What is the Tobin tax?
The Tobin Tax is a tax levied on spot currency conversions, intended to discourage short-term currency speculation, named after economist James Tobin.
Unlike a consumption tax paid by consumers, the Tobin tax is meant to apply to financial sector participants as a means of controlling the stability of a given country’s currency. It is more officially known today as the Financial Transaction Tax (FTT), or less formally the Robin Hood Tax.
Key points to remember
- The Tobin tax is a proposed fee on spot currency transactions to penalize short-term currency transactions in order to stabilize markets and discourage speculation.
- The Tobin tax can be used to generate income streams for countries that see a lot of currency movement in the short term.
- The Tobin Tax is sometimes referred to as the Robin Hood Tax, as many see it as a way for governments to levy small amounts of money on people who conduct large, short-term currency exchanges.
Understanding the Tobin tax
When the fixed exchange rates of the Breton Woods system were replaced by flexible exchange rates in 1971, there was a massive movement of funds between different currencies that threatened to destabilize the economy. In addition, the rise of short-term currency speculation encouraged by the nature of the free currency market has increased the economic costs incurred by countries trading currencies.
The Tobin tax, proposed by James Tobin in 1972, seeks to alleviate or eliminate these problems. The tax has been adopted by a number of European countries and the European Commission to discourage short-term currency speculation and stabilize currency markets.
The tax on currency transactions has no impact on long-term investments. It is imposed only on the excessive flows of money which circulate regularly between the financial markets by the action of speculators looking for high short-term interest rates. The tax is paid by banks and financial institutions that take advantage of market volatility by taking excessive short-term speculative positions in foreign exchange markets.
The Tobin tax was originally introduced by American economist James Tobin (1918-2002), who won the 1981 Nobel Prize in economics.
To function effectively, such a tax would have to be adopted internationally and be uniform, with revenues returned to developing countries, Tobin said. Although Tobin suggested a rate of 0.5%, other economists have suggested rates ranging from 0.1% to 1%. But even at low rates, if every financial transaction made around the world was subject to tax, billions in revenue could be collected.
The original intention to impose the Tobin tax has been distorted over the years by various countries implementing it. While Tobin’s proposed tax on currency exchanges was intended to curb destabilizing capital flows across borders, making it difficult for countries to implement independent monetary policies by quickly transferring money between countries with different interest rates, some countries now impose the Tobin tax as a means of generating income for economic and social development.
Example of the Tobin tax
For example, in 2013 Italy adopted the Tobin tax not because it faced exchange rate instability, but because it faced a debt crisis, an uncompetitive economy and a weak banking sector. By extending its tax on foreign exchange transactions to high frequency trading (HFT), the Italian government has sought to stabilize markets, reduce financial speculation and increase income.
The Tobin tax has been controversial since its introduction. Opponents of the tax say it would eliminate any potential profit for the foreign exchange markets as it is likely to decrease the volume of financial transactions, thereby slowing long-term global economic growth and development. Proponents say the tax would help stabilize exchange and interest rates, as central banks in many countries lack the cash in reserve that would be needed to balance a massive sell-off of currency.