John Dillon
Ecumenical Coalition for Economic Justice
Canada

Abstract:

When Nobel Laureate economist James Tobin first proposed a small tax on international financial transactions back in 1972 (and then again in 1978) he was consciously applying to the international sphere an idea that the famous British economist John Maynard Keynes had first proposed for dealing with a domestic problem.

Like Keynes, Tobin was concerned with how to bring more stability to financial markets so that governments could pursue full employment policies. Whereas Keynes was concerned about the destabilizing effects of excessive speculation on domestic financial markets, Tobin wanted to counteract the ability of financiers to undermine full employment policies by moving large amounts of money quickly around the globe in search of short-term profits.

With a memorable turn of phrase Keynes wrote: “Speculation may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.”

In another memorable phrase Keynes observed that “when the capital development of a country becomes the by-product of the casino, the job is likely to be ill-done.” He then added “It is usually agreed that casinos should in the public interest be inaccessible and expensive.” To achieve this goal he proposed a “government transfer tax on all transactions... [as] the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise.”

Today the financial gambling casino is global with approximately US$1.8 trillion worth of currencies exchanging hands on international capital markets every business day.

James Tobin’s basic proposal is for a small tax on currency transactions as a measure to “throw sand in the wheels” of international financial markets in order to deter speculation without unduly interfering with trade or long-term investment. Tobin’s original proposal was for a tax on 0.5% or one half of a percentage point. Subsequent research determined that a smaller tax, as small as 0.02% to 0.1% would still be sufficient to deter unnecessary trading since currency speculators customarily buy and sell currencies to take advantage of very small price differentials. Even though these prices margins are very small, they are still large enough for speculators to make substantial profits as they trade in thousands or millions of dollars worth of currency contracts or bond at a time.

A small CTT would be sufficient to make unprofitable quick “round trips” in which speculators buy and then quickly resell large amounts of foreign currency, or tradable financial instruments such as bonds, to take advantage of small movements in exchange rates or interest rates. Since the effective tax rate under a CTT is highest for short-term holdings and lowest for long-term investments, it would encourage investors to make long-term investments rather than engage in fly-by-night ventures.

Official discussions concerning international financial reform concentrate on proposals for changes to government policies as though errant policies, and not market failures, were the root cause of financial instability. This official discourse ignores some important lessons from economic history.

Historically, financial markets have not behaved like other markets for goods and services. Financial markets are much more prone to instability. As economic historian Charles Kindleberger has documented, international financial markets are prone to go through cycles characterized by buying manias, followed by panic selling and finally market crashes.

The inability of financial markets to channel resources into long-term, stable investments and least of all into areas of greatest human need constitutes a prime example of market failure. This market failure is well described by the most famous speculator of them all, George Soros, who wrote:

“The private sector is ill suited to allocate international credit. It provides either too little or too much. It does not have the information with which to form a balanced judgment. Moreover it is not concerned with maintaining macro-economic balance in the borrowing countries. Its goals are to maximize profit and minimize risk. This makes it move in a herd like fashion in both directions.”

The economists at the International Monetary Fund still act as though the liberalization of financial markets is necessary for the efficient deployment of financial capital despite all the evidence to the contrary. Left to their own devices the owners of financial capital do not always invest where there is the greatest need or the best prospects for long term growth in the real economy. Instead they tend to engage in what Aristotle called “chrematistic” behaviour which may be defined as “the manipulation of wealth so as to maximize short-term monetary exchange value to the owner.”

Aristotle’s classic example of chrematistics concerned the philosopher Thales of Miletus. When the local citizens chided Thales for his simple lifestyle — saying in effect that his philosophy was obviously useless because he had accumulated no wealth through it — Thales took up their challenge. Through his knowledge of astronomy, he was able to predict a bumper olive harvest. While winter still lay over the land, he leased all the olive presses in the area at a bargain price. When harvest time came, he was able to make huge monopoly profits.

Thales employed chrematistics to his advantage. The difference between him and the modern-day chrematists engaged in speculation on international capital markets is that he saw his activities in their true light, as little more than a cheap trick to extract profit at the expense of others. Thales planted no olive trees, built no olive presses, discovered no new uses for olive oil, and made no one better off but himself.

The attitude of the modern day chrematists is well summed up by the reply an anonymous European banker gave to an interviewer from the Mexican newsmagazine Proceso. When he was asked why banks would make short-term investments in Mexico at a time when its finances were particularly shaky, the banker’s reply went beyond referring to the obvious lure of higher returns available due to a large risk premium. The banker said “When a financier lends money or invests capital, his problem is not to lend to someone or invest in an industry that will not go bankrupt. Potentially everyone can go broke. His problem is to lend or invest up to 15 minutes before the crash...[and then] get out on time.”

