Sam Bowman is Head of Research at the Adam Smith Institute.
Nobody likes to shoot the messenger more than a politician. As Europe’s economies disintegrate, markets are often blamed for creating “volatility”, and are a convenient scapegoat for political failures. The EU-wide Tobin tax announced this week by Angela Merkel and Nicolas Sarkozy is intended to reduce such “market volatility”. As our new paper on the Tobin tax argues, it may have the opposite effect. And, if introduced in Britain, it could cripple Britain’s financial sector.
The report – The Tobin Tax: Reason or Treason? (pdf) – argues that the Tobin tax is an immature idea that has not worked in the past, would not raise revenues, would hurt the UK’s financial sector and could actually increase market volatility. The report looks at the economic case for the Tobin tax, and the only example of a “pure” Tobin tax being implemented in a developed country – Sweden, in the 1980s. In both cases, the arguments for such a tax are shown to be deeply flawed.
A Tobin tax is a small tax, usually between 0.1% and 0.5%, on all spot conversions from one currency into another. It was invented by Cambridge economist James Tobin, who argued that such tax would reduce market volatility by reducing the number of currency exchanges that could be made. This, he thought, would make markets less sensitive and reduce the number of fluctuations that take place. The idea has been seized upon by the “Robin Hood Tax” movement, which claims that a small spot tax on all financial transactions would raise billions of pounds in revenue.
Tobin’s hypothesis was incorrect. No cross-study empirical case has been made that shows a causal link between an increase in transaction costs and a reduction in market volatility. In fact, the opposite is often the case. Tobin taxes can increase volatility by making it too costly for traders to make small adjustments in currency values to reflect small changes in market fundamentals, deferring the change until one very large transaction has to be made. In this case, the market swings will be even bigger and more difficult to anticipate than before.
Serious advocates of a Tobin tax do not claim that it will raise much revenue. However, the Robin Hood Tax campaign is not a serious organization. Its projections come from looking at the total volume of trading that takes place. If, say, £1m is traded back and forth one hundred times, the volume of trade is one hundred million pounds. To look at this and suppose that the taxable amount of wealth is one hundred million pounds is, frankly, economically illiterate. A campaign based on this misunderstanding of simple economics cannot be taken seriously. James Tobin himself rejected the idea that a transaction tax could raise revenues.
As the only developed country to have introduced a Tobin tax, the Swedish experience is critically important to assessing its efficacy. The tax raised one thirtieth of the proceeds predicted and provoked an exodus of financial activity from Sweden. By 1990, six years after the tax’s introduction, 60% of the trading volume for the top 11 most traded Swedish stocks and trading for 50% of Swedish equities had moved to London. Sweden’s experience with the Tobin tax was an unequivocal failure, and by 1991 it was reversed altogether.
A Tobin tax in Britain would hurt the City and increase market volatility. If, as some European leaders are now discussing, Merkel and Sarkozy’s proposals are extended to all EU countries, rather than just eurozone states, London must oppose it at all costs. To bring in a tax that is as countereffective and costly as the Tobin tax would only make Europe’s economic nightmare worse.
Perversely, a eurozone-only Tobin tax might be relatively good for Britain, as it would drive trading volumes away from the eurozone states to the City. But this is akin to winning a race because your opponent’s car has exploded. There’s no zero-sum game here. To quote the great French diplomat Talleyrand: a Tobin tax would be worse than a crime – it would be a blunder.