An Idea that Gained Currency but Lost Clarity

More than 30 years after I first explored the idea of a levy on cross-border currency speculation, the "Tobin tax" is gaining popularity. In Europe, France's Lionel Jospin and Germany's Gerhard Schroder have both expressed enthusiasm; so, too, have various critics of globalisation. Of course, there are no such transactions within the eurozone. But it may be time to recall the origins of the proposal and the uses to which, I believe, it should properly be put.

In 1971 I gave the Janeway lectures at Princeton.* My subject was macroeconomic policy, in which my long-time academic interest had been deepened by service on President J.F. Kennedy's Council of Economic Advisers 10 years earlier. The early 1970s were troubled times for the US dollar and currency markets were becoming crucial for policymakers everywhere. In my lectures, I found myself giving much more attention to foreign payments balances and exchange rates than had seemed necessary in America in 1961.

The Bretton Woods system of exchange rates had collapsed after the US withdrawal. As financiers and economists surveyed the wreckage, they mainly debated whether to restore fixed exchange rates or settle for market-floating rates. I thought the difference was exaggerated, because fixed rates were not really fixed. They were "adjustable pegs", vulnerable to change when central banks lost reserves because of trade deficits or speculative runs. The International Monetary Fund still allowed exchange controls of capital outflows but these defences were crumbling. Private claims on central banks' reserves were multiplying much faster than these reserves and IMF resources. Advances in communications and calculations were making worldwide financial transactions fast and easy for anyone anywhere at any time. And in 1971 all this was just beginning.

Why not a single world currency, unadjustable pegs, world currency union for ever, the euro writ large? Very desirable, I thought, but not feasible, then or now, given the heterogeneity of nations. We cannot even yet be sure of the euro. Argentina today is a frightening object lesson.

In 1971 I thought the issue of international monetary reform was not a question of fixed versus floating rates but of how to impart reasonable stability to market exchange rates. I remembered Keynes's interest, after the 1929 stock crash, in a turnover tax to "marry" investors to their assets. He was thinking of US speculators; his countrymen, he thought, were sufficiently sobered by the London Stock Exchange's own turnover charge.

My principal objective has been to preserve some measure of national monetary autonomy. Market arbitrage and speculation tend to keep money-market interest rates (risk-adjusted) the same in every currency throughout the world, preventing a central bank from adjusting its monetary policy to its local economy. But if such arbitrage and speculation require repeated taxed transactions, one nation's interest rate can differ from those in New York or Tokyo.

A tax of 0.05 per cent is negligible for a one-time transfer but, if paid once a week, it cuts 2.5 percentage points off the annual rate of return and much more off the yield of day trading. The buffer, 2.5 percentage points in the example, provides the central bank with some room to move its own short-term interest rate.

Briefly described in the Janeway lectures, then elaborated in 1978, my proposal was mainly ignored for many years but was the subject of a scholarly symposium at the United Nations Development Programme in 1995.** Still ignored in the US, the Tobin tax is in Europe now the focus of reform and protest movements. I have had nothing to do with them and am not informed of their platforms.

This disavowal does not mean I disavow my own proposal. I certainly do not. I cannot control the use of the words "Tobin tax". While I assume that most advocates mean well, I deplore the tactics of some extremists.

I am, like most economists, in favour of free trade and I welcome developmental capital investment in poor countries, both private and public. I regard the World Bank and the IMF as essential institutions; while critical of some of their policies and actions, I favour expanding their resources and functions. Ideally, the IMF could be the instrument for administering the transactions tax.

I do understand that a transactions tax impairs liquidity and that the tax would have to be paid on the stabilising transactions of fundamentalists as well as the destabilising trans-actions of speculators. The virtue of the tax is that it hits the most frequent transactors hardest. (The foreign exchange market does involve frequent technical trades among banker-dealers. They should not be taxed on each transfer but on net changes in positions over a period of time, maybe a week.)

To ward off tax havens, the tax would have to be levied in most nations where currency exchanges are significant banking business. A further defence would be for jurisdictions with the tax to define as taxable any transfer of funds to non-tax jurisdictions, even within the same bank.

Contrary to suspicions raised by Senators Jesse Helms and Bob Dole in election year 1996, I was not advocating UN taxes. I would expect each national government to levy and collect the agreed tax by its regular procedures and to decide for itself what to do with the revenues, which might provide inducements to participate. From the beginning I suggested that revenues from multinational taxes might appropriately be used for international purposes such as World Bank activities. But this was never my primary purpose; indeed I aimed to diminish the volume of taxable transactions. But revenue may be the Tobin tax's principal attraction for its enthusiasts, along with the mistaken notion that it somehow would be a blow against the alleged evils of globalisation.

* The New Economics: One Decade Older (Princeton University Press, 1974).

** The Tobin Tax (Haq, Kaul, and Grunberg eds. Oxford Press 1996).