In April 2010 I applied for the Marjorie Deane internship at the finance and economics section of the Economist in London. As part of the application I was asked to write a 500-word article of the kind that could be published in the Economist. I have reproduced it below. Though it refers to an IMF report about to be published at the time I think it is still relevant to the debate. And it did get me shortlisted for the internship!
What is seen and what is not seen
Does the Robin Hood Tax miss the bullseye?
A common reaction to the financial crisis has been to demand that banks pay for the expensive state support they have received. One option being considered by the IMF in a report to be released this weekend is a tax on financial transactions, or as campaigners call it, a Robin Hood Tax. A slick campaign backed by over 50 charities and trade unions claims more than 45,000 supporters, including George Soros, a financier, and heavyweight political leaders including Gordon Brown, Nicolas Sarkozy and Angela Merkel.
Supporters believe a tax rate averaging 0.05% could raise about $400bn. But sceptics argue that such a large amount of money could hardly be creamed off without economic consequences. Giles Wilkes, chief economist of CentreForum, a British think-tank, argues that a transaction tax would be devastating to low-margin transactions like foreign exchange trades, which would in turn reduce the amount of money the tax could raise: “It is like trying to guess what the yield from a £1-per-email tax would be.”
A more serious problem would be if the tax harmed “socially useful” trading. A recent World Bank paper points out that most foreign exchange transactions are not speculative but hedge risk or insure liquidity. Because most foreign exchange transactions usually use a “vehicle currency” like the US dollar as a step between two less frequently traded currencies, small and developing countries would face effectively double the tax rate compared with the USA or the Eurozone. This would raise additional barriers to trade and investment with already poor countries.
Supporters of the Robin Hood Tax use the UK’s 0.5% stamp duty on share trades as an example of a successful transaction tax. But a study by the Institute for Fiscal Studies (pdf), a respected non-partisan outfit, argues that stamp duty leads to lower levels of investment than a corporation tax raising the same revenue because it penalises marginal investment projects.
Though the stated aim of the Robin Hood Tax is to raise revenue, many also hope that it will penalise speculation. Supporters argue this can be achieved without passing on costs to customers. Sony Kapoor, who runs Re-Define, a development think-tank, argues that (pdf) “the financial sector has ample capacity to absorb a significant proportion of the transaction tax through a combination of lower profits and lower compensation to employees.” But according to the World Bank paper, “Market-makers would change their method of handling risk in any of a variety of ways that would sharply reduce the volume and total value of transactions.” Because market-makers use frequent trading to reduce their exposure to risk, their most likely response to falling volumes would be wider spreads. If the Robin Hood Tax had that effect, its burden would fall on pension funds and other wholesome investors as well as on high-frequency traders, while an oligopoly of investment banks would continue to make large profits. Perhaps not what Robin was aiming for after all.
As it turned out the “Strictly Confidential” IMF report (pdf) was leaked the day after I had sent in my article. It argued against adopting financial transaction taxes, instead advocating a Financial Activites Tax or balance sheet levies.
P.S. If you’re wondering about the title of my article, it’s the title of a famous pamphlet by Frédéric Bastiat, in which he argues that it is important to consider all of the economic consequences of an action (like breaking a window or introducing a tariff), not just the obvious ones. A lesson that some of today’s economic policymakers seem to have forgotten.
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