Fairytales like a ‘Robin Hood Tax’ won’t help anyone

By Patrick Nolan, Chief Economist, Reform

A coalition of domestic charities, aid agencies, unions, faith organisations and green groups has proposed a global tax on financial transactions to help “fight poverty, protect public services and tackle climate change”. This tax is based on an academic idea that has never worked in practice. The idea was first proposed by James Tobin, who was awarded the Swedish Bank Prize in Economic Science (Nobel Prize), but not for this.

The Tobin tax would work by charging a tax every time people exchange currencies. Some advocates believe that given the large number of currency transactions that take place every day this tax would generate almost endless revenue and reduce currency speculation, which would benefit the economy. But these views are little more than a fairytale.

In the almost 40 years since a Tobin tax was first proposed this idea that has never gotten off the ground. The reason for this is simple – it will never work. For it to work it would require every tax jurisdictions to agree on it. But the international community struggles to agree on trade talks (such as the failed Doha round) or on climate change (COP 15 in Copenhagen), so the idea that an international consensus will arise over a tax issue is hopelessly naive.

Where international tax negotiations have shown promise is in areas where there is a real prospect for success. The IMF, US, UK and other major European economies are, for example, investigating an insurance levy on banks to protect against another financial crisis, which is very different from taxing currency exchanges to fund extra public spending.

There would also be significant harm to the economy from a Tobin tax. Economic volatility would increase as currency exchange is a central part of many important activities, such as exporting. Many currency transactions are for ‘insurance purposes’, such as exporting firms ‘hedging’ against the possible movements in exchange rates between the time a contract is agreed and the time when they finally get paid. Presumably when you next take an overseas holiday you would also pay the Tobin tax when you purchase some spending money at the airport. Ordinary people and businesses will pay this tax.

Finally, an additional tax fails to address the problem of poor quality government spending. In relation to ‘fighting domestic poverty’, for example, the UK already has one of the most expensive welfare states in the developed world, but performs poorly as much money goes to people not in need (middle class welfare costs around £31 billion a year). Underperformance not underfunding is the real problem facing the welfare system and public services. Indeed, as Sir Roger Douglas, former New Zealand Chancellor of the Exchequer has argued:

"[Voters] seem to have bought the false notion that we can all be made wealthy through government. Elections have become an opportunity for politicians to promise they will take more money off you, only to give it back to you in another way – a gold card for superannuitants [pensions], a tax credit for working families, or an interest write off for students. If we each pretend that we can be made wealthy through taxing others, then we’re destined for poverty. We are increasingly relying on others – be they foreign lenders or domestic taxpayers – to sustain our way of life."

These are challenging times for the public finances in the UK and abroad. However, fairytale tax policies will do nothing to address the problems we face in the real world. We need adult thinking, not children’s bedtime stories. The advocates of the Robin Hood tax would be doing themselves, and us all, a favour if they left the fairytales at home and based their thinking on some real classics in public finance, starting with Richard and Peggy Musgrave and James M Buchanan.