GUEST COMMENT: Why a Tobin tax for Europe would never work

eFC logo

The prospects for a Tobin tax have seemed never more favorable. Angela Merkel said today that European ministers should map out plans for its implementation.

The hope is that such a tax would curb financial speculation and, as long requested by tax proponents, collect vast sums for the global fight against poverty. These hopes may be disappointed.

The intention is that stock and bond trades would be taxed at the rate of 0.1 percent, with derivatives deals at 0.01 percent. This could raise between €30bn and (if currencies were included) more than €50bn per year.

The percentage rates may look small but the effects on individual banks are by no means negligible as the following example from Forbes’ Trefis Team demonstrated last year:

“We can look at the implication of this tax on Barclays – which had close to $221 billion in bonds and other fixed-income securities in 2010 and just less than $40 billion in equity-based securities including derivatives.

 Assuming the entire portfolio is subject to a transaction, the bank essentially pays a transaction tax of $221 million on its fixed-income securities and $4 million on the equity-based securities. This totals $225 million in additional taxes for the sales & trading division. And this number represents the lower-end of the potential payout as banks normally enter in a large number of transactions using their portfolio and each transaction would attract the tax.”

Beside the cost of the tax to individual banks, a Tobin tax also threatens to have a distortionary affect. The success of the tax and the size of the revenue it raises will largely depend on the inclusion of OTC derivatives, and above all foreign exchange transactions. Given current market practices and the state of reporting, this seems impossible.  The danger is that a tax would affect only activities that are well-documented and under regulators’ influence, whilst sparing others. As a consequence it may exacerbate developments supervisors generally regard as undesirable such as the trend for deals to take place outside exchanges and growth of a shadow banking system.

Equally, it is wrong to think that a transaction tax would be absorbed by market participants. High-frequency traders who make the highest volume of transactions will suffer most and may be driven out of the market. To the extent that arbitrage is an important part of price discovery and liquidity is indispensable, harm will be done.

Contrary to popular opinion, it is not the ‘speculators’ that will suffer most from such a tax: for those betting on changes in the value of securities of several percent, the tax burden will be small compared to the gains.

Like the euro the Tobin tax risks becoming a failed European experiment. Unlike the euro it can be rescinded easily. That is the good news.

Beate Reszat is an author an economist focusing on international financial and currency markets. She was head of research on international financial markets at the Hamburg Institute of International Economics and has worked at the International Monetary Fund in Washington. A version of this article first appeared on her blog.