Despite all the evidence that financial markets do not do a very good job of allocating funds either among nations or for productive purposes, the IMF still advocates the decontrol of financial markets.

Alex Michalos cites evidence that since the IMF advised so may countries to remove capital controls the result has been an accelerated flood of financial flows accompanied by a slackened growth of investment, savings, output, trade and productivity both in the developing world and among OECD countries.

David Felix sagely observes that the official agenda for financial reform is “dangerously one-sided in demanding that developing countries reform to accomodate the needs of the financial markets of the creditor countries, while devoting little attention to taming the volatility of these markets.”

A Currency Transactions Tax (CTT) is not a panacea for all the ills of unregulated or deregulated financial markets. It will not, by itself, eliminate chrematistic behaviour. Nevertheless it does address two significant problems. First a CTT would reduce excessive speculation on currency markets. Second, a CTT would lessen the danger of capital flight and thereby give national or regional central banks more leeway for pursuing independent monetary policies.

Most opponents of a Tobin tax concede that it would make short-term “round-trips” of speculative currency transactions unprofitable. Tobin’s critics tend to attack the proposal on the grounds of its feasibility, not its stated goal - to make exchange rates reflect long-term economic fundamentals rather than short-term expectations.

James Tobin himself insists that the most important effect of his proposed tax would be the leeway it would give for autonomous national monetary policies. A 0.25% transaction tax would allow a country to maintain up to a two percentage point differential on three-month interest rates from the rates prevailing on similar financial instruments in other jurisdictions. In other words a tax of that size would make it unprofitable to sell one country’s bonds and buy those of another unless the second country offered to pay more than two percent higher interest on its 90-day treasury bills.

Thus a CTT could be a powerful tool for enabling countries to use monetary policy to stimulate employment without fear of capital flight due to the availability of higher interest rates on short-term investments in another jurisdiction.

Journalist Linda McQuaig cites several examples of the reaction of professional currency traders to the very idea of a tax on transactions. She recounts how one responded with a “mini-tirade about the utter stupidity of the tax.” Another exploded in “furious opposition” saying that “if you inhibit cash flows, the alternative is war!” without explaining who would go to war against whom.

McQuaig astutely concludes that the fury of the speculators’ opposition make it “harder and harder to resist the feeling that there must be something to this tax.” The money traders, after all, thrive on volatility. They do not want, predictable, stable exchange rates.

Rather than argue for a crass defence of unfettered capital flows and for opportunities to make speculative profits, opponents of a CTT raise a host of technical objections. They commonly make three claims:

1. Traders will use off-shore tax havens to avoid a CTT.

2. They will shift their investments out of currency trades into other financial instruments.

3. A CTT would require a spra-national authority that would strip nations of their sovereignty.

In a very readable booklet published in 1997 entitled Good Taxes Alex Michalos summarizes many cogent responses to these charges. He explains how co-operation among the seven, largest financial centres that control 80% of foreign exchange trading could overcome most of these problems.

Today I do not propose to review Dr. Michalos’ responses in detail for a simple reason - most of the claims and counterclaims that raged back and forth throughout the 1990’s concerning the feasibility of a Tobin tax have largely become redundant due to changes in international financial markets. Rodney Schmidt has tracked how these changes have overtaken the premises of most of the critics’ objections.

Rodney Schmidt is a former junior economist with Canada’s Department of Finance. Schmidt left the Ministry after his superiors refused to show the Minister his studies demonstrating that a Tobn tax is both desirable and feasible. In a subsequent study written for the North-South Institute, a Non-Governmental Organization, Schmidt describes how “the infrastructure for settling foreign exchange trades is becoming increasingly formal, centralized and regulated... [This transformation is] due to new technology [that is] subject to increasing returns to scale and to co-operation between trading and central banks to reduce and eliminate settlement risks.” (Settlement risk refers to the danger that one party to a trade will fail to fulfill its side of the bargain after the other has paid up.)

The fact of the matter is that a Tobin tax is becoming easier to administer and more difficult to evade because the financial institutions themselves are transforming the way they conduct currency trades. Banks make thousands of currency transactions every day. Rather than transfer funds to each other for every trade, they have evolved systems whereby offsetting trades are periodically “netted” out and only the net amounts owed are actually transferred between banks. Schmidt has shown that if a CTT were applied at this “netting” stage all the original transactions could be traced and taxed by the central banking authority that oversees the netting process. Moreover, central banks or their supervisory bodies can regulate offshore netting systems involving their currencies(as codified by the BIS Committee on Interbank Netting Systems in 1990 and reaffirmed in 1998).

