Why the Currency Transaction Tax is a Win/Win Scenario
NB: This note is based especially on the much longer and more technical work of Sony Kapoor [a former and perhaps present banker: "Currency Transactions: A Report to the Tobin Tax Network"] plus the "Landau Report" of the commission established by the French government ["Les Nouvelles contributions financières internationales"] and Peter Wahl of the German NGO WEED ["International Taxation: Regulating Globalisation and Financing Development"]. Remaining questions could undoubtedly be sorted out by Kapoor who knows the responses to technical objections inside-out and has explained them in great detail in the annexes to his report.
Proposals for a Currency Transaction Tax [CTT] have moved from utopian to mainstream in five or six years. Since James Tobin first made his proposal in the 1970s, much work has been done and many refinements added to the idea, which is why campaigners for the idea no longer refer to the "Tobin Tax" but to the CTT.
In Tobin's time, the volume of currency transactions [CTs] was about $80 billion a day; it is now $1.200 billion a day. CTs now represent 50 times the volume of global trade [in the late 1970s, they were only 3 times as great].
The four major currencies [dollar, euro, yen, pound sterling] make up 75 percent of all transactions. Currencies of less developed countries are also traded but in small quantities. Most trades are realised in a few hours or at most a few days; the vast majority of positions [at least 75 %] are closed within a week. The positions taken to pay for actual goods or services at a later date represent only about 2 % of transactions; most trades are simply bets on the movements of relative currency prices.
Concentration in the CT market is high: 30 banks, most of them American or British, are responsible for some 80% of the trades. Profit margins on CTs are thin and profits on them for these important banks are $30-40 billion a year. This is only 5-10 % of their total annual profits, a small share.
Why do we need a CTT?
We need such a tax first for financial market stabilisation and second to raise additional finances for development purposes. Tobin thought of his tax as a device for the first purpose and did not consider the second. Now it is clear that both are possible with a single instrument; the additional financing for development emerging in part indirectly because of financial market stabilisation.
I. Stablilsation: What actually happens in currency markets?
According to the ILO ["Economic Security for a Better World", 2004] there were over 90 serious financial crises between 1990 and 2002. What actually occurs during a financial crisis? Traders [those of the 30 large banks, plus a few others] are rewarded when they "chase the trend" in the jargon of the métier. They will bet in the same direction the currency is going [generally falling] so long as no market signal comes that this trend has reached its limit. As the Bank for International Settlements said in one of its mid-1990s Annual Reports, the traders display "herd behaviour". Their collective actions are self-reinforcing, but market incentive is structured so that this is their interest. These traders are not "evil speculators" but simply doing their jobs. If they do not "chase the trend", they can lose or seriously spend down the risk capital allowed them by their bank. By not chasing the trend, they at the least reduce their bonuses and at worst lose their jobs.
In other words, market destabilisation and currency "overshoot" are built into the system; markets are structured so as to produce necessarily extreme volatility, particularly where vulnerable currencies are concerned. The point is not to condemn the traders but to fix the markets to stop rewarding the behaviour they are obliged to adopt.
This built-in volatility of financial markets is the reason for what is now called the CTT or the "Tobin-Spahn" tax [for its other inventor, Professor Paul Bernd Spahn]. It combines the idea of a tax on every trade at a very low level [usually one basis point or one-tenth of one percent; 1/1000th] plus a "circuit breaker" tax at a high, punitive rate which automatically kicks in when the value of a given currency falls outside of a pre-established band [usually 2.5 to 5 % of an average based on a previous time period; Kapoor gives technical formulas for establishing such bands. The idea is like the European Monetary Serpent that preceded the euro. The mechanism is like the one that automatically stops trading on the New York Stock Exchange and other exchanges if a stock plunges more than X percent in a trading day.
