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Issues Action Briefing Paper No. 45
February, 1999

Stabilizing the world economy: Tobin Tax may be best bet

Introduction

We are currently in the midst of economic turmoil involving several
Asian countries (Thailand, Japan, South Korea), Russia, and Mexico;
Brazil is threatened. There is great concern that this economic turmoil
could envelope other countries, including Canada, the US, Europe,
eventually the World. The turmoil has been economically, socially and
politically devastating in those countries it has hit, causing
widespread loss of jobs, poverty for millions, sometimes even
starvation. With economic collapse, governments lose control of their
economic policies. Revenue to pay for much needed social programs
(health, education) dries up.

Can anything be done about this? We must first understand the causes of
this turmoil, and then learn something about the advantages and
disadvantages of various possible remedies.

Background

One important cause of the turmoil is international currency
speculation. Speculators can profit from buying and selling large
amounts of money in different countries' currencies as the exchanges
vary, even if they vary only slightly.

Here's a simplistic example of how it works. Suppose you had a million
Canadian dollars to invest, and you have just heard on the early morning
radio that new figures show the unemployment rate in Canada has risen,
again. You decide this probably means the value of the Canadian dollar
relative to the U.S. dollar will dip later in the day, but only
temporarily. Therefore you quickly turn your million Canadian dollars
into U.S. $634,500 at an exchange rate of 63.45. Sure enough, a few
hours later you hear that the value of the Canadian dollar has fallen to
63.42 cents U.S.. Quickly you turn your U.S. dollars back into Canadian
dollars - you can buy more of them now because they're cheaper than they
were that morning, so instead of the million Can. dollars you started
with, you now have $1,000,473. Of course these are still worth only U.S.
$634,500, but by the following morning the panic over the unemployment
rate has evaporated, as you expected, the Can dollar is worth 63.45
again, and if you wanted to change your Canadian dollars back into
American ones, you'd now have U.S. $634,800. However you look at it,
you've made $473 Canadian, or $300 U.S. in 24 hours. That's not a bad
day's pay! Keep it up for 300 days of the year, and you'll have made Can
$141,900, even if you've spent each day's profit along the way, and not
added it to your $1 million capital. That's an annual interest rate of
14%!

There are several things to note. First, the fluctuation in the
exchange rate on which you've made so much money was only 3/10ths of a
percent, or 0.03%. Second, to make your two transactions worthwhile,
they had to be done in a very short time (because the difference in
exchange rates was so small). You had to gamble on how currencies would
change value, which is why this marketplace has become known as the
"Global Casino". Third, your overnight "investment" in American dollars
did nothing to improve American manufacturing or production. Not all
investment is like this; much of it is longer term and beneficial.

In the example, only a million dollars was transferred, but in  total
the daily transactions of this sort exceed U.S. $1.4 trillion! The
"sloshing about", as it has been described, of so much money can have
devastating repercussions on national economies. If, for instance,
everyone holding Thai bahts, hears that the value of the baht is likely
to fall, they will start selling them. Since nobody wants bahts, their
value tumbles. When this happens in countries with strong economies,
their central banks buy back their own money, using reserves of U.S.
dollars (or now maybe Euros) which they are holding for that purpose.
Countries with weaker economies, and Thailand is one of them, don't have
enough reserves to prevent the value of their currency from crashing.
Even strong but small economies can have trouble maintaining a
reasonably stable exchange rate. The result is that overnight the cost
of all imported goods in the affected country can become prohibitively
expensive for the common person. The populace and the economy can be
devastated; political instability can follow.

Obviously there are good reasons for wanting to prevent the  speculative
short-term buying and selling of different currencies to prevent this
sort of devastation. There's more than one possible remedy. We'll
quickly look at several of them, before examining an apparently
promising one - the "Tobin Tax" - in more detail.
 

WAYS OF REGULATING INTERNATIONAL CAPITAL FLOWS

There are various methods of regulating international capital  flows, of
which some major ones are: 1) currency exchange rate controls, 2) direct
controls on capital in- and outflow, 3) national and international taxes
on currency transfers.

Currency exchange rate controls limit the volume or price at which a
currency may be traded. Fixed exchange rates lead to black markets if
the market value of the currency differs much from the pegged value.
Floating exchange rates can be controlled to some extent by a country's
central bank buying or selling foreign currency to protect the value of
its money, as outlined above, or by adjusting interest rates on
government held bonds.

