Globalisation of the world economic system is proceeding at a very rapid pace and is even promoted as welfare-improving. However, the presumed virtues of globalisation are far from being materialised. Until now, no orderly or stable financial system has been implemented as recent currency crises in Southeast Asia and Russia painfully demonstrate. Furthermore, the current financial system does not channel sufficient funds to finance crucial world problems such as adequate social development in poor countries.

     A proposed solution is to use a straightforward mechanism designed to tax the currently undertaxed (international) financial flows. Specifically, this proposal calls for the implementation of a tax that is levied on international currency transactions, i.e. a ‘Currency Transaction Tax’ (CTT).

     The most well-known proposal, although not the most feasible, was by Nobel Prize laureate for Economics, James Tobin, which called for an internationally uniform tax to be payable every time a currency was converted. Since then, most proposals of this nature have generally been described as “Tobin(-type)” tax proposals.

     In the 1990s, the idea of taxing international currency operations, and particularly the Tobin tax proposal, gained credibility in new international governance, with proposals including: strengthening the role of the UN, creation of an Economic Security Council, supervision of international banking, and a range of international taxes such as a tax on energy consumption or air travel. In 1994, the Human Development Report, published by the United Nations Development Programme (UNDP) focused on and propagated many of these international taxes as part of a new design for development cooperation, and concluded that a Tobin-tax proposal seemed to be the most easily implemented.

     It received a lot of attention at the World Summit for Social Development in Copenhagen and at the 50th anniversary celebrations of the UN, both held in 1995. The issue was also considered during the preparatory process for the G7 summit in Halifax, but was, at that time, thought to have too many technical complications, and, more significantly, was, politically unwelcome. This political resentment was felt most strongly in the United States, where the ‘Prohibition on United Nations Taxation Act of 1996’, designed to prohibit UN officials from developing or promoting Tobin-tax or other global tax proposals, was introduced to the US Congress. This proposition successfully prevented UN agencies and officials, who were central to discussions on global taxes, from discussing Tobin-tax proposals further.


The dramatic effects of excessive currency speculation

     In principle, large-scale speculation is triggered because the underlying ‘fundamental’ economic and political indicators worsen or necessary reforms are not carried out. Under a fixed exchange rate system, usually the central bank of a country tries to defend the current parity by selling its foreign exchange reserves for local currency and thereby matching the increased supply of local currency by increased demand, or by increasing domestic interest rates that increase the attractiveness of holding local currency. Such a stand-alone defence of a central bank cannot succeed for very long against the market. Alternatively, a country could try to (re)install controls on international transactions to make a currency attack more difficult; this might be more effective.

     These speculative transactions are not just zero-sum games, where one party gains what the counterparty in the transaction loses. Because of their potential to trigger a financial crisis, these ‘games’ can have large social costs:

• for the countries involved, especially on their most vulnerable groups;
  
• by contagion for other countries that are not directly involved and which provokes a global chain of reaction of financial panics and crashes (the so-called ‘systemic risk’). In the 1995 Mexico peso crisis, the impact spread to other countries, such as Argentina. The Asian currency crisis had direct contagion effects on countries, such as the Philippines and Singapore, and ultimately, to the whole world. The direct costs are huge: the Asian currency crisis lowered current world growth projection for 1998 by about 1%, amounting to at least US$300 billion. The International Labour Organisation (ILO) in its 1998 World Employment Report estimated that unemployment increased by 10 million people worldwide, solely due to the Asian financial crisis.

     The increased potential for destabilising currency attacks is caused by the worldwide liberalisation of international capital flows, including the trend towards complete abolition of capital controls; it is seen as the virtuous twin sister of liberalised trade flows. This has facilitated global financial speculative behaviour: large sums of money can move largely uncontrolled – and untaxed – around the globe in search of the highest possible return in the shortest amount of time.

     It is essential that an effective sanctioning mechanism, e.g. through taxation, is developed in order to eliminate this behaviour that is driven by individual short-term profit. This is the case not only from an economic viewpoint, but especially from a social justice perspective.

     According to financial experts, a transactions levy on financial flows, such as a CTT, could indeed be effective here, as it discourages and/or punishes undesired speculative behaviour.


The simple Tobin CTT proposal

      A Tobin-type tax proposal calls for a tax that would be payable every time a currency is converted. The original proposal by James Tobin in 1972 calls for an internationally uniform tax (set at 1%) on all spot conversions of one currency into another, proportional to the size of the transaction. Tobin’s proposal has a large intuitive appeal since it kills two birds with one stone:

• to discourage speculation by making currency trading more costly and penalising especially short-term speculation, which would supposedly lead to greater exchange rate stability;
  
• this globally-raised revenue (figures range from tens to hundreds of billion US dollars), largely out of the control of sovereign states, would create a truly global revenue base to be (partly) used to meet global challenges, such as maintaining a stable international financial system or worldwide poverty alleviation. An added benefit is not having to spend scarce resources of IMF-lending to restore financial stability after the crisis. Moreover, to the extent that part of the revenue could be used nationally to solve national problems, this increases the attractiveness of it to budget-constrained (also industrialised) countries.

