Tobin tax
A Tobin tax was originally defined as a tax on all spot conversions of one currency into another. It was suggested by James Tobin, an economist who won the Nobel Memorial Prize in Economic Sciences. Tobin's tax was originally intended to penalize short-term financial round-trip excursions into another currency. By the late 1990s, the term Tobin tax was being applied to all forms of short term transaction taxation, whether across currencies or not. The concept of the Tobin tax is being picked up by various tax proposals currently being discussed, amongst them the European Union Financial Transaction Tax as well as the Robin Hood tax.
Original proposal
Tobin suggested his currency transaction tax in 1972 in his Janeway Lectures at Princeton, shortly after the Bretton Woods system of monetary management ended in 1971. Prior to 1971, one of the chief features of the Bretton Woods system was an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold. Then, on August 15, 1971, United States President Richard Nixon announced that the United States dollar would no longer be convertible to gold, effectively ending the system. This action created the situation whereby the U.S. dollar became the sole backing of currencies and a reserve currency for the member states of the Bretton Woods system, leading the system to collapse in the face of increasing financial strain in that same year. In that context, Tobin suggested a new system for international currency stability, and proposed that such a system include an international charge on foreign-exchange transactions.In 2001, in another context, just after "the 90s' crises in Mexico, Southeast Asia and Russia," which included the 1994 economic crisis in Mexico, the 1997 Asian financial crisis, and the 1998 Russian financial crisis, Tobin summarized his idea:
The tax on foreign exchange transactions was devised to cushion exchange rate fluctuations. The idea is very simple: at each exchange of a currency into another a small tax would be levied - let's say, 0.5% of the volume of the transaction. This dissuades speculators as many investors invest their money in foreign exchange on a very short-term basis. If this money is suddenly withdrawn, countries have to drastically increase interest rates for their currency to still be attractive. But high interest is often disastrous for a national economy, as the nineties' crises in Mexico, Southeast Asia and Russia have proven. My tax would return some margin of maneuver to issuing banks in small countries and would be a measure of opposition to the dictate of the financial markets.
Though James Tobin suggested the rate as 0.5%, in that interview setting, others have tried to be more precise in their search for the optimum rate.
Economic literature of the period 1990s-2000s emphasized that variations in the terms of payment in trade-related transactions provided a ready means of evading a tax levied on currency only. Accordingly, most debate on the issue has shifted towards a general financial transaction tax which would capture such proxies. Other measures to avoid punishing hedging were also proposed. By the 2010s the Basel II and Basel III frameworks required reporting that would help to differentiate them and economic thought was tending to reject the belief that they could not be differentiated, or should not be.
Recent proposals
In March 2016 China drafted rules to impose a genuine currency transaction tax and this was referred to in financial press as a Tobin tax. This was widely viewed as a warning to curb shorting of its currency the yuan. It was however expected to keep this tax at 0% initially, calculating potential revenue from different rate schemes and exemptions, and not to impose the actual tax unless speculation increased.Also in 2016 US Democratic Party POTUS nominee Hillary Clinton included in her platform a vow to "Impose a tax on high-frequency trading. The growth of high-frequency trading has unnecessarily placed stress on our markets, created instability, and enabled unfair and abusive trading strategies. Hillary would impose a tax on harmful high-frequency trading and reform rules to make our stock markets fairer, more open, and transparent.". However, the term "high-frequency" implied that only a few large volume transaction players engaged in arbitrage would likely be affected. Clinton referred separately to "Impose a risk fee on the largest financial institutions. Big banks and financial companies would be required to pay a fee based on their size and their risk of contributing to another crisis." The calculations of such fees would necessarily depend on financial risk management criteria. Because of its restriction to so-called "harmful high-frequency trading" rather than to inter-currency transactions, neither of Clinton's proposals could be considered a true Tobin tax though international exposure would be a factor in the "risk fee".
Concepts and definitions
Hedging vs. speculation
Critics of all financial transaction taxes and currency transaction taxes emphasize the financial risk management difficulty of differentiating hedging from speculation, and the economic argument that they cannot in principle be differentiated. However, advocates of such taxes considered these problems manageable, especially in context of broader financial transaction tax.Tobin's concept
James Tobin's purpose in developing his idea of a currency transaction tax was to find a way to manage exchange-rate volatility. In his view, "currency exchanges transmit disturbances originating in international financial markets. National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exchanges, without real hardship and without significant sacrifice of the objectives of national economic policy with respect to employment, output, and inflation."Tobin saw two solutions to this issue. The first was to move "toward a common currency, common monetary and fiscal policy, and economic integration." The second was to move "toward greater financial segmentation between nations or currency areas, permitting their central banks and governments greater autonomy in policies tailored to their specific economic institutions and objectives." Tobin's preferred solution was the former one but he did not see this as politically viable so he advocated for the latter approach: "I therefore regretfully recommend the second, and my proposal is to throw some sand in the wheels of our excessively efficient international money markets."
Tobin's method of "throwing sand in the wheels" was to suggest a tax on all spot conversions of one currency into another, proportional to the size of the transaction. In the development of his idea, Tobin was influenced by the earlier work of John Maynard Keynes on general financial transaction taxes.
Keynes' concept stems from 1936 when he proposed that a transaction tax should be levied on dealings on Wall Street, where he argued that excessive speculation by uninformed financial traders increased volatility. For Keynes the key issue was the proportion of 'speculators' in the market, and his concern that, if left unchecked, these types of players would become too dominant.
Variations on idea
The most common variations on Tobin's idea are a general currency transaction tax, a more general financial transaction tax and Robin Hood tax on transactions only richer investors can afford to engage in.Pollin and Baker
A key issue with Tobin's tax was "avoidance by change of product mix... market participants would have an incentive to substitute out of financial instruments subject to the tax and into instruments not subject to it. In this fashion, markets would innovate so as to avoid the tax... focusing on just spot currency markets would clearly induce a huge shifting of transactions into futures and derivatives markets. Thus, the real issue is how to design a tax that takes account of all the methods and margins of substitution that investors have for changing their patterns of activity to avoid the tax. Taking account of these considerations implies a Tobin tax that is bigger in scope, and pushes the design toward a generalized securities transaction tax that resembles the tax suggested by Pollin et al.. There are four benefits to this. First, it is likely to generate significantly greater revenues. Second, it maintains a level playing field across financial markets so that no individual financial instrument is arbitrarily put at a competitive disadvantage versus another. Third, it is likely to enhance domestic financial market stability by discouraging domestic asset speculation. Fourth, to the extent that advanced economies already put too many real resources into financial dealings, it would cut back on this resource use, freeing these resources for other productive uses such substitution is costly both in resource use, and because alternative instruments do not provide exactly the same services just as the market provides an incentive to avoid a Tobin tax, so too it automatically sets in motion forces that deter excessive avoidance." - Palley, 2000Pollin, Palley and Baker emphasize that transaction taxes "have clearly not prevented the efficient functioning of these markets. "