Australia needs a Tobin tax

See the latest Australian dollar analysis here:

Hodlers pounded

But I see offhand no other way to prevent financial transactions disguised as trade – James Tobin

In 1972, after the collapse of the Bretton Woods system (where currencies were pegged to the USD, which itself was backed by gold), economist James Tobin proposed a tax on the currency exchange. As he says:

The tax on foreign exchange transactions was devised to cushion exchange rate fluctuations. The idea is very simple: at each exchange of a currency into another a small tax would be levied – let’s say, 0.5% of the volume of the transaction. This dissuades speculators as many investors invest their money in foreign exchange on a very short-term basis. If this money is suddenly withdrawn, countries have to drastically increase interest rates for their currency to still be attractive. But high interest is often disastrous for a national economy, as the nineties’ crises in Mexico, Southeast Asia and Russia have proven. My tax would return some margin of manoeuvre to issuing banks in small countries and would be a measure of opposition to the dictate of the financial markets.

A 1978 article where Tobin reflects on global monetary reform is here, and well worth a read. The relevance to Australia in 2011 is quite clear when he says:

National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exchanges, without real hardship and without significant sacrifice of the objective of national economic policy with respect to employment, output and inflation.

Given that volatility of the Aussie dollar over the past four years or so due to the surge of funds in and out of the currency, this seems a particularly opportune time to consider such a proposal.

While Tobin originally suggested that all countries cooperate to implement a standard tax rate, with revenues raised pooled centrally, the idea is equally valid for a single currency-issuing nation to tax conversions of its own currency.

The logic behind the tax is quite sound. An influx of foreign funds only provides domestic benefits when it backs real investment in productive enterprise. And investing in a real business takes time. As Canadian economist Rodney Schmidt noted in 1994:

In two-thirds of all the outright forward and [currency] swap transactions, the money moved into another currency for fewer than seven days. In only 1 per cent did the money stay for as long as one year.

A currency exchange tax reduces the gains from short term currency trades, and for a single country, allows them to reduce distortionary taxes elsewhere in the economy leading to productivity benefits. It also means there is a strong incentive for national savings to be invested locally, and a cost to banks seeking offshore funding to support their capital requirements. It also provides local governments some degree of control over their economy, rather than being at the mercy of global conditions. These are all good things.

Of course, like any tax, the risk is that governments simply spend this extra revenue unproductively and do not reduce distortionary taxes elsewhere in the economy, which greatly reduces its potential benefits.

In 2009 Brazil implemented a similar financial transaction tax regime that applies to foreign investment in stocks and fixed-income securities at a rate of 2%. And it seemed to work:

Brazil’s currency and stocks fell sharply yesterday after the government imposed a 2 per cent tax on foreign portfolio investments to stem the rapid rise of its exchange rate.

But only for a while. The chart below shows the Real regained its strength fairly quickly.

(This is not to be confused with Brazil’s former Contribuição Provisória sobre Movimentação ou Transmissão de Valores e de Créditos e Direitos de Natureza Financeira, or CPMF, which was a transaction tax levied at 0.038% on all bank transactions from 1993 till the end of 2007)

Of course the empirical macroeconomic problem arises once again here – would the Real have been even stronger if not for the tax? Who knows? My gut feeling is that because economic agents adapt very quickly to new taxes, their offsetting behaviour can greatly reduce the intended effect.

Since that time, the global battle to devalue domestic currency has resulted in many calls to implement Tobin taxes, from the British Prime Minister to the French President, with all political leaders seeking input from the IMF. The IMF is now coming around to the idea (recently releasing this working paper), and Christine Lagarde being a fan, chances have improved that this tax will be supported globally.

There is even strong support from the economics profession, with 1000 economists writing a letter in support of the idea earlier this year. A good summary of the breadth of support (and not) for such a tax is here. Even economists at the Australian Treasury are talking about it.

The cynic in me says that such a tax is unlikely because those who benefit from fast and cheap currency exchange are those with the most money, while those who bear the burden of a high domestic currency are usually the workers in marginally competitive industries.

For Australia I see only upsides to this tax. A lower Australian dollar and reduced foreign investment will help to slowly rebalance our economy to become more diversified and stable.  Australia also has an agenda for tax reform outlined in the Henry Tax Reivew  to accompany the introduction of a Tobin tax (the review noted the many submissions suggesting a Tobin tax, it was not one of the final recommendations).

