Tobin Tax

The Tobin tax is a proposed tax on short-term currency transactions. The tax is designed to deter only speculative flows of hot money—money that moves regularly between financial markets in search of high short-term interest rates. It is not meant to impact long-term investments. The effective rate of tax will be higher the shorter the investment cycle (i.e., the time between buying and selling a currency), thus providing market-based incentives for lengthening the term structure of investments. Such taxes tend to be named after James Tobin, the Nobel laureate in Economics who first popularized the idea of a levy on currency transactions in the early 1970s. In one of his final interviews for the German newspaper Der Spiegel, Tobin subsequently distanced himself from the campaign that now typically bears his name, arguing that campaigners were right to support a currency transactions tax, but they were doing so for the wrong reasons. Three reasons are usually cited for introducing such a tax and, while Tobin concentrated on the economic justifications for taxing speculative flows of hot money, others have recently focused instead on the positive global causes that could be financed from the revenue from the tax.

This is perhaps understandable because the daily turnover on foreign exchange markets is now so out of proportion compared with all other forms of economic activity that even the tiniest currency transactions tax would raise huge sums of money. It would provide a means of global redistribution, enabling poverty to be tackled at the source. Despite concerns about the viability of enforcing the tax, its revenue would allow any number of development goals to be met. In addition, a Tobin tax would also act as a defense mechanism against destabilizing speculation within the foreign exchange market. As the Asian financial crisis proved so conclusively, whole economic systems can fall prey to the effects of momentum trading, whereby the loss of confidence in a currency can lead to wholesale economic collapse.

However, neither of these were Tobin's reason for supporting the imposition of a currency transactions tax. Tobin's concern was that policymakers should be able to determine policy in a context that was undisturbed by flows of hot money destabilizing the domestic currency. The tax therefore represents a means of reactivating a sphere of autonomous policy making. Tobin tailored his argument primarily to the position encountered by developing countries. He wished to see developing countries integrated more fully into the dynamics of international trade, and using public policy to reduce speculation against their currencies assisted this goal. At the time that Tobin was writing, speculative pressures against the currencies of developing countries proved particularly difficult to resist, which added a considerable degree of exchange rate [Page 971]risk into, and hence undermined, their trading relationships with other countries.