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Why imposing Tobin tax won't help
THE recent G20 summit was the occasion for another dusting-off of the arguments in support of the Tobin tax.
The tax was initially proposed by the US Nobel Laureate James Tobin in 1972 as a way of throwing sand in the wheels of international finance, so as to combat market volatility.
In essence, a small tax, for instance 0.1 percent, would be applied to all currency market transactions and it was hoped that this would make short-term purely financial movements uneconomical, without being a burden on trade.
Every year US$912 trillion is traded on the world's foreign exchanges and pocketing a even a tiny fraction of this by way of a Tobin tax has been the holy grail for development groups.
In its latest incarnation, the tax has been suggested a way of increasing regulation in international financial transactions and, in particularly, as a means of financing a bailout fund for distressed banks.
All very laudable, but how practical is the proposed tax?
There is a problem from the outset - that the tax may itself cause a decline in the tax base from which it hopes to extract its largesse.
Tax avoidance, though, is the biggest problem, and it comes in two forms: first, the migration of the foreign-exchange market to tax-free jurisdictions; and second, the substitution of tax-free for taxable transactions.
Capital migration would occur unless all jurisdictions with major foreign exchange market turnover adopted the tax, drawn to offshore markets.
To preclude the substitution of taxable and non-taxable forex transactions, the Tobin tax would have to cover a multitude of financial instruments and maintain coverage of those new ones designed to circumvent the effects of the tax.
For example, a tax on spot transactions can be easily avoided by using short-dated forward transactions. So these would need to be taxed also.
And as swap transactions combine a spot with an offsetting forward contract, they would also have to be taxed.
Moreover, taxing currency swaps alone will not do, as a foreign exchange transaction can be replicated by a combination of a currency and a treasury bills swap, thereby evading the currency market tax.
It is understandable that people want to see banks make some restitution to taxpayers who were forced to provide billions for bailou, but putting in place a Tobin tax migh not work.
(The author is counsel of AllBright Law Offices in Shanghai. The views are his own. His e-mail: sbmaguire@allbrightlaw.com.)
The tax was initially proposed by the US Nobel Laureate James Tobin in 1972 as a way of throwing sand in the wheels of international finance, so as to combat market volatility.
In essence, a small tax, for instance 0.1 percent, would be applied to all currency market transactions and it was hoped that this would make short-term purely financial movements uneconomical, without being a burden on trade.
Every year US$912 trillion is traded on the world's foreign exchanges and pocketing a even a tiny fraction of this by way of a Tobin tax has been the holy grail for development groups.
In its latest incarnation, the tax has been suggested a way of increasing regulation in international financial transactions and, in particularly, as a means of financing a bailout fund for distressed banks.
All very laudable, but how practical is the proposed tax?
There is a problem from the outset - that the tax may itself cause a decline in the tax base from which it hopes to extract its largesse.
Tax avoidance, though, is the biggest problem, and it comes in two forms: first, the migration of the foreign-exchange market to tax-free jurisdictions; and second, the substitution of tax-free for taxable transactions.
Capital migration would occur unless all jurisdictions with major foreign exchange market turnover adopted the tax, drawn to offshore markets.
To preclude the substitution of taxable and non-taxable forex transactions, the Tobin tax would have to cover a multitude of financial instruments and maintain coverage of those new ones designed to circumvent the effects of the tax.
For example, a tax on spot transactions can be easily avoided by using short-dated forward transactions. So these would need to be taxed also.
And as swap transactions combine a spot with an offsetting forward contract, they would also have to be taxed.
Moreover, taxing currency swaps alone will not do, as a foreign exchange transaction can be replicated by a combination of a currency and a treasury bills swap, thereby evading the currency market tax.
It is understandable that people want to see banks make some restitution to taxpayers who were forced to provide billions for bailou, but putting in place a Tobin tax migh not work.
(The author is counsel of AllBright Law Offices in Shanghai. The views are his own. His e-mail: sbmaguire@allbrightlaw.com.)
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