Dr Patrick Nolan, Chief Economist, Reform
Earlier this year a coalition of domestic charities, aid agencies, unions, faith organisations and green groups proposed a global tax on financial transactions to help “fight poverty, protect public services and tackle climate change.” The extensive marketing campaign behind this proposal lacked a serious discussion of the merits or otherwise of the tax and was described by the economist Tim Harford as “evidence-free policy-making.” In the almost 40 years since a Tobin tax was first proposed this idea has never gotten off the ground. The reason for this is simple – arguments in favour of it are little more than a fairytale.
More recent commentary has suggested that a Robin Hood Tax on foreign exchange (collecting £17.6 billion world-wide (£7.7 billion from the UK) rather than the £250 billion hoped for in the earlier marketing campaign) could be viable. This is based on work by Neil McCullock and Grazia Pacillo of the Institute of Development Studies on whether a financial transaction tax is a good idea – although this is a question they do not directly answer (briefing, draft paper). Indeed, the evidence contained in this research does not justify, and in some cases contradicts, the policy prescription it draws (the need for a currency transaction tax on sterling). To illustrate this the key conclusions are discussed below.
- The research notes that a tax on financial transactions would not make the financial system more stable and could increase instability. This is important as stability is the major rationale for a financial transactions tax aside from raising revenue. To illustrate how volatility can increase Tim Harford has given the analogy of paying a charge when using a cash machine. If it costs more to withdraw cash then people will tend to make fewer but larger withdrawals. The amount of cash they hold will vary more widely and volatility will increase.
- The research highlights that the costs of the tax (the economic incidence) will not be limited to wealthy participants (some bankers) in financial markets (who may face the legal incidence). As economists know some agents will pass the higher costs of taxes onto their customers through higher prices or charges. Agents who cannot pass the costs on will end up paying the taxes and these agents will be likely to be smaller businesses rather than larger ones.
- The research notes that changes in the ways in which transactions are settled mean that it could be technically possible (although presumably not without associated monitoring and compliance costs) to levy a tax on some foreign exchange transactions. This research also notes that this means that the UK could conceivably go it alone and introduce a tax unilaterally. Yet being technically possible does not necessarily make something a good idea.
- As the research also notes the tax could be collected on a national basis (financial institutions pay the tax in their home country on their world-wide dealings) or on a market basis (taxes are paid on transactions in the countries in which they take place). Unilaterally introducing a tax on a market basis encourages the creation of tax havens and firms to migrate to these places. Unilateral introduction on a national basis disadvantages home country financial institutions relative to their competitors in other countries.
The authors of this research then argue that the UK government should design and implement a currency transaction tax on sterling. But such a prescription too heavily discounts concerns over the loss of competitiveness of the financial sector (and the possibility that firms will change their home country), the damage done to (particularly smaller) exporting firms and any increase in volatility in financial markets.
For example, as I noted in a post on this issue earlier this year, many currency transactions are for “insurance purposes,” such as exporting firms hedging against possible movements in exchange rates between the time a contract is agreed and the time when they finally get paid. This tax would make this sort of insurance more expensive. This increase in costs would hold back firms’ ability to expand into new markets, to hire more staff or pay taxes on profits. As has been shown in the case of the Great Depression taking an anti-business approach to policy will weaken the business environment and delay recovery.
The proposal also fails to address the major problem facing the UK, which is the level and poor quality of government spending. There are areas of government spending where the cost of the funds that pay for them is higher than the benefits they provide. It is nonsense to suggest that the government should increase taxes to spend money on projects that do not provide value – as the costs of higher taxes are incurred without gaining anything in return. Poor quality spending needs to be cut and we need to recognise that, as Sir Roger Douglas, a former New Zealand Chancellor of the Exchequer, has argued, "If we each pretend that we can be made wealthy through taxing others, then we’re destined for poverty."