It's time to take the Tobin tax seriously

Research suggests a small tax on financial transactions would work, and could raise more than $25bn annually worldwide
trader new york tobin
Traders work at the New York Stock Exchange. A 0.005% tax on financial transactions could raise billions of dollars to fund anti-poverty and climate change initiatives. Photograph: Richard Drew/AP

Campaigners for the introduction of the Tobin tax (or Robin Hood tax) should be buoyed by preliminary findings of a review I've been working on that suggests levying a small tax, maybe 0.005%, on banks' and traders' transactions could raise billions of dollars a year worldwide.

Many campaigners hope that revenue from such a tax could be used to fund global anti-poverty and climate change initiatives.

This week the full research report is launched in Brussels, where European politicians have been calling for action on this issue, ahead of the publication of the EU impact assessment of such a tax. There is already substantial support for a Tobin tax among European leaders, including Nicolas Sarkozy and Angela Merkel.

In 1978, the Nobel prize laureate in economics James Tobin proposed levying a small tax on all foreign exchange transactions to penalise short-term speculators but not long-term investors. Our research involved gathering as much of the existing evidence on such taxes as possible. Over the last 20 years theoretical models have attempted to explain how financial markets work and deduce what impact a Tobin tax could have on them.

But we did not just look at models – as we have recently discovered at great cost, real financial markets do not necessarily behave the way theoretical models say they should. There is also a wealth of real data from around the world on the impact of raising transaction costs in financial markets.

This substantial body of evidence contains good news for those campaigning for a Robin Hood tax (pdf).

These taxes are feasible. In fact, since Tobin's day they have become more so. Due to changes in the way transactions are settled, it is now much easier for countries to unilaterally introduce certain forms of transaction taxes. Indeed, lots of countries already have one in the form of stamp duty on share transactions, including the UK. It would also be possible to have a tax on transactions in your own currency, eg sterling or the euro, since central banks have control of the issuance of their own currencies.

A transaction tax would have to be applied to a broad range of areas to avoid market actors simply moving away from taxed financial instruments to untaxed ones, and tax rates themselves would have to vary depending on what instrument you are taxing.

But clearly a multilateral tax would help prevent the kind of tax avoidance we might see if it was introduced in just one country.

How much these taxes would collect depends entirely on what you tax and at what rate. But the numbers are big. We found that applying a 0.005% tax to foreign exchange markets alone might raise around $25bn per year worldwide. The revenue potential in the UK would be around $11bn (£7.6bn), roughly as much as the entire UK overseas aid budget. Applying a financial transaction tax (FTT) on other markets, for example derivatives and over the counter markets, would be more difficult but would raise much larger sums.

Some theoretical models suggest that transaction taxes reduce volatility, while most empirical evidence shows that higher transaction costs are actually associated with more rather than less volatility. But overall it appears that if these taxes were appropriately designed, they are no more likely to increase market volatility than reduce it. And there is little hard evidence to support the critics' assertion that such taxes, if well designed, will inevitably damage markets.

The pro-Tobin tax lobby claim it would be progressive, paid by the most wealthy institutions and individuals. This fits with a general mood that we would like to punish the banks for their role in the financial crisis.

Critics say the opposite is true, and that the cost would be passed on to end users in the form of higher borrowing costs. The facts suggest that wholesale traders would bear the initial cost of the tax but in the long run a significant proportion of the tax could end up being passed on to the owners of "capital".

However, given that most of us earn relatively little of our income on returns to capital (eg dividends on shares, rental income from houses, or profits from your own business), it would seem likely that a transaction tax would be more progressive than several other forms of taxation, such as VAT.

Given all of this evidence, it is surprising that a significant source of currently untapped revenue continues to be ignored by so many politicians. Commonly held assumptions that such taxes would be impossible to design and levy, and would create market distortions and damage economies are not backed up by the latest available evidence.

A Tobin tax is implementable, both at a European and national level. It isn't a panacea and won't "calm the markets", but it might make a useful contribution to public finances and to generating resources for tackling global problems such as climate change and poverty. With increasing political support for such a tax among EU leaders, it is time for policymakers and the financial sector to take these proposals far more seriously.