Chapter 2: Instrumentation What Concept to Choose for a Tax on Foreign Exchange Transactions?

Chapter 2: Instrumentation What concept to choose for a tax on foreign exchange transactions?

Before posing the question of the feasibility of a tax on foreign exchange transactions it is necessary to clarify how the concept of the tax to be realized should look like. The Tobin tax as originally conceived is not the only option of a tax on foreign exchange transactions. Alternative proposals have been developed starting from points where the Tobin tax exhibits clear conceptual weaknesses. It is therefore necessary to clarify the question of the concept and its instrumentalization before posing the question of its operationalization and implementation. The purpose of this Chapter is to develop a basically functioning and politically feasible concept of a tax on foreign exchange transactions. This requires to first reduce the complexity that goes with the original proposal by Tobin.

» Reduction of complexity. The alledged non-feasibility of the Tobin tax is often explicated by a number of economic, legal, administrative and political complexities.

1 For an analysis of these weaknesses see in particular Spahn (1995), Shome and Stotsky (1996), Nadal-De Simone (1997), or (in German) Buch, Heinrich and Pierdzioch (2001).

» Under economic aspects, it is criti- equally to expect that there is cor- cized that the Tobin tax would responding interjurisdictional co- operation in this matter. Most of 1. produce similar inefficiencies the governments of OECD coun- as the multi-phase tax on gross tries (in particular the United transactions of commodities that States) reject the idea of a Tobin applied in the Federal Republic of tax at present. Germany before 1968. It was cen- sured to entail a cascading effect, » Under political aspects it is a to- which led to a varying tax burden tally open question who would be on final products in accordance entitled to collect the tax revenue. with the number of transactions. Tobin himself thought of interna- This must provoke organizational tional organization (IMF, World- reactions (such as the vertical in- bank, United Nations). But there tegration of processes), which un- could also be supranational or- doubtedly distorts economic deci- ganizations to be newly created, sion making; international public foundations and non-government organiza- 2. produce particularly heavy dis- tions (NGO). In principle it would tortions of this kind as long as it is also be possible to distribute the impossible to introduce the tax tax revenue onto national tax au- universally, since this would dislo- thorities, however the distribution cate parts of foreign exchange formula is likely to be highly con- markets to non-cooperating tax troversial. havens. Moreover the tax could be avoided by moving into trading Even if those questions would with other instruments such as have been resolved it is still open short-term foreign securities for which purpose such revenue (treasury bills etc.) or through for- should be used, who would be the ward and derivative trading. recipient, who would administer it, and how a legitimate democratic 3. put a one-sided burden onto and administrative mechanism for the competitiveness of the respec- controlling such institutions should tive financial centers and squeeze look like.2 If one thinks in particular worldwide liquidity trading, which of a transfer of resources toward would trigger unsolicited systemic developing countries, it is open in changes. which way these countries could » Under legal aspects it is often as- participate in the decision proc- serted (without further examina- ess.3 tion) that the tax would disagree As to legal questions, these do not fall with the idea of capital liberaliza- into the terms of reference of this tion in accordance with the Liber- study. It has to be emphasized how- alization of Capital Movements ever that the freedom of capital Code of the OECD or, in the case movements is not abolished or put in of the EU, the Maastricht Treaty.

» Under administrative aspects it is 2 reckoned that the international Patomäki (2001) argues that a global tax on community of important financial foreign exchange transactions would also centers is unlikely to cede sover- strengthen national sovereignties, and he con- ceptualizes an institutional framework for its eignty in the area of taxation and administration that aims at the democratization consent to the creation of a world of the process of globalization. tax organization, which would be 3 This question is unsatisfactory even now as reasonable for operating a univer- to the development of international financial sal and multilateral tax on foreign markets. See for instance Griffith-Jones exchange transactions. It is (2001).

