Tobin Tax, Merkel & Sarkozy's Euro "Saviour"?

At various times in the aftermath of the US-engineered global financial crisis, Angela Merkel and Nicolas Sarkozy have both called for a Tobin Tax to be applied to financial transactions. By imposing a small tax on financial transactions such as foreign exchange trading, seriously large revenues can be raised in theory (Sarkozy bandied about the figure of $100B at the G20 earlier this year).



While left-leaning activists want to apply a Tobin Tax to help address global poverty and slow the velocity of finance, these European leaders are more interested in generating revenues that help keep troubled Eurozone economies afloat. Little noticed in all the hullabaloo about these two attempting to fashion a definitive (if shopworn) solution to the EU's financial woes were new proposals for an EU-wide Tobin Tax. Although I am in principle supportive of such a tax, applying it only in the EU is difficult. For, banks trade with each other in various global financial centres--many of which are obviously outside the EU. If applied only in the EU, the likely effect of the Tobin Tax would be to merely shift speculative activity to non-EU locations and financial institutions to avoid paying up.



Meanwhile, it is with much pleasure that I found my erstwhile sparring partner in the blogosphere, Economist's View blogfather Mark Thoma, penning an op-ed supporting Merkel and Sarkozy. As he says, what's not to like?

So is a financial transactions tax a highly distortionary, costly tax? The answer is no. The tax would discourage short-term speculative activity, but much of this activity provides little social value. It pushes money around among winners and losers, and traders like it for that reason, but if this activity is discouraged through taxation it would have little effect on long-term investment decisions by firms. For example, one thing this would discourage is high frequency computer trading to exploit minute differences in prices. Does it really matter for long-term investment if these differences persist for a few seconds or minutes more?



In fact, there’s even an argument that this tax will improve the efficiency of financial markets. The late economist James Tobin, the originator of the tax, argued that speculative activity causes harmful fluctuations in financial markets. For example, pursuit of speculative gains can cause firms to increase leverage, and if a financial crisis hits it can be very disruptive to the economy when firm are forced to unwind that leverage quickly. That wouldn’t be so much of a problem if the costs fell only on those making the decision to take on so much leverage. But, unfortunately, as we have seen in this crisis, the costs can be very large and spread beyond the firms and individuals making the decision to take on so much risk. Thus, just as with pollution there are externalities — costs that fall on the innocent — and to the extent that a transactions tax forces firms to internalize the costs of their decisions, it improves rather than hinders the efficiency of financial markets.

Well said, Mark Thoma--but it is instructive to note that a G20-wide solution didn't come to pass over strong vested interests voicing their objections before. So, what about *just* a pan-EU set-up? Let's just say prospects for even that are daunting. Some say bank stocks across the EU fell today in response to this idea being resurrected by the two EU bigwigs. Angela Foyle at the accounting firm BDO, for instance raises questions about The Great Unknown of something which has never been implemented:

The economic consequences of introducing a Tobin Tax are completely unknown. There has been insufficient analysis of costs and benefits, and such a tax has not been introduced on any real foreign exchange market so far...[b]ut the German and French leaders seem committed to the transaction tax as the one concrete proposal for their efforts to save the struggling euro...



This is being presented as a measure which will increase tax revenues by up to €200bn (£175bn) per year, and discourage speculative transactions. In reality, this is likely to be a highly optimistic figure, an across the board transaction tax tends to be a blunt instrument which does not distinguish between speculation and transactions vital to jobs and businesses.



There are valid concerns that a transaction tax will increase costs for long-term investors, reduce liquidity and decrease market efficiency and growth. Taxpayers should also be concerned as to whether this could, in fact, decrease the tax base and further slow Europe's growth prospects if it is limited to either the EU or the eurozone and pushes market liquidity, business and related jobs to countries which do not impose such a tax.

Even if Germany's financial services industry is comparatively smaller than that of many major EU economies, rest assured that they're unhappy while explaining that it will do little to quell the Eurozone crisis. (On the latter point I am actually in agreement.) And surprise, surprise: many in the UK are really (Euro-)sceptical, especially about it hurting the City of London:

If applied in Britain, it would cost the City billions of pounds...Tory former Cabinet minister John Redwood urged the Treasury to veto it. "It really does take the biscuit that France and Germany get together to discuss how to raise money for the poor parts of the eurozone and come up with a tax that hits Britain hardest," he said. "It is a very unfriendly gesture."



Mark Field, Tory MP for Cities of London and Westminster, said eurozone stability was important, but added: "London is going to want to do all it can to resist going down that path."



The Treasury has emphasised that any such tax would need to be truly international so as not to disadvantage participating countries. A source today said officials were waiting to see details, but vowed: "We will defend the British national interest every step of the way."



The British Bankers' Association said the cost to London would be "particularly high". Spokesman Brian Mairs said it did not "believe this is a practical possibility".

This may be the understatement fo the year, but I believe that much remains to be done to implement a workable Tobin Tax. While obviously self-interested, critics who point out that an EU-wide tax may only succeed in disadvantaging European financial institutions make sense. Having wrested so much business from New York via financial deregulation during the Big Bang, will London now succumb to EU overregulation? Tobin tax supporters would also do well to remember that a global proposal fell under deaf ears at the G20 when voiced by Merkel and Sarkozy.