Many countries impose direct controls on capital moving in and out by
making investors adhere to requirements such as a minimal time for
investments, or the type of industry to be invested in. Such controls
can be difficult and complex in practice, but Chile has used it
effectively. (They would likely have become illegal under the
Multilateral Agreement on Investments (MAI), a controversial
international treaty which was recently shelved following protests from
numerous citizens groups around the world.)

That leaves taxes. Taxes can be imposed upon transfer of funds,  equity,
bonds, stocks etc. both within and between nations. Nationally imposed
taxes include the "Security Transition Excise Tax" or STET, the
Financial Transactions Tax (FTT) and the Securities Transition Tax
(STT). These national taxes require payment upon the sale of
"securities" (bonds, stocks, etc., but not "capital" or money, per se)
within each country. Because most trading of foreign exchange is for the
purpose of buying or selling these assets, the tax would lessen
volatility in the foreign exchange market. Individual countries can
impose them, and benefit from the proceeds. Many countries have such
taxes, but not Canada or the US.

The "Tobin Tax", proposed by the Nobel Prize winning economist  James
Tobin in 1978, if implemented, would be an international tax on currency
transactions and other "exchange equivalents" (things that can be used
instead of money, such as Treasury bills (T bills), and stocks and
bonds). It would be effective in curbing international currency
speculation even if the taxation rate were low; in the example above, a
tax of as little as 0.02% would have removed all profits. However, since
more profitable situations abound, a slightly higher tax, probably
between 0.2% and 0.5%, is suggested as necessary to stop the unwanted
currency speculation.

One problem with any tax is that at the mere word economists,
politicians, and many other people react like the proverbial cat with
its tail in a light socket! Nonetheless, there are such things as "good
taxes", and the Tobin Tax would appear to be one of them. Like all
taxes, it slows commerce; this is usually bad, but in this case it is
precisely what is needed and intended. The commerce being slowed mostly
benefits banks, plus a few individuals or corporations - is there any
reason they shouldn't pay something for benefiting from the system?
Currency stability generally benefits business, and certainly benefits
control of national economic policies. The revenue provided, by one
reasonably and conservative estimate as much as U.S. $54 billion per
year, could pay for much needed social programs in developing countries.

Nevertheless, even if the Tobin Tax is a "good tax", there are
potential problems and difficulties which must be considered before
governments will muster the political will to agree to try and implement
it.

DIFFICULTIES AND PROBLEMS WITH THE TOBIN TAX

(1) Need for Universality

There is a consensus that to be effective the Tobin Tax must be all but
universal. Unlike the STET, FTT and STT (see above) which can be applied
by individual national governments, the Tobin Tax would have to be
applied by at least a majority of developed countries. If not, currency
transactions would simply move to "tax havens", countries where the tax
is not applied.

However, if a majority of powerful economic countries can be persuaded
the tax is a good thing, there are carrots and sticks available for
encouraging developing countries to comply as well. For instance, some
of the revenues can be turned over to them for social programs (the
carrot); or they can be told the IMF will provide no loans if they run
into financial trouble unless they implement the Tobin Tax (the stick).

Countries applying the Tobin Tax must apply it not only to currency
transfers, but also to other "foreign exchange equivalents" to prevent
evasion of the tax by transferring currency as, say, T-bills instead of
dollars. There is disagreement on how easily people could evade taxation
through tax havens and foreign exchange equivalents, and therefore on
how truly universal the Tax must be. It would depend, in part, on the
rate of taxation: if the rate is sufficiently low, currency traders
might feel the trouble, risk and cost of working through tax havens was
greater than the small amount of tax to be paid. By keeping the tax rate
low, therefore, evasion can be made not worthwhile. The rate of taxation
must, of course, also be universally uniform.

In sum, there would certainly be difficulties getting a majority of
countries to agree to apply the tax to a wide range of transfers and at
a uniform rate, but these difficulties are surmountable.

(2) Collection and Use

The financial industry has the sophisticated technology required for
tracking the kinds of transactions that would need to be taxed.
Computers can be programmed to deposit the tax automatically upon each
transaction in an agreed upon account. Would this 'account' be
administered by the IMF, or World Bank, or some new agency established
for this purpose?  A much trickier question would be deciding what
should be done with the revenues. There are literally thousands of
worthy projects and causes, and eyes will glitter at the thought of so
much booty!

