Q&A: WHAT IS THE TOBIN TAX ON FINANCIAL TRADING?

A TOBIN TAX IS INTENDED TO AFFECT ALL SHARE, BOND AND CURRENCY TRANSACTIONS Source: http://www.bbc.co.uk/news/business-15552412, 10 September 2013 Last updated at 11:32 GMT

Eleven EU member countries have said they wish to move ahead with introducing a financial transactions tax. The nations - which include France and Germany - intend to use the tax to help raise funds to tackle the debt crisis. The tax has the backing of the European Commission. The other countries that wish to introduce it are Italy, Spain, Austria, Belgium, Greece, Portugal, Slovakia, Slovenia and Estonia. Yet the tax is opposed by other nations, such as the UK, where the government feels it would damage the City of London. The US has also expressed its opposition to the idea. EU lawyers have now issued a 14-page legal opinion saying the move would be illegal, since it would exceed member states' tax powers. The idea of such a tax - often described as a Tobin tax or "Robin Hood" tax - was first outlined 40 years ago. What is the Tobin Tax? It was put forward in 1972 by the Nobel-prize winning American economist James Tobin. Originally he suggested a tax on all payments from one currency to another. His aim was to curb massive and destabilising movements of funds between foreign currency exchanges. He proposed that the cash raised should be used as aid for developing countries. The idea has since been extended to cover a tax on all share, bond and currency transactions. How would it work? Tobin said it had to to be an internationally agreed uniform tax to work effectively. He said each government would levy it with the proceeds paid into a global financial body such as the World Bank or the International Monetary Fund (IMF). Critics said it would be impractical: a high rate would undermine financial markets, but if it were too low, it would not achieve its aim. It has also proved impossible to get global agreement to introduce it. Without worldwide agreement, the 11 European countries have decided to move ahead on their own, with the support of the European Union. And instead of paying the proceeds to a global body, they will use the funds to help bring down their respective national debts. How much would it cost? Tobin suggested a rate of 0.5%, but other economists have put forward rates ranging from 0.1% to 1%. Even at a very low rate, supporters argue that if it were imposed on all financial transactions across the world, it could raise billions of pounds.

What are the advantages and disadvantages of the tax? The advantage of the tax is that it could be a huge money-raiser for governments. Others add that it is only fair that banks and other financial firms pay an additional tax to help tackle government debt levels that they helped increase, as a result of the bailout schemes which many of them required during the financial crisis. Those in favour of the tax also argue that it helps to increase stability. They say that in the 1990s, it could have prevented countries such as Russia, Mexico and those in South East Asia having to raise their interest rates to very high levels, as their currencies came under threat from speculators. Critics argue that the tax will result in fewer financial transactions being made, resulting in job losses in financial centres. Others warn that the tax will mean pension funds and savers get less returns, as banks will simply pass the cost of the tax onto their customers. Has a Tobin tax been tried anywhere? A version of it was tried in Sweden in 1984, where a 0.5% tax was introduced on the buying and selling of shares. The results were disappointing. It had been hoped that about 1.5bn Swedish kronor (142m) per year would be raised. On average, 50 million was raised. Capital gains tax revenues also fell. But the impact on market trading was also more dramatic. During the first week of the tax, the volume of bond trading fell by 85%. In 1991, the tax was scrapped. Yet Tobin taxes are still in place in some of the world's fastest-growing financial centres - Hong Kong, Mumbai, Seoul, Johannesburg and Tapei - where they are said to collectively raise 12bn a year. How quickly could the 11 European nations introduce the tax? No timetable has yet to be released. The tax will, however, need to be backed by a majority of the 27 European Union member states, including those who will not be introducing it. It will also need to be approved by a majority in the European Parliament. When such backing has been secured, Europe's Taxation Commissioner Algirdas Semeta can release a detailed proposal on the tax and its implementation.

DO TOBIN TAXES ACTUALLY WORK? Source: The Economist, Sep 9th 2013, 23:50 by C.R. ON SEPTEMBER 2nd Italy became the first country in the world to extend its financialtransaction tax to high-frequency share trading. The Italian government hopes the tax will stabilise markets, reduce financial speculation and raise revenue for the government, as do ten other Eurozone countries considering similar policies. Such levies have been dubbed Tobin taxes after James Tobin (pictured), a Nobel Laureate in economics, who in 1972 first suggested taxing financial transactions. But do Tobin taxes actually work? Tobin originally put forward his idea in a very different context to that faced by the Italian government today. He promoted it as a way of stabilising currency markets after the Bretton Woods system of fixed exchange rates collapsed in 1971. His proposed tax on currency exchanges was intended to curb de-stabilising capital flows across borders. Tobin envisaged a global tax, which was impossible to avoid by moving financial markets offshore. The proceeds

would be donated to developing countries. But today Italy is implementing the tax on its own in a very different context. Its problems include a debt crisis, an uncompetitive economy and a weak banking sector, rather than exchange rate instability. The aim is not only to reduce stock market volatility, but to use the extra revenue to reduce Italys budget deficit. The evidence to support Tobin taxes is thin on the ground, however. Most academic studies generally agree that they may not necessarily decrease volatility in financial markets. An experimental study in 2010 by researchers at the University of Innsbruck suggested that a global Tobin tax would have little impact on volatility. And there is not much evidence at all that unilateral Tobin taxes work. Although large markets might see a fall in volatility, smaller markets would see a rise due to a fall in liquidity. Even Barry Eichengreen, a supporter of Tobins original proposals, now argues that a European Tobin tax may prove a distraction that allows systemic risks and instability to increase in other areas. For instance, according to Harald Hau, an economist at the Swiss Finance Institute and the University of Geneva, credit misallocation in the economy as the result of distorting equity and bond prices may make l ife difficult for small and medium sized business that cannot raise finance from abroad. In practice Tobin taxes imposed unilaterally have proved unsuccessful as markets have moved abroad to avoid them. Swedens experiments in the 1980s with a transaction tax on shares, equity derivatives and fixed-income securities ended in failure as activity moved offshore to avoid the levies. In the first week of the fixed-income tax bond trading volumes fell by 85%; the amount eventually raised from the tax averaged only about 3% of what was predicted. By 1990 over 50% of Swedish equity trading had moved to London. Similar difficulties may lurk in Italy. Il Sole, a financial daily, has reported that Italian traders are beginning to move their residency to Malta, which has excluded itself from any such proposed tax. This suggests that the Italian government may not raise as much revenue as it originally thought. However, by not extending the tax to bonds, the Italians have attempted to avoid the pitfall identified by the International Monetary Fund that a tax on trading government bonds might increase the cost of public borrowing. This would have been disastrous for Italy, a country faring badly in the European sovereign-debt crisis. But has it avoided all the potential adverse effects of the policy? Current academic opinion suggests that this is unlikely. The rest of Europe will no doubt be watching closely.