The global financial crisis has reopened the debate on the relevance and effectiveness of a Tobin tax on global capital flows. It is now argued that the ill effects of volatility and the risks of volatility are inherent to all financial markets and not currency markets alone.
Lord Turner of the UK noted that several parts of the financial sector growth are in excess of socially desirable levels. Some developing countries have found it necessary to moderate capital flows through use of several instruments, of which a Tobin tax is one of the measures undertaken.
The main arguments of those who oppose taxes, such as the Tobin tax, are based on non-feasibility and sometimes acceptance, even as a temporary measure to get over the crisis.
It is sometimes argued that measures such as the Tobin tax are not effective over the long run, but may be useful in the context of a crisis. The objective of the Tobin tax is clearly to prevent the eruption of volatility and, therefore, to argue that it should not be taken up before the event is somewhat surprising.
It will be useful to briefly review the experience in regard to such taxes, or measures that have the effect of such a tax.
A quick review of the literature available on the subject leads to some very general observations: (a) The experience of Thailand has not been very positive in terms of realizing the objectives. However, it may be argued that adequate determination of public policy to implement the measures to curtail inflows including a tax was not evident. In any case, the possible volatility in the absence of such measures is difficult to assess.
(b) In Columbia, the capital controls reduced external borrowings, but the overall impact is not clear.
(c) In Chile, there have been a reduction of short-term flows and some injunction of stability, and to that extent, the taxes may be considered partially effective. However, quasi-fiscal losses, lower investment and growth cannot be ruled out.
(d) In Malaysia, the intended results were obtained on all fronts. It is noteworthy that there was a display of determination of public policy in intervention and coordination of several policies. (e) In Brazil, it is still early to draw conclusions, but the tax appears to have achieved some of its intended results, according to the Institute of International Finance. (f) Both China and India have taken recourse to several measures that have had the effect of the Tobin tax in some ways. The empirical evidence in terms of stability and longer-term growth is noteworthy.
While it is difficult to generalize, cross-country analysis made so far seems to indicate that capital account management, in particular measures like the Tobin tax, has the effect of dampening of flows in the short run.
There is some change in the composition of flows towards the longer term. The non-financial direct investment is relatively unaffected. The longer-term implications on growth are not easy to assess.
Often, these measures had been undertaken in the context of a crisis, and it is difficult to judge the position if these actions had not been taken. In brief, there is no evidence of serious downside risks of capital account management and recourse to the Tobin tax.
It may be useful to review, in this context, the variety of taxes on transactions in financial sector that are in place at the moment.
These taxes vary between different countries. An examination of these taxes would show that distortion effects of such taxes on efficiency of financial sector or profitability of financial sector should not be assumed. Stamp duties are outdated, but they are not inconceivable. In many countries, there are financial transaction taxes (including on repos, swaps, etc.), and there are also turnover taxes on financial institutions. —