KANANASKIS G7 SUMMIT ISSUE BRIEFS (June 2002): What's Shutout of the G7?

What’s Shutout of the G7? – The Tobin tax and Mountains of Money for Development

Should one ever think that the G7 is a legitimate forum of equals, take a closer look at the Tobin or currency transactions tax. In 1999, Canada passed a motion in support of implementing such a tax, by a resounding majority and with all party support. In 2001, France passed legislation mandating the adoption of the tax. The European Union has studied it and Germany has just released a study that advocates implementation in the Euro zone.
With all this interest in member countries and with an economic and development agenda at Kananaskis, why won’t a measure to stabilize economies and generate enormous new revenue streams be discussed? Because the US, heavily influenced by the world’s biggest banks and investment firms, refuses to consider any measures that might impede the global flow of footloose capital. It is the height of hypocrisy that while discussing meagre measures to lift Africa from devastating poverty, the G7 will ignore a sin tax on big banks that could generate billions for social development and environmental protection. Fortunately, the illegitimate nature of the G7 as a forum for global decision-making is only reinforced by these actions. Public pressure continues to build globally for a measure that puts people ahead of markets.
What is the Tobin tax and how does it work?
In 1978, Nobel prize-winning economist James Tobin proposed that major countries levy a small tariff on all foreign exchange transactions. This tax would eliminate the small margins currency speculators profit from thereby reducing the incentive to speculate and the volume of speculative capital flows. By reducing the flow volume, the tax is designed to help stabilize exchange rates and increase the fiscal and monetary policy autonomy of national governments.
Recent proposals by economists Rodney Schmidt and Paul-Bernd Spahn have revised and improved on Tobin’s original concept to respond to changing times and conditions. Schmidt addresses concerns that Tobin’s proposal was too difficult to adopt and too easy to avoid. Spahn responds to criticisms that Tobin’s tax would be useless during financial crises. The terms “Tobin tax”, “currency transactions tax (CT tax)”, “Tobin-type tax” are often used interchangeably.

Why are CT taxes necessary?
Currency transactions taxes can help:

  • Prevent financial crisis
    The deregulation of financial markets, coupled with a dramatically increased volume of financial transactions, has increased the inherent volatility of financial markets and contributed to the financial crises in Mexico, Russia, SouthEast Asia and Latin America. These crises are not isolated but reveal the systemic instability of financial markets, which behave irrationally and are driven by panic selling and herd behaviour. Speculators have a vested interest in creating and maintaining these severe fluctuations as profit potential increases in volatile markets. The taxing of currency transactions represent one means by which countries can reassert control over unstable financial markets by reducing the volatility speculators thrive in.


  • Restore economic sovereignty
    By cutting down on the overall volume of foreign exchange transactions, CT taxes would reduce the volume of reserves necessary for countries to defend their currency. Historically, a central bank’s cash reserve was sufficient to offset any speculative selloff or “attack” and maintain relative exchange rate stability. Global official reserves, however, are now less than one day of global foreign exchange trading. This means that many countries do not have the ability to intervene to protect their currencies from speculative attack. When a country cannot defend the value of its currency effectively, it loses control of its monetary policy and ultimately, its economy. CT taxes would allow governments the freedom to act in the best interests of their own economic development, rather than being forced to shape fiscal and monetary policies in accordance with the perceived “demands” of fickle markets.


  • Generate significant public finance 
    CT taxes could yield anywhere from US$ 100 - 300 billion annually at rates discussed below and with widespread participation. Faced with large debts and deficits, governments are looking for new sources of revenue. Given the declining commitment to bilateral and multilateral aid around the world, these taxes could generate important new resources to alleviate poverty and enhance development.


Why the Tobin/CT tax now?
Recent trends to liberalize financial flows globally have increased not only the volume of transactions, but volatility in recent years, inviting destabilizing speculation and abrupt capital flow reversals. From 3.5 times the level of dollar value of exports in 1977, foreign exchange transactions rose to 68 times the value of world exports by 1998. The global daily foreign exchange trading volume us now $US 1.5 trillion per day. Markets will remain volatile and financial crises, inevitable, until the incentive for speculation is removed.

How much is a TRILLION?? A million dollar pile of stacked $100 dollar bills would be 2 metres tall; a one trillion dollar pile would be 200 times the height of Mt. Everest.


 What would the tax rate be?
The rate would be determined by each country enacting the tax, but the tax range recommended to calm markets and raise revenue is between .1 and .25%. While this may seem very small to consumers paying up to 20% taxes on goods and services, the impact on currency speculators would be enough to curb their activities.