By 2001, there will be one centralized global settlement system linked to the domestic settlement system in most countries. All transactions are electronically recorded at this settlement site. Thus tracking and taxing transactions will be relatively easy as most netting services are already delivered by a single telecommunications system, the Society for Worldwide Interbank Financial Telecommunications (SWIFT).

While the tracking of settlements is becoming centralized, the actual collection of a CTT can still be undertaken by national governments or entities such as the European Union. No new supra-national authority is needed as each central bank can collect the tax on trades transactions involving its own currency.

Implementing a CTT at the settlement site would allow a participating country’s central bank to refuse to settle transactions emanating from non-cooperating sites such as offshore tax havens.

Schmidt states “The technology and institutions now in place ... make it possible to identify and tax gross foreign exchange payments, whichever financial instrument is used to define the trade, wherever the parties to the trade are located and wherever the ensuing payments are made.”

Schmidt concludes that “if the tax is applied to the intermediate systems that net deals, it is feasible and can be unilaterally impose by any country on all foreign exchange transactions worldwide involving its own currency.”

While a unilateral imposition of a CTT by any one major currency issuer is technically feasible no one country is likely to do so under normal circumstances. As Schmidt explains one country would not act alone “to avoid giving the impression that [its] economy is under stress or that [its] macroeconomic policies are inconsistent or imprudent.” Accordingly political agreement among the major currency issuers is still needed to implement a Tobin tax.

Nevertheless, the technical ability of one country to act alone has another dimension. if that country finds its currency under siege it could unilaterally raise its CTT to a higher level to counteract the speculators. This opens up the possibility of using a higher CTT during an exchange rate crisis as an alternative to raising interest rates to deter capital flight at great cost to the domestic economy.

Co-operation among the major hard currency issuing entities is still needed to implement an effective CTT regime.

It is now clearer than ever that the CTT is a political and not a technical matter.

However much we wish to support a CTT we should be careful not to oversell its merits. Writing in the 1994 UNDP Human Development Report James Tobin himself calls the Tobin tax “a second-best option”. It would be preferable, in his view, to have a common world currency, much as Keynes proposed in his writings prior to Bretton Woods.

But a common world currency would require something like a world central bank and perhaps other institutions of global governance. Tobin concludes that it will be many decades before the conditions exist to create a common world currency. This would involve a huge surrender of sovereignty by nation states.

In my view those commentators who claim that a CTT could prevent crises on the scale of the Mexican crisis of 1994-95 or the Asian crisis of 1997-98 are overselling its potential. The devaluations that occurred in the Mexican peso and the Thai baht and other Asian currencies were simply too large and too sudden to be contained by a small transactions tax. Other measures, such as the foreign exchange controls imposed by the Malaysian government, are needed in those kinds of situations.

When an interviewer for The Economist asked James Tobin whether a Tobin tax would have prevented the Asian crisis he replied “Certainly you would need other things as well.”

A small tax is not sufficient to rectify all the deficiencies of unregulated financial markets nor is it enough to deter all chrematistic behaviour. It is only one tool among many others. Other complementary measures could include capital controls on the model of Chile’s encaje which oblige investors to keep their investment within the country for a minimum period (e.g. one year) and/or deposit a portion of their investment with the central bank.

Another needed reform is an international debt arbitration tribunal (modeled after Chapter Nine of the US insolvency law applied to municipal governments) to allow orderly write-offs of the huge, illegitimate debt burdening the peoples of the South.

While a CTT by itself could not have prevented the Asian or the Mexican crises it could have helped to contain the contagion effects. In the aftermath of these crises hot money flowed out of any number of other countries seeking an elusive safe haven. Chile was spared the worst of the “tequila effect” which followed the Mexican crisis because of its system of capital controls. Much of this hot money ended up back in the United States where it has contributed to a dangerous and unsustainable overvaluation of stock market prices, setting the stage for another kind of financial crisis.

Proponents of a CTT have come a long way in a relatively short time. Back in 1995 when Non-Governmental Organizations in Canada launched the Halifax Initiative in preparation for the G7 Summit meeting in Halifax, Nova Scotia the aim was simply to put the Tobin tax onto the international agenda.

