility to invest most of that immobile capital in domestic development.
An ethical argument: evening out the burden on capital and labor
European and other Western countries generate their revenue mainly through taxation on labor. Belgium for example, obtains 60% of its revenue from income tax. If a universal tax is to be applied on capital, the unfair distribution of the taxation burden can gradually be evened out. This should be a great deal more fair than the current situation. It is a method for making employment less expensive through the lowering of the taxation burden, without having to implement new savings. This is also a good thing for any economy. It is one of the proven methods in fighting against unemployment.
The CTT is a so-called "blind" tax: the tax itself cannot see how large your income or assets are - it is the same for everyone. In view of the fact that it is mainly the wealthy who speculate on currency, the tax will not burden the ordinary or poor people. From the point of view of distributing fairness, it is a good instrument for steering away from the gap between the rich and the poor.
6. Conclusions
A currency transaction tax, as proposed by professor Spahn, is a domestic instrument to raise revenue that can be dedicated to social and sustainable development purposes. The tax is technically far more easy to implement than existing (income) tax systems. This proposal provides at the same time a certain amount of revenue, a monitoring device and effective protection against major currency crises. Some governments successfully put into practice similar measures. By preference, this domestic tax instrument should function in the context of an international agreement in order to avoid tax competition between different nation-states. The advantages of this proposal gain in respect from more and more experts with international expertise and reputation.
It is our hope that this proposal will seriously be taken into consideration within the context of the United Nations Finance for Development process.
Thank you.
Bart Bode,
on behalf of CIDSE and Caritas Internationalis
Source: Spahn [1996].
Sources consulted:
"Taxing Excessive Currency Speculation to prevent Social Crisis and Finance Global Challenges" - CIDSE Background Paper, Dr. Danny Cassimon, UFSIA, January 1999
"Currency Crises, Tobin Tax and International Justice" - draft paper, Luc Van Liedekerke, Centrum voor Ethiek, UFSIA, October 1997
" Report of a Consultation held by CIDSE in collaboration with the University of Antwerp (UFSIA)", 22 October 1999, Antwerp , Belgium by Prof. Anthony Clunies Ross – Economics Department, University of Strathclyde (Glasgow, Scotland), February 2000
"The Social Impact of the Asian Financial Crisis", ILO, 1998
"IMF Economic Issues N° 19, Hedge Funds", Barry Eichengreen, September 1999
"A Feasible Foreign Exchange Transactions Tax" – The North-South Institute, Ottawa, Canada – paper by Rodney Schmidt, July 1999
About the Author: Bart Bode is the head of the Policy Department, Broederlijk Delen (member of CIDSE)
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