Sunday, November 23, 2014

Europe’s Tobin Tax Distraction

CAPE TOWN – At last, European leaders have revealed their top-secret plan for solving the euro’s crisis. And it is – drum roll – a version of the “Tobin tax,” a levy on financial transactions first suggested in 1972 by the Nobel laureate economist James Tobin.

Now, 40 years later, the European Commission has proposed – and French President Nicolas Sarkozy and German Chancellor Angela Merkel have endorsed – a turnover tax on all financial transactions, varying from 0.1% on stocks to 0.01% on financial derivatives like futures and credit-default swaps. If the tax can’t be imposed globally or even Europe-wide, France and Germany will go it alone. Given Sarkozy’s enthusiasm for the tax, there is even talk of France adopting it unilaterally.

But how, exactly, a tax on financial transactions would help to cure Europe’s ills is unclear. According to the European Commission’s own estimates, it would raise only about €50 billion ($65.7 billion) a year, even if imposed throughout the European Union. This is a pittance compared to the eurozone’s debts and deficits, and would fall far short of funding Europe’s permanent rescue facility, the European Stability Mechanism, which is supposed to be capitalized to the tune of €500 billion.

Moreover, the Commission’s €50 billion estimate surely overstates the prospective receipts. If France imposes the tax unilaterally, trading in equities and derivatives will simply migrate to Frankfurt. If it is limited to the eurozone, transactions will move to London. And if it is adopted by all EU member states – a fanciful scenario, given British resistance – the market will simply migrate to New York and Singapore.

European leaders claim that they can create mechanisms to ensure that their residents pay the tax, regardless of where trades are booked. But banks are widely reported to be devising new instruments to enable their clients to avoid the tax. On whom would you bet – the tax authorities or the financial engineers?

If the aim is to augment revenues, a Tobin tax is the wrong tool. Indeed, Tobin designed it to solve an entirely different problem: excessive volatility in currency markets. By discouraging foreign-exchange transactions, Tobin’s proposal sought to promote exchange-rate stability by preventing national currencies from coming under speculative attack.

The irony, of course, is that eurozone members have no national currencies to attack. As members of a monetary union, they enjoy a relatively high degree of exchange-rate stability – far too much stability, in fact. In the current circumstances, with much of Europe lacking competitiveness, a weaker exchange rate is precisely what the continent needs.

European leaders sometimes extend Tobin’s logic from the currency market to financial markets generally. An across-the-board tax on transactions, they argue, would dampen financial volatility.

But the logic behind this conclusion is lacking. What we know is that a tax on transactions would result in fewer transactions. Some investors would exit the market. But which ones – the opportunist speculators, who sell when everyone else is selling, or the contrarian speculators, who do the opposite and stabilize volatile markets?

Maybe a Tobin tax is intended to shrink Europe’s bloated financial sector. In that case, it is, once again, misdirected. Europe’s problem is its banks, which are too big to fail – and also too big to save. A Tobin tax would do nothing to shrink them. On the contrary, by discouraging trading in securities, it would encourage investors to shift their funds into bank accounts and certificates of deposit.

Nor would a Tobin tax address the fact that Europe’s banks are undercapitalized, or that pro-cyclical bank lending amplifies business cycles (and that regulation does too little to restrain this).

Forgive my naiveté, but I have begun to think that politics rather than economics explains European leaders’ enthusiasm for a Tobin tax. Sarkozy can preempt a long-standing proposal of the Socialists in the run-up to this spring’s presidential election. By supporting Sarkozy, Merkel can get in return what she really wants: French support for stronger fiscal rules. And EU leaders can claim that the financial sector is being made to contribute to the costs of Europe’s financial cleanup.

To paraphrase the famous put down of then-Senator Dan Quayle in the US vice presidential debate in 1988: I knew James Tobin; James Tobin was a friend of mine, my mentor, and, for a brief privileged period, coauthor. Tobin would not have been pleased to see his proposal repurposed in this way.

Though no one can say for sure what Tobin would have thought of Europe’s crisis, his priority was always the pursuit of full employment. One suspects that he would have urged European policymakers to dispense with their silly fixation on a financial transactions tax and instead repair their broken banking systems and use all monetary and fiscal means at their disposal to jump-start economic growth.

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    1. CommentedOliver R

      Some Eurosceptics, particularly those in the British Conservative Party, are eagerly anticipating the imposition of a Financial Transaction Tax on the continent. They expect investors to come streaming out of financial centres like Paris and Frankfurt straight into the welcoming arms of The City.
      They are surely not wrong in thinking this; but what they don't take into account, either due to an innocent omission or willful blindness, is the effect this could have on the European economy. The imposition of a Financial Transaction Tax would reduce liquidity and make it harder for banks to raise funds, which would only serve to exacerbate the already severe shortage of credit in European economies. Here in Britain we would be hit hard by slower growth on the continent, which is indeed what is already happening.
      If one were to liken the imposition of a Financial Transactions Tax to a grenade thrown at Europe's economy then, although in Britain we wouldn't be hit directly by the blast, we would still suffer shrapnel damage in the form of lower export growth to Europe.

    2. CommentedGraham Hodgson

      Share trading in London is already subject to a Tobin tax, a 0.5% stamp duty payable by purchasers. The avoidance scheme is spread-betting.

    3. CommentedAndrew Purdy

      If the EU needs a source of Federal revenue, why don't they take a page from US history and give Brussels the power to impose excise taxes and external tariffs. The Early USA's first tax was on booze, and this resulted in the very first tax rebellion, which President George Washington quickly put down.