Will the tax harm trade in goods and services?
No. The difference between speculative trade in money and investment in the productive economy is the frequency with which each conducts financial transactions. Investors in goods and services have medium to long time horizons. Speculators, on the other hand, are profiting by the daily, hourly and minute-to-minute fluctuations in interest rates, currency values and bond markets. Over 80% of all speculative transactions occur within 7 days or less - 40% occur in two days or less. CT tax proposals automatically penalize these short-term exchanges, while negligibly affecting the incentives for commodity trading and long-term capital investments. CT taxes will benefit long-term investors in the real economy. Reduced exchange-rate volatility means that businesses need to spend less money hedging (buying currency in anticipation of price changes), thus freeing capital for new investments.

In the new “casino” economy, money has ceased to be a means of exchange and has become a commodity.


Who would be taxed?
CT taxes target only those profiting from currency speculation. The majority of foreign exchange dealing is done by 100 of the world’s largest commercial and investment banks. The top 10 control 52% of the market. Citibank is at the top of the list with a 7.75% market share and a 1998 foreign exchange transaction volume that exceeded the GDP of the US at US$ 8.5 trillion. These banks operate in their own interest and on behalf of clients including large corporate and private investors, insurance companies, hedge funds, mutual funds and pension funds.


 What would be taxed?
The scope of CT taxes varies. Tobin would have taxed all purchases of financial instruments denominated in another currency. Schmidt broadened the tax to include all foreign exchange transactions. These would include simple exchanges of one currency for another (spot transactions) as well as complex derivative financial instruments including forwards, swaps, futures and options if they involve two currencies.

Who collects the tax?
Any country with the authority to tax could adopt a currency transactions tax unilaterally under the CT tax proposal of Rodney Schmidt. Collection of the tax would be the responsibility of the national central bank and subject to all the tax laws of the implementing nation. Once adopted, the CT tax would then automatically apply to every transaction involving the taxed currency, anywhere in the world. Critics falsely claim that CT taxes represents “global taxation” and an “unwelcome infringement on sovereignty”. CT taxes cannot be imposed upon any country.

How should the revenue be distributed?
One of the most devastating costs of financial crises is a human one. When currency values collapse in the wake of speculative attack, prices skyrocket, wages fall, companies unable to pay debts denominated in foreign currencies go bankrupt and joblessness soars. Because the responsibility for preventing financial crisis is a global one, the responsibility for repairing the damage wrought should also be a global one. Thus, while CT tax revenues will accrue to individual participating nations, a portion could be targeted to assist the most vulnerable nations in preventing speculative attack and ensuring social development. An international agreement between participating nations could be negotiated under the aegis of the United Nations. Broad participation in the treaty would be encouraged by the prospect of revenue sharing.

The inevitability of future crises makes the re-regulation of capital a global imperative.


Won’t speculators find ways to evade the tax?
CT taxes could be quite difficult to evade and easy to collect. Economist Rodney Schmidt’s proposal would utilize the wholesale banking market, which is highly centralized and regulated. All transactions are already tracked electronically. Monitoring systems are already in place and all major currencies participate. Because the tax will be collected at centres controlled by the central bank, non-cooperating tax havens could be refused the right to utilize the taxed currency.

Would CT taxes have prevented the crisis in SEAsia?
The proposed CT tax level would have been too low to have stopped the crisis in Southeast Asia once exchange rates began to plummet, but it could help prevent future crises by reducing overall speculative volume and the volatility that feeds speculative attack. A “circuit-breaker” variation of the CT tax by German economist Paul Bernd Spahn would address crisis situations by raising the tax to prohibitive levels for short periods, thereby stopping all trading. Once the panic had passed, the tax would be reduced to a lower level.

What is the biggest barrier to the adoption of CT taxes?
The biggest barrier is not technical or administrative, as critics claim, but political. CT taxes are taxes on the most powerful banks and investment institutions in the world. The very idea of putting peoples’ needs ahead of market whims challenges the dominant economic paradigm of our times. Only sustained public pressure will ensure continued debate and successful implementation.

Can political barriers be overcome?
Yes. The risk of future financial, economic and social crisis, coupled with the revenue potential for a currency transactions tax, are providing political incentives and opportunities unimaginable in the mid-1990’s. Nations can ill-afford the economic devastation, political turmoil and untold human suffering of the last few years. In the wake of recent financial crises governments around the world are examining their former faith in unfettered free markets.

In the face of increasing income disparity and social inequity, CT taxes represents a rare opportunity to capture the enormous wealth of an untaxed sector and redirect it towards the public good.