While nothing concrete emerged from the Halifax summit persistence has paid off. Continual education and campaigning has put the Tobin tax front and centre among the demands of various social movements such as the World March of Women whose successful mobilizations last October lifted the spirits of thousands of women and men around the globe even if the march was largely ignored by the mainstream news media.

Mobilizations for a Tobin tax in Canada led to motion in the House of Commons by a social democratic Member of Parliament, Lorne Nystrom. Although the vote was not binding on the government many members of the governing Liberal party, including the Finance Minister, Paul Martin, voted for the motion which said “That, in the opinion of this House, the government should enact a tax on financial transactions in concert with the international community. "

The vote was 164 in favour to 83 opposed.

Since this vote in Canada’s Parliament, an International Legislators and Parliamentarians call for Tobin-style taxes has been successfully launched. On January 20th of this year the “Capital Tax, Fiscal System and Globalisation” Intergroup within the European Parliament fell just 4 votes short of winning support for a resolution calling upon the European Commission to submit a report within six months concerning how a Tobin tax might be introduced.

Political support of groups like ATTAC (Association pour la taxation des transactions financières pour l’aide aux citoyens) which now has over 100,000 members in over 100 French cities and affiliates in 14 countries including - Argentina, Austria, Belgium, Brazil, Greece, Ireland, Italy, Morocco, the Netherlands, Québec, Senegal, Spain, Switzerland and Tunisia - has been crucial in building support for a CTT.

All of these efforts led to an important breakthrough at the special General Assembly in Geneva last July marking the five year review of the Copenhagen World Summit on Social Development. That the Canadian government was actually willing to sponsor a resolution calling for a study of a CTT was a triumph of political organizing.

John W. Foster is a long time United Nations observer and co-author of Whose World Is It Anyway? a comprehensive review of civil society involvement at the United Nations. In a recent conversation he remarked “Seldom does one see such a clear relationship between political organizing and a desired outcome than in the UN Special General Assembly’s decision to approve the motion.” I am told that a Canadian delegate with the support of some very effective work by a German delegate and astute lobbying by many NGOs brokered this victory over the adamant opposition of the United States.

Granted it is only a motion for further study. But what is important here is the context. The call for a further study of a CTT comes in a section of the document concerning “proposals for developing new and innovative sources of funding ... for social development and poverty eradication programs.”

Thus the motion achieves a very important political goal - it establishes a clear link between the idea of an international tax on financial transactions and social development.

Strangely, James Tobin himself does not put much emphasis on the question of how the revenues from such a tax might be used. But for those of us who are dedicated to the eradication of poverty throughout the world this dimension of the debate is crucial.

Estimates of the revenue potential vary according to the assumptions about how effective the tax will be in deterring speculation, the substitution of other instruments to avoid the tax and of course the tax rate.

A realistic set of estimates by David Felix and Ranjit Sau published in 1996 put the global revenue potential at around US$302 billion a year for a 0.25% tax; US$148 billion for a 0.1% tax and US$90 billion at a 0.05% tax rate. These calculations assume 1995 foreign exchange volumes, pre-tax transition costs of 0.5% and the non-taxation of 35% of foreign exchange trading due to the exemption of official transactions (10%) and tax evasion (25%).

Felix has since updated his estimate in line with increased volume of transactions on foreign currency markets. Felix now says a 0.1% tax might cut foreign exchange turnover by up to 50% and still generate annual revenues of US$200 billion.

We should not hesitate to make a strong argument that the revenues from a tax on international gambling should be used first and foremost to meet the most pressing needs of the vitims of the global casino economy.

At the time of the World Summit on Social Development it was estimated that US$40 billion a year in additional spending would bring basic social services to the poorest: $25 billion for health; US$6 billion for primary education; and US$9 billion for sanitation and clean water. The United Nations Development Program’ 1998 report estimated that another US$40 billion a year would be enough to bring 1.3 billion people who earn less than a dollar a day above this threshold of absolute poverty.

Just half of the revenues from a 0.1% CTT would be sufficient to cover these expenditures and still leave other monies available for other pressing needs such as environmental protection.

The campaign for a CTT is important for another reason. It raises some fundamental ideological and ethical questions.

At the risk of oversimplification I would venture to say that the debate over a CTT reveals much about our fundamental values.

Behind the technical language lies a fundamental question:

Should the desire of private financiers to seek profits through speculative, unproductive investments take precedence over the need for public regulation of financial markets through democratic institutions?

In ethical terms the question might be posed this way:

Must the desire of the wealthy to make money by trading money prevail over the needs of the poor?

My answer is clear: the needs of the poor must take precedence over the wants of the rich.

That’s why I believe we must establish a CTT.