Europe's misguided enthusiasm for a Tobin-tax remedy

A 40-year-old idea, the Tobin tax, is not what Europe needs to get back on full financial footing, writes Barry Eichengreen.

A protester holds a banner which reads "No to the Tobin tax in the Euro zone. FDP policy for 1.8 per cent" during a rally. Fabrizio Bensch / Reuters

At last, European leaders have revealed their top-secret plan for solving the euro's crisis - a version of the "Tobin tax", a levy on financial transactions first suggested in 1972 by the Nobel-laureate economist James Tobin.

Now, 40 years later, the European Commission has proposed - and Nicolas Sarkozy, the French president, and Angela Merkel, the German chancellor, have endorsed - a turnover tax on all financial transactions, varying from 0.1 per cent on stocks to 0.01 per cent on financial derivatives such as futures and credit-default swaps. If the tax cannot be imposed globally or even Europe-wide, France and Germany will go it alone.

But how a tax on financial transactions would help to cure Europe's ills is unclear. According to the European Commission's own estimates, it would raise only about €50 billion (Dh241.97bn) a year, even if imposed throughout the EU. This is a pittance compared with the euro zone's debts and deficits, and it would fall far short of funding Europe's permanent rescue facility, the European Stability Mechanism, which is supposed to be capitalised to the tune of €500bn.

Moreover, the commission's €50bn estimate surely overstates the prospective receipts. If France imposes the tax unilaterally, trading in equities and derivatives will simply migrate to Frankfurt. If it is limited to the euro zone, transactions will move to London. And if it is adopted by all EU member states - a fanciful scenario, given British resistance - the market will simply migrate to New York and Singapore.

European leaders claim they can create mechanisms to ensure that their residents pay the tax, regardless of where trades are booked. But banks are widely reported to be devising instruments to enable their clients to avoid the tax. On whom would you bet - the tax authorities or the financial engineers?

If the aim is to augment revenue, a Tobin tax is the wrong tool. In fact, Tobin designed it to solve an entirely different problem: excessive volatility in currency markets. By discouraging foreign-exchange transactions, Tobin's proposal sought to promote exchange-rate stability by preventing national currencies from coming under speculative attack. The irony is that euro-zone members have no national currencies to be attacked.

European leaders sometimes extend Tobin's logic from the currency market to financial markets generally. An across-the-board tax on transactions, they argue, would dampen financial volatility.

But the logic behind this conclusion is unsound. What we know is that a tax on transactions would result in fewer transactions. Some investors would exit the market.

Maybe a Tobin tax is intended to shrink Europe's bloated financial sector. In that case, it is, once again, misdirected. Europe's problem is its banks, which are too big to be allowed to fail - and also too big to save. A Tobin tax would do nothing to shrink them.

Nor would a Tobin tax address the fact that Europe's banks are undercapitalised, or that pro-cyclical bank lending amplifies business cycles.

Forgive my naiveté, but I have begun to think that politics rather than economics explains European leaders' enthusiasm for a Tobin tax. Mr Sarkozy can pre-empt a long-standing proposal of the Socialists in the run-up to this spring's presidential election. By supporting Mr Sarkozy, Mrs Merkel can get what she really wants: French support for stronger fiscal rules. And EU leaders can claim that the financial sector is being made to contribute to the costs of Europe's financial clean-up.

Tobin would not have been pleased to see his proposal repurposed in this way. His priority was always the pursuit of full employment. One suspects he would have urged European policymakers to dispense with their silly fixation on a financial transactions tax and instead repair their broken banking systems and use all monetary and fiscal means at their disposal to jump-start economic growth.

Barry Eichengreen is a professor of economics and political science at the University of California, Berkeley

* Project Syndicate

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