By Rajendra Rampersaud
The International Monetary Fund (IMF) in its latest December issue of the Survey Magazine pointed out that it is examining the policy option on a possible tax on the financial sector. It argued that government has to recover the billions of dollar in public support used to prop up the banking and financial system during the current crises as well as meeting future potential cost. This put the Global Financial Transaction Tax or the Tobin Tax back on the front burner as the global economies continue to reel from the impact of the recent financial crises. This mandate to the IMF was handed down by the leaders of the Group of Twenty (G-20) that included the industrialize and emerging market economies at the recently concluded summit in Pittsburg in September 2009. They are expected to prepare a report for discussion in June 2010. This article reviews the Tobin Tax against the backdrop of the policy action taken by the G-20 countries and the global financial crisis.
James Tobin a 1981 Nobel Prize winner in Economics first touted the idea for a levy on international currency transaction at the Janeway Lecture in honour of Joseph Schumpeter at the Princeton University, New Jersey in 1972. Tobin himself admitted that the idea at first did not create any ripple and sank like a rock. This was also the period when the world moved away from the gold standard and also from fixed exchange rate regime to floating rate. Since then the world has moved towards greater financial liberalization that has been synonymous with financial crises with each crises digging deeper than its predecessor. In the mid 90s, as policy makers around the world tried to grapple with the impact of the Asian Financial crisis the meeting of the American Economic Association expressed concern about the excessive volatility of exchange rate. They saw the Tobin Tax as a useful measure if enforcement problem could be resolved. Moreover, Stanley Fischer, then First Deputy Managing Director of the IMF an ardent champion of full convertibility of all member’s currencies also welcomed discussions on the Tobin Tax. The Asian Financial Crisis popularly described as the “Twin Crises” that is the exchange rate and banking crises forced a rethink of the policy and might have stopped the amendment to the IMF Articles of Agreement for complete current and capital account convertibility.
Tobin’s arguments for the transaction tax were mainly two fold; first it will make exchange rate reflect to a larger degree long-run fundamentals relative to short range expectations and risks. The reason for this being as Tobin argued that more than ninety percent of foreign exchange transactions involve round trips of seven days or less that encourage speculation and lead to exchange rate volility. Secondly, Tobin argued that the transactional tax on foreign exchange movement will preserve and promote the autonomy of national macroeconomic and monetary policies. The transaction tax will be helpful in both fixed and floating exchange regime and even hybrids like floating rate band.
The Tobin tax became more popular in the aftermath of the East Asian crises especially after Chile’s experience with capital restriction in the midst of a dramatic surge in capital inflows in the 90s. Chile implemented a scheme based on two requirements, first a stay of one year for all Direct Foreign Investment, and second, an unrenumerated reserve requirement that mandates 30% of all direct foreign investment entering Chile to be deposited in a fund at the Central Bank for one year at zero interest rate. These requirements represent an implicit tax on all foreign inflow. While most large Latin American countries suffer from the contagion effect of the Asian crises Chile was most solid due to what most analysts thinks was their control on the movement of speculative capital.
The Transaction Tax was the subject of a grand debate by academics and policy makers at a conference organized by the International Financial Institution in Washington D.C in the late 90s that involved world renowned economist and policy makers. The output of this conference resulted in an Oxford University Press Publication called the Tobin Tax. The book carried the discussion on the pros and cons of the Tobin Tax. Barry Eichengreen concluded in the final chapter that answers are needed if domestic and international policy – makers are to make informed decision about whether a Tobin Tax is a partial solution to the crisis in development finance, to the problem of exchange rate volatility and to the difficulty of formulating a coherent national economic strategy in an environment of high capital mobility.
My first encounter with the Tobin Tax was when President Dr. Cheddi Jagan in 1995 presented his idea of a New Global Human Order that included the Tobin Tax as a proposal at Bishops’ High School in 1995. While the Tobin Tax seemed to come alive with every financial crisis in the current era it might have gathered its greatest momentum with the outcome of the recent Global Financial crisis. Both friend and foe of the Global Financial Transaction Tax have come to agree that it be placed on the agenda for discussion and decision. Moreover, the stride made recently with the G-20 last summit at Pittsburg to placing this proposal high on its agenda was groundbreaking since it was estimated that the Industrialized Economics stand to lose US$1.6 Trillion as a result of the fall out from the global financial crisis.
Peer Steinbruck, Germany’s Minister of Finance wrote recently from Project Syndicate and carried by Stabroek News (03/10/09) that the political answer to the financial crisis must encompass more than just improved regulatory regimes, risk management strategies and capital requirements. He argued for a fair burden sharing between Wall Street and Main Street. He further pointed out that German Chancellor Angela Merkel has received support for the idea from British Prime Minister Gordon Brown and Nickolas Sarkozy of France.
The idea of the Global Financial Transaction Tax first crafted by James Tobin is now beginning to gain international currency with some modifications at the level of the most influential political directorate. The current debate on the subject has certainly opened up new horizon in the area of International Monetary Policy. The Global Financial Tax now seemed as if it is now here to stay with the broad consensus that is now emerging and as with most good ideas it takes a long time to materialize.