However, the outcome of this political battle with the global financial elite is anyone’s guess.

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  1. I wouldn’t draw any conclusions from the USD/BRL chart. The USD/AUD chart looks remarkably similar from 2008 onwards, including a peak in 2009 at the same time, not due to anything that happened in Australia or Brazil, but due to the common denominator of USD fluctuations.

    We are a flea on the elephants back, along for the ride.

    Almost as an aside, if I see 1000 people signing up to something, I know straight away that they are following the crowd, hanging with their mates, and that few if any are actually thinking about what they are signing up to. So I don’t view 1000 economists signing up in support of a Tobin tax as a strong argument that we need one.

      • ps. Of course, the USD looks to have turned the corner in recent weeks, with good odds it’ll be strengthening in coming months, so the game has changed. I can see a time not too far away when the 1000 economists are petitioning the RBA to support the ailing Aussie dollar.

        • I hope you’re right, but I doubt it. Although I too see a big jump coming for the $US, barring a total breakup of the euro the next up cycle will still see $US weakness and Aussie above parity. Not until China slows or commodity supply overwhelms the financialisers will the Aussie fall for good.

        • +1 🙂

          To me the problem is not that the level of the currency, but the fluctuations. How can real business adapt when the currency moves in a 50% range over 3 years?

          The tax should dampen this movement in both directions.

          But the Real has also weakened against the AUD in the past year, so perhaps there is something to it.

          • I agree that the high and potentially wildly fluctuating Aussie dollar is a huge problem for business, if they don’t hedge. So, hedge.

            While the tax would dampen short-term volatility (day to day), I don’t think it would reduce the size of larger trends.

            We are part of the global economy, a small player. The USD is behind the wheel of the car, we’d best accept that and put our efforts in to changing the things that we do have the power to change. The behaviour of the USD is not one of those things.

          • Agree with AC…you cant introduce taxes and regulations to stablise every factor that affects the business dealings of your exporters…they need to prepare themselves for these wild swings.

          • It been reported that more traders are moving from equities to FX trading so a Tobin tax would act like a futures margin hike to reduce speculation.

            One other thing Cameron, in Brazil all foreign transactions have to go through Banco Central do Brasil.


            I know a company who just invested in Brazil, and the process is not easy and time consuming. I don’t know if it’s intentional, but this slows the flow of capital which is also a deterrent IMO to the carry trade.

          • I’m not sure it is that easy AC.

            Say two business are in the game of importing a good. One hedges the currency, the other doesn’t. The one business hedging incurs a transaction cost the other does not, and if the currency moves the right way, this non-hedging company can use its short term luck to wipe out the opposition (potentially domestic competitors).

            Yet when the currency moves the other way, the remaining hedging companies win and wipe out the risk taking non-hedging guy.

            There are competitive dynamics at play as well. A more stable currency provides a level playing field prosper without competing on the willingness to take risk on the FX markets.

          • Agreed, hedging introduces new risks.
            I don’t think the tax will result in a more stable currency. You may get less day to day volatility, but the larger swings and trends lasting months and years, will not be reduced much at all.
            Also I am horrified at the thought of a new tax giving the World’s Best Treasurer more revenue to misuse 😉

          • “the larger swings and trends lasting months and years, will not be reduced much at all.”

            We now have a natural experiment in Brazil, so we may very well find out in the coming months (given we both expect big currency swings globally in the near future).

            Yes, I too am horrifed by a new tax, which I why I tried to repeatedly mention that it is effective only if taxes elsewhere are reduced (although that might make Australia a more attractive place to invest? Oh oh).

          • Yep it’ll be an interesting to keep an eye on the relative performance and volatility of the two currencies going forward.
            All that I have said is conjecture, am happy to let the market be the arbiter. It’s humbled me many many times before…

  2. Some questions, i’m new to all this.

    Would a drop the $OZ affect our “worlds best” from achieving a balanced budget as he has factored in about $1.06 (i believe)? Cost of debt may increase but on the other hand plenty of revenue for the govt.

    would it have an impact on short term inflation? costs increase as the speculators bail and $ drops from the sky.

