This month, Iowa’s soon to-be retired Senator Tom Harkin and Oregon Senator Peter DeFazio are planning to reintroduce their bill for a so-called Tobin tax. The Tobin tax is named after –wait for it—the economist who theorized it – James Tobin. In the 1970s, Tobin developed the idea for a transaction tax (amounting to less than 0.1%) on foreign currency to reduce currency speculation and reduce exchange-rate volatility. The concept of a Tobin tax gained favor during the Asian financial crisis of the late 1990s. And in the midst of the European debt crisis, many governments needing cash, and lots of debate of between Wall Street and Main Street, the Tobin tax is en vogue once again as way to both collect revenue and reduce high frequency trading. Eleven European Union countries have a draft to implement a Tobin tax at a rate of 0.1% on securities trades and 0.01% on derivatives trades. As comparison, the Harkin-DeFazio bill asks for only 0.03% for most trades.
There are downsides to the tax. Money market mutual funds in Europe are upset –they’d have to potentially pay the tax twice and, in this low-rate environment, that double-cost may hit them hard. Money market mutual funds are not exactly high risk, speculative trading vehicles. There are also concerns that traders will just pack up and trade somewhere else—Bloomberg cites the creation of the Eurobond market in the 1960s after the U.S. imposed the interest-equalization tax. Reuter’s blogger Felix Salmon is concerned about how well the European tax in particular will reduce speculation, since it is not much of problem there.
This tax can be structured to be hard to avoid and may collect lots of revenue. The UK collects 0.5% tax (they call it a Robin Hood tax) any time anywhere someone purchases a UK company stock. The UK has been successfully collecting this tax since 1986 and other big financial centers do the same – Hong Kong, Seoul, Mumbai, Johannesburg, and Taipei. The EU tax is expected to raise €37 billion in the initial 11 countries and up to €57 if implemented Eurozone wide. Harkin and DeFazio forecast that their proposed tax could add $352 billion in much needed revenue from now through 2021. ProPublica has a great examination of the current proposal and its potential effects.
Tax development can be tricky, but if designed correctly though, a financial transactions tax could reduce high frequency trading and be an easy way for the U.S. federal government to collect revenue.