     The appeal of the proposal is even greater since it could correct other existing distortions, such as uneven distribution in global wealth and wealth creation. From an ethical point of view, there is no good reason why financial transactions – as opposed to all other transactions – should not be taxed. Here, a Tobin-type tax could act as a surrogate for a more general capital income tax.

     Despite this appeal, the proposal was never seriously considered in the major international decision-making fora; not even in periods of financial crises. Apart from the political aversion to international tax measures that are perceived to threaten national tax sovereignty, the proposal is strongly criticised by financial economists.

     The basic flaw of the Tobin tax is the difficulty of determining the magnitude of the tax rate: if it is set at a high rate, it would indeed be a strong instrument to penalise speculation, but it would also seriously impair also the more desirable currency transactions, e.g. related to international trade. Yet if the tax were to be imposed as a low rate, it would not impair normal transactions but the deterrence effect on speculation would be low. Working with one uniform rate cannot accommodate both goals at the same time.


One realistic way out: a two-tier CTT

     Fortunately, there is a solution to the basic flaw in the original Tobin tax. A CTT proposal was suggested by Bernd Spahn, a professor of public finance at the University of Frankfurt/Main and a consultant to the IMF (International Monetary Fund). Spahn proposed a two-tier Tobin tax, levied as a national tax but introduced through an international agreement, with a minimal-rate transaction tax on all transactions (the ‘basic tax’) and a high tax rate (an exchange ‘surcharge’) that, as an anti-speculation device, would be triggered only during periods of exchange rate turbulence and on the basis of well-established quantitative criteria.

     The international financial establishment, as well as a number of political decision-makers (especially in the US), might continue to oppose the tax because of the expected negative consequences of an additional distortion. However, the counterarguments are:

• it would act as an effective monitoring device: administration of this tax will allow for automatic statistical reporting of market behaviour, allowing for the easy follow-up of movements in the market and monitoring;
  
• the Spahn tax would not prevent the functioning of the market mechanism: unlike capital controls, the changing target rate allows for market reactions to fundamentals and the sanctioning of policy failures, since it would mean that the exchange rate would lose value steadily. However, changes in value of the currency would be less drastic, avoiding the social costs of a strong and sudden currency crisis, by spreading it out, and allowing the government more time to execute the necessary policy corrections;
  
• the minimal-rate tax would not act as a substantial distortion: it would not change market behaviour.
  
• the tax would not necessarily require worldwide approval: to the extent that the mechanism is, in essence, a national tax and is administered nationally, political resistance against loss of national fiscal sovereignty is lessened. More importantly, as a start, the Spahn mechanism could be successfully implemented unilaterally by a few countries, without necessitating global consensus in the beginning.
  
• the mechanism would not require costly monetary action from the central bank: exchange rates would be kept within the target range through taxation rather than through central bank intervention, typically via interest rate increases or depleting international reserves. Instead of depleting reserves, it would generate revenues.

Remaining issues of implementation

     Studies on the technical feasibility of this global tax proposal have shown that a practical way of implementing the tax is through an international agreement though revenue collection would be a national responsibility. Therefore, tax collection would be delegated to the central banks of each country.

While revenue considerations should always be secondary to the prevention of devastating impact of excessive speculation, the tax proceeds could provide an important additional base, calling for a fair scheme of distribution. Two main issues regarding revenue distribution must be addressed: one is redistribution caused by the disproportionately high revenue collected in countries with major financial centres (London, New York, Tokyo); the other is the distribution of total revenue between the national and international level.

     A fair distribution mechanism could be to allow lower and middle-income developing countries to keep total revenue coming from the basic tax. For high-income countries (generally also those with important financial centres), a case could be made to make them transfer most of the basic tax revenue, e.g. 80%, to the global level.

     A case could also be made to allow those countries that experience excessive volatility in exchange rates triggering the surcharge mechanism to keep the full proceeds in order to tackle the consequences of excessive volatility. However, it could be restricted to uses linked to the problem itself, i.e. investment in the sectors of regulation and strengthening of control of the financial sector and the monitoring of (especially short-term) capital flows, on the one hand, as well as investment in social safety nets and social development, in general, to reduce vulnerability to the social impact of economic and financial crises.

     The recent currency and other crises in a number of developing countries and Russia have proven that one international organisation alone cannot adequately tackle these immense problems. The recent surge of criticisms, especially of the IMF, has resulted in a large stream of proposals for reform. However, most of the proposals seem to share the elements of closer concentration of activities; by closer collaboration or the merging of different organisations, and of an increased role to be played by the representation of developing countries themselves. The delicate issue of administration should be tackled in light of further debate on reforming these international organisations.


Dr. Danny Cassimon is an Assistant Professor of Finance at the University of Antwerp and consultant of CIDSE/Caritas Internationalis/Justice and Peace Europe.
Contact: danny.cassimon@ufsia.ac.be or bart.Bode@crv.ngonet.be