Summary:
– The Tobin Tax was recently adopted by eleven European countries but remains controversial.
– The Tobin Tax has several major drawbacks: capital flight, circumvention of the law, and low tax revenues.
– Other options exist, such as the introduction of a capital buffer or a specific tax on systemic banks.
This time it’s official: the Tobin Tax will be implemented in Europe in 2014-2015. More specifically, it will be implemented in 11 European countries: France, Germany, Portugal, Spain, Italy, Greece, Estonia, Austria, Slovakia, Slovenia, and Belgium. Other European countries, including Luxembourg and the United Kingdom, will not be following suit, which could have very negative consequences for convergence between countries, particularly in terms of tax competition. This tax will be levied on all financial transactions (stock exchanges, investment companies, hedge funds, shares, bonds, etc.) at a rate of 0.1% (0.01% for derivative contracts). Analysis.
The Tobin tax has had an unusual history. It was first proposed by liberal economist James Tobin to stabilize rapidly developing markets after the end of the Bretton Woods agreements, before being taken up, much to the chagrin of its initiator, by certain anti-globalization movements. It then appeared in a few proposals by the Socialist Party, before the idea was taken up by the right after the crisis. However, the sudden resurrection of this tax has been met with widespread criticism.
An old idea, never before adopted in France
The idea of adopting the Tobin Tax is not new. It stems directly from a draft directive that was rejected in Europe due to a lack of agreement among the 27 member states. Furthermore, it was part of Nicolas Sarkozy’s program, and the idea of a similar tax (this time at the global level) had already been put forward after the crisis, but Dominique Strauss-Kahn, then director of the International Monetary Fund (IMF), opposed it, considering the system simplistic and very difficult to implement (notably because of the risk of capital flight to untaxed locations)The entire political sphere has been considering this mechanism for a long time, as it would generate revenue while also improving the government’s image among a large part of the population.
Two major uncertainties: capital flight and low tax revenues
The current financial system, governed by the 2007 MiFID directive, allows for the existence of « dark pools » and other alternative systems, which are opaque trading platforms. Consequently, despite all the goodwill in the world, it would be absolutely impossible to implement a tax on all transactions. Even though MiFID is currently being revised, the elimination of alternative markets does not appear to be on the agenda, and in any case, the agreement of the British would be required to do so (which is far from certain). The tax can therefore only apply to regulated markets, creating a significant competitive disparity. However, financial services are not comparable to airline tickets or other tangible services; they are essentially completely intangible and can therefore very easily be subject to arbitrage. Thus, even if each structure currently has its own advantages and disadvantages, the presence of a strong arbitrage opportunity would lead to a significant loss of trading, ruining the attractiveness of the Paris stock exchange compared to alternative markets and other dark pools, and at the same time contributing to making modern finance even more opaque.
Secondly, the United States and the United Kingdom are currently strongly opposed to the introduction of a Tobin tax, reducing to zero the chances of this project being adopted on a global scale, or even throughout the European Union. However, the introduction of a financial transaction tax by a limited number of countries is doomed to failure due to the arbitrage mechanisms analyzed above. And this reasoning is not just theoretical, as history confirms. Indeed, Sweden introduced a similar tax in 1986, an experiment that was abandoned four years later due to the measure’s blatant failure: the revenue generated was disappointing and the tax caused a significant capital flight from the country. Furthermore, no country currently applies this tax, apart from our 11 European musketeers who will adopt it shortly. Similarly, the stamp duty, equivalent to a small Tobin tax affecting only market capitalizations of more than €1 billion, has only brought in €250 million to France since 2011 (a five-month period between its introduction and the end of the year), compared to the €1.1 billion that had been announced. The volume of these securities is said to have fallen by 18%, while the volume of other securities jumped by 16% over the same period. This example shows that a Tobin tax in Europe will bring in much less than the €10-30 billion announced (which is already a very wide range) and that it will result in a shift of flows to opaque markets.
In view of the arguments presented, it seems likely that, far from filling the government deficit, a tax on financial transactions would prove to be particularly harmful.
There is another alternative, targeting the cause of the problem.
If we are so vehemently opposed to the Tobin tax, it is because other solutions exist that we believe are much better. As we have just seen, the introduction of a tax on financial transactions at the international level is not feasible, and even if all the major countries were to approve it, there would still be the problem of the development of offshore centers, which would become new « tax havens » for financial transactions.
A viable solution in a globalized and interconnected economy such as ours can only exist on a global scale. However, it turns out that the G20 has proposed some extremely relevant solutions. Let us begin by pointing out that the 2007 crisis was mainly caused by large banks posing a systemic risk. They were the ones that spread subprime mortgages and caused the crisis to spread globally. Furthermore, these banks are called « too big to fail, » creating a moral hazard problem: they can do whatever they want because they know they will be bailed out by the government in the event of bankruptcy. Faced with this problem, the state can set an example (as was the case with Lehman Brothers, with the consequences we all know) or try to put in place prudential rules to limit this risk. This is the whole objective of the Basel III agreements, the Dodd-Frank Act in the United States, and the G20 proposal.
The latter, which we strongly support, would require banks posing a systemic risk (currently between 20 and 30, including four French banks) to increase their capital by around 2.5%. This larger safety net would limit the risk of bankruptcy and therefore the impact of such an event on the world, without « disrupting the real economy or calling on taxpayers. » This mechanism could even be taken to its extreme by introducing a tax on banks posing a systemic risk, which would feed into a global rescue fund to intervene in the event of a problem. Some would argue that this insurance would lead to moral hazard for these banks, but as this already exists, insurance can only be a plus.
Conclusion
There are many arguments that lead us to conclude that, given its harmful effects and past experience, a Tobin tax applied only in France or in a limited part of Europe is not a good solution—quite the contrary. Other proposals, such as strengthening prudential rules at the global level, seem much more appropriate in the current situation.
References:
« A fair and substantial contribution by the financial sector interim report for the G-20, » IMF, April 2010.
« Taxation on the financial sector, » European Commission, Working Document No. 25, 2010.
European Commission, Markets in Financial Instruments Directive (MiFID).
Financial Transaction Tax (FTT), Law No. 2012-354.