    Would the RBA be exempt? After all they trade quite a bit to hold the $OZ dont they?

    As you say it may make us more competitive in areas where we have failed like manufacturing over the last few years and may increase employment in these areas. this would take time though would’t it?

  3. Can someone please tell me the purpose of the Henry Tax review?

    From what I have heard it appears to be a lot of very good suggestions for tax reform that have been ignored.

  4. It will be difficult to impose a tax on currency exchange, as most trades takes place outside Australia’s jurisdiction. Furthermore, It makes no sense to impose a Tobin tax when the Australian government goes to New York begging international investors to buy Aussie bonds.

    It’s more efficient to put a tax on debt, payable by the bank and finance companies offering the loan. The rate will be determined by leverage and income ratio, and a loans with 95% LVR taking up 40% of disposable income will have a tax rate over 100%. The ultimate effect will be the same as the Tobin tax, because the money eventually enters the Australian system as debt.

    • I don’t think it would be that difficult to implement, if the government was committed to it. Have a read here (starting p101)

      But you are right. This is not on the agenda for the current government, and I have heard nothing to say that the opposition has a different agenda.

      I also like your idea of a tax on debt, which would go some way to offsetting the seniorage tax from creating new money

      But I don’t think it will have an impact on the value of the currency, given that the trade in currency is on existing dollars.

    • I really like the idea of a tax on debt. One suitably high enough would reduce the carry trade to zero and people would only be buying the AUD to invest directly. This would also squeeze the banks who are arguably bigger than they should be.

    • A Tobin Tax would be a tax on symptoms, not causes. The causes of the GFC were excessive and dubiously-rated debt, focussed in the property market, and the sudden realisation that the security underlying that debt was illusory.

      More balanced taxation of property and capital gains would be more appropriate, perhaps coupled with better measurement and regulation of total credit growth including securitisation.

  5. I’ll back you up on this, Cameron. Tobin taxes are another good idea that is not adopted thanks to the pressures of vested interests. Land taxes are a similar example.
    So is the example of the vested interests that oppose genuine free markets in land.

  6. I believe a Tobin tax is required but as part of an overall tax reform package including re arranging the Fiscal arrangements with the states.

    I would love to see Tassie turned into an Australian Isle of Man and have the Tobin tax hit as all the money poured into Tassie. Low corparate tax rates for manufacturers.

  7. It depends what the Tobin tax is trying to achieve.

    If it is to be used as a tool to stabilize the exchange rates (as Tobin suggested), I think it has to be implemented globally (otherwise some exchanges will be tax havens).

    If it is to raise revenue. Wouldn’t it be easier just to tax the speculators directly (instead of the indivdual transactions)?

  8. I think a lot of the people here want what is best for Australia and out future prosperity. While I think there are better ways to achieve this (i.e limit foreign borrowings for example) I do think anything that makes Australia better off should be implemented. At the very least this would allow the public some of the proceeds of financial speculation.

  9. We have to be able to implement fiscal and monetary policy that fits our aims as a nation.
    For example, we should run positive real after-tax interest rates. I expect the hordes will descend on that one…but..suppose that is what we decide. At the moment we cannot implement such a policy because the carry trade, with the US running seriously negative interest rates, would kill every industry we have.

    There is nothing worse than the system under which we are now currently operating…NOTHING!

  10. We also need this for stock market transactions…. return the market to “investment” rather than “speculation”. All market participants should pay the same commission rates.

  11. Dear MB’ers, has it occurred to you that the migration of the
    exchange of EVERYTHING under the sun (except labor) to be
    priced in the SPOT market, where it fluctuates nanosecond by
    nanosecond on exchanges, in alleged response to the ever
    changing “conditions” which affect the price, is the cause of
    the VERY PROFITABLE need for hedging (profitable for the seller,
    not the buyer, and passed on as a cost to the ultimate buyer).
    It is this post 1971 continuous 24/7 markets in everything for
    everything which has brought us these vast “capital”migrations
    which so destabilize the world economy. The flows have little
    to do with investment, and everything to do with gambling.

    • I think it probably has occurred to most of us. Tobin taxes would dampen this down, and force it to contribute to the public good, in so far as the gambling was continued.