Two economists at the influential and respected Institute of Development Studies have just published a systematic review of  the evidence for and against financial transaction taxes (FTTs). They find “no reason to believe” that a FTT would be “significantly worse than most alternatives, nor that it would be any more difficult to collect”.
Neil McCulloch and Grazia Pacillo’s systematic review of financial transaction taxation provides important answers to four key questions: will it destabilise markets; is it feasible; how much money would it generate; and who will pay for it? It’s an easy and accessible read, making it an essential resource for supporters of campaigns such as the Robin Hood tax. So what does the literature tell us?

What is the effect of FTT on financial market volatility?
Not a particularly reassuring start as the authors conclude: “Although some theoretical models suggest that FTTs reduce volatility, most empirical evidence shows that higher transaction costs are actually associated with more, rather than less, volatility”. Of course, the devil is in the detail, and the important factor here is the amount of tax being proposed.  There aren’t many examples of transaction taxes, but the one the authors cite (in Sweden) imposed much higher tax (2%) than that proposed by the Robin Hood tax (0.05%). If a Tobin Tax style FTT were imposed – and the authors suggest a 0.005% tax (less than the 0.05% proposed by Robin Hood) – then the authors can find no evidence to suggest that it would destabilise markets. Indeed, a redesigned Tobin Tax could even have a stabilising effect.

Is it feasible?

Two points here: international agreement and flexible tax rates. To be feasible, a FTT would have to be applied across different instruments and adopted by all the main financial centres (otherwise traders will migrate to those that don’t tax). There is disagreement about whether the tax should be levied at point of trade (POT) or point of settlement (POS). If at POT  ”most authors…concur that an international agreement would be necessary to prevent migration to non-compliant jurisdictions”; if POS, implementation at national – but more feasible regional such as the EU – without international agreement would be possible. Because of associated costs, there would have to be different rates of tax for different markets (less for currency transactions, more for equity and OTC). The authors conclusion is reassuring:

“there is a clear sense that the significant shift towards centralisation in the foreign exchange market and the widespread use of common messaging and clearing systems means that a Tobin tax could be successfully implemented”.

How much money will it raise?

The authors calculate that a 0.005% tax (note that the Robin Hood campaign is proposing a 0.05% tax) on foreign exchanges would generate $25bn globally per annum. If you include derivates, it goes up to $250, and if you add over the counter transactions (much harder to implement) the total could potentially soar to $800bn. Caution is needed here, as the authors argue: “considerable care needs to be take in the design of the tax to minimise avoidance opportunities, and tax authorities would need to monitor avoidance and modify or supplement measures as appropriate”

Who will pay?
It seems from the review that there is very little evidence to help us know who would pay for the tax. The short answer is: initially traders then the costs would be passed on to consumers. Nevertheless, the authors conclude:

“Nonetheless, even assuming that the tax is ultimately passed on in the form of lower returns and a higher cost of capital, this will have a disproportionately large impact on the owners of capital. Since the distribution of capital is significantly more unequal than the distribution of income, it would seem likely that the medium-run incidence of the tax is no worse, and quite possibly significantly more progressive, than other forms of taxation”

So what are the take home messages for campaigners and supporters of a Robin Hood or Tobin tax?
• Evidence does not support the argument that a FTT would increase volatility, but it is essential to get the tax rate right;
• FTT is feasible if all the major financial centres are on board and the tax rate is flexible;
• The potential sums generated are huge – at least $25bn per annum globally and potentially up to $800bn
• The tax is progressive (costs are likely to be met by wealthier consumers)

Overall, the authors surprise themselves with an optimistic conclusion:

“The incidence of an FTT would not be as progressive as its proponents claim, but we have no reason to believe that it would be significantly worse than most alternatives, nor that it would be any more difficult to collect. In short, we conclude that, somewhat contrary to our initial instincts, a financial transaction tax may not be such a bad idea after all”

Andrew Harmer

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