Some critics have objected to a CTT on grounds that it would require universal compliance by every country in the world to make it work. This is wrong. The tax applies to the currency itself, not to the jurisdiction [territory]. A little-known institution called the Continuous Linked Settlement Bank settles FOREX [foreign exchange] transactions every day and could easily collect the tax at the point of settlement--this is a matter of a few lines of software code. Furthermore, the Central Bank issuing the currency is well aware of transactions in its own currency and all foreign banks dealing in that currency hold "nostro accounts" with the Central Bank. Not only developed countries have such systems but also countries like India, Malaysia or Chile. The Central Bank of Brazil already levies a CTT on trades that include reals. A Central Bank's decision to tax all trades in its own currency [buying or selling] can be unilateral and there is no need for universality.
Tax evasion at such a low rate is not worth the potential costs--a Bank would certainly not risk losing its Charter in any country for such a paltry amount of money.
II. Financing for development
Financial market instability acts as a huge tax on investment, trade and development. The ILO estimates that such crises have resulted in 10 million more unemployed, including half a million in the United States, because trade is penalised. Crises lead to high interest rates, often imposed by the IMF or simply applied because governments are trying to protect and make their currencies more attractive. High interest rates raise costs for business and discourage the housing market. In the case of financial trading and "portfolio equity investment" the market does not allocate efficiently. During the crises of the late 1990s, Southeast Asia's growth rates plunged from an average of +7 percent to -10 percent .
Who would win with a CTT? First off, the tax itself [at one basis point] could raise directly about $10-15 billion a year for development, an amount easily accommodated by the banks [the CTT is a tax on volume, not on profits]. This could be allocated for development purposes through the UN or some newly created specialised agency as is already the case for the airplane ticket tax.
Indirectly, however, developing country governments would profit enormously. For example, the government of Brazil holds $50 billion in FOREX reserves because it must guard against a repetition of financial crisis. These reserves are placed in low-yield OECD government bonds which bring in perhaps $ 1 billion a year, whereas Brazil is paying back interest on its debts at about 13%. By holding its FOREX reserves and not placing them in more lucrative instruments or investing them in health, education, etc. Brazil is forgoing [according to some calculations] about 1 percent of its annual GDP. Worldwide, developing countries hold at least $1500 billion in FOREX reserves which could be reduced by at least half if a tax guaranteeing greater stability were in place. This reduced volatility would allow greater investment in health, education, etc.
More jobs would be created and governments would enjoy a broader tax base. Business is also "taxed" because of uncertainty regarding currencies: for example, businesses in the developed world now have to hedge against currency volatility losses which increase the costs of investing abroad. Toyota spends about $250 million a year on hedging and several mining companies which did not hedge have sustained large losses. Business would also pay lower interest rates.
Arguably, even the Banks would gain. Their profits on CTs would probably be reduced but they could make up for that because there would be more Foreign Direct Investment and more business borrowing.
Belgium has already passed well-thought out Tobin-Spahn CTT legislation which could be used as a template by other countries, especially European countries, wishing to do the same. The Landau Commission and the subsequent decision by the French and other governments to launch an airplane ticket tax shows that international taxation is possible. President Chirac's "thank-you" letter to the French Attac economist who participated in the Commission pointed out that it was now established that a CTT was "economically rational and technically feasible". The endorsement by over 100 heads of State and government of the idea of a CTT, presented by the French, Spanish, Brazilian and Chilean governments at the UN Special Session in September 2004, shows that this idea is now well beyond the category of utopias.
At least two large problems remain. One is that the United States would probably refuse to join, but the impact of its decision would be limited because American banks would have to pay the tax on buying/selling say, the Euro or the pound anyway. The European Central Bank with its totally independent status might see the measure as an obstacle to "free and undistorted competition" which was omnipresent in the European Constitutional Treaty. Various articles in the ECT would have made the CTT unconstitutional; this was one of the reasons it was opposed by Attac and other NGOs. However, the Eurogroup of Finance Ministers could make a decision on their own to levy a tax on euro-trades.
The direct and indirect returns for North and South, business and ordinary people would be considerable. This is one measure which is virtually costless, a Win/Win situation for everyone.