(3) Opposition from financiers

The people who would suffer most under such a tax, wealthy  investors,
financiers and bankers, have more political clout than any other group
in the world, and some of them are bound to resist. Indeed, some are
already doing so. Decreased bank profits may mean decreased interest
rates on your and my savings in those banks, a fact which opponents of
the tax will doubtless point out. However, other bankers and investors,
remembering the great losses from such things as the Barings Bank
fiasco, see the value of the reduced risk and exchange rate volatility
which this tax would bring.

Powerful opposition should not dissuade attempts to have the tax
implemented. The many environmental, church, labour, women's and other
groups, and their coalitions (such as the Halifax Initiative), which
already support this tax, have a reasonable expectation that democratic
governments will listen to them.

There are some other difficulties in addition to the three major  ones
listed above, but they would all appear more easily surmountable.

Canada's Parliament considers the Tobin Tax

A motion (M239) has been brought before the House of Commons by  Lorne
Nystrom (NDP Member of Parliament for Regina-Qu'Appelle). Second reading
was scheduled for Feb. 3rd, 1999. A vote on the Motion will take place
some time later in this session of Parliament. The motion calls upon the
government to show leadership in enacting a tax on financial
transactions in concert with the International Community.

The motion is supported by NDP and Bloc Quebecois MPs and,
significantly, by some Liberals (including Tony Valeri, Parliamentary
Secretary to Minister of Finance). A number of non-governmental
organizations and affiliates of the Canadian Labour Congress are
campaigning in support of the Motion.

A motion is not a bill. It does not become law, nor force the government
to act. However, if a motion is adopted by the House, it will help build
political momentum for the idea. Passage of the Motion would strengthen
the hand of the Minister of Finance, Paul Martin, who has supported
Tobin Tax proposals in the past but run into opposition from others from
within his own Ministry as well as G7 allies.

The world badly needs more economic stability, more revenue for social
programs, and more room for increased democratic decision making on
economic policies. G7 governments recognize the inadequacies of present
arrangements. That's why they recently called for "new institutional
architecture" to regulate international finance. (Too bad though that
they can't seem to agree on what this "new architecture" should look
like.)

The Tobin Tax would appear to be one of the best, but certainly not the
only, tool for helping to stabilize world economies. Its adoption poses
some difficulties, but none of these seems insurmountable if sufficient
political will can be mustered in support of the idea.

The Motion before Canada's Parliament would help move political opinion
to supporting the Tobin Tax, at least in principle. Experts can then
turn their attention away from dwelling on the theoretical problems of
implementation, to finding ways to overcome these problems and make the
Tobin Tax work.

 World Federalist Analysis

Regulation of the global economy in order to promote the public good is
one of the main reasons why World Federalists support the goal of a
democratic, federal world government. Arguably, if we had a world
government, then we would also have the means (taxes, a global currency,
central banking and regulatory structures) to manage the economy and
address global problems, such as poverty and instability in
international financial markets.

However, we don't have a world government. And there is no sign that
this larger goal is about to attain widespread political support in the
foreseeable future. In the meantime, what we do have is an increasingly
interdependent global economy, and a growing roster of global economic
problems which are inadequately addressed by the governance structures
which states have established to date.

The real challenge for World Federalists is to put forward pragmatic
proposals which improve global economic governance, while also being
marketable in the current political context.

The Tobin Tax may be such an idea, one whose time may be coming. Then
again, it may not. What's needed at this stage is more support for the
idea in principle. Governments should commit their support for measures
like the Tobin Tax which would increase international cooperation to
promote the common interest in global economic stability and increased
resources for shared public policy objectives. Once governments are
committed in principle, then the likelihood is greater that some of the
problems associated with implementation of the Tax will be overcome.

Recommended Action

Write polite, constructive letters to your local Member of Parliament
asking him or her to support the Motion (M239) for discussion of the
Tobin Tax. If possible send the letters to your Member's local
constituency office, but otherwise to the House of Commons (where no
stamp is needed). Send a copy of your letter to the Hon. Paul Martin,
Minister of Finance. Letters to Members of Parliament can be mailed to:
House of Commons, Ottawa, Ontario, K1A 0A6.

This paper was prepared by Philip Symons, Victoria and Fergus Watt, WFC
national office,  with files from the Sierra Club, The Halifax
Initiative and Friends of the Earth U.S.A.
For more on the Tobin Tax, see the book,
"Good Taxes" by Alex C. Michalos
(1997, Science for Peace, Dundurn Press, Toronto).



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