Paul Bernd Spahn ® [email protected]frankfurt.de On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 13 jeopardy just because a tax is levied gitimate parliamentary institutions. on such transactions. Taxes are lev- The tax would therefore work uni- ied on various transactions of goods laterally and partially, not multilat- and services and are typically re- erally and universally. garded by economists as conforming » The same legislature that is ac- with the market. In most respects they countable for the tax will also de- are superior and to be preferred to cide on the apportionment and use other types of government interven- of the tax proceeds. It implies the tion such as capital controls, or mone- revenue to fall to a national gov- tary policy involvement of the ortho- ernment (respectively jointly to all dox type. The key question under le- governments that engage in a co- gal aspects is whether taxes are neu- ordinated effort), but under no cir- tral with regard to the competitiveness cumstances would it go to interna- of different actors in the market. 5 tional organizations. A tax on for- In the following I shall assume that eign exchange transactions to be legal problems would not emerge introduced unilaterally by the within the framework of the European European Union would be subject Union as long as certain preconditions to decisions of the European are fulfilled. This point of view is sup- Council and the European Parlia- ported by a study for the Parliamen- ment as well as national parlia- tarian Working Group “Tobin tax” of ments that would have to ratify the the European Parliament.4 law. This study asks in particular for a All proposals that go beyond such small rate of the tax on foreign ex- limitations must be considered unreal- change transactions, which „à la lu- istic, and be excluded as politically mière de ses objectifs, n’entrave pas “unfeasible” for the time being. les mouvements de paiements de In the following I shall call this limited manière déraisonnable ou dispropor- decision space “politically feasible”. In tionnée.“ This must have repercus- order to account for eventual legal sions on the fiscal objectives of the scruples, I shall also posit a much tax. They will be addressed later on. lower tax rate than was considered by Tobin and his supporters.6 » Limitations. In view of a multiplicity While I have been using the terms of unresolved political questions that „tax on foreign exchange transactions” relate to the universal and multilateral and “Tobin tax“ synonymously so far, I character of the Tobin tax, this report shall speak of a „politically feasible will confine itself to limited scenarios. Tobin tax (PFTT)“ from now on, In order to be realistic these scenarios which shuns the critical objections will have to acknowledge the follow- against a multilateral and universal ing: tax. » The tax on foreign exchange Before entering into examining eco- transactions cannot be introduced nomic and technical aspects that are universally. It is required that the important for the realization of a tax be planned by an existing au- PFTT, I shall first discuss a few vari- thority, a government or a coordi- ants of taxes on foreign exchange nating body such as the European Council, and be introduced by le- 5 This could eventually be achieved in a sec- 4 ond round via the explicit earmarking of tax The study has been prepared by Lieven A. proceeds or through budgetary decisions of Denys, professor for European tax law at the (the) parliament(s). Faculté de Droit of the Vrije Universiteit Brus- 6 sels. It dates of April 18, 2001. See also Clunies-Ross (2000).

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 14 transactions that are politically feasi- PFTT. ble and are relevant in the context of a Chile has used NNR to fend off short- PFTT. term capital inflows and to avoid artifi- cial short-term appreciations of its » Relevant variants of taxes on for- currency. At the same time the device eign exchange transactions. The was expected to secure solvability in the case of a reversal of foreign capi- following concepts are related to taxes 7 tal flows, and to deal with the pressure on foreign exchange transactions: of depreciation. 1. “Non-remunerated reserve re- It is debatable whether this strategy quirements (NRR)” on short-term for- was successful, because nobody is in eign exchange deposits. a position to say whether speculative 2. The taxation of cross-border capi- capital inflows have been successfully tal transactions with a „cross-border suppressed by the measure. The capital tax (CBCT)“. mere indication that capital inflows 3. A two-tiers „Tobin-cum-Circuit- have endured and the Chilean peso has appreciated in spite of the meas- Breaker Tax (TCCBT)“. It consists of a PFTT as a base and an „exchange- ure is not sufficient for prove. The rate normalization duty (ERND)“ that fundamental data of the Chilean responds to exchange rate volatility. economy were extraordinarily positive during that period, and the country was therefore highly attractive for non- » „Non-remunerated reserve re- speculative foreign capital regardless quirements“ (NNR)—NNR have of the NNR. Under fiscal aspects the been used in various forms as unilat- Chilean NNR were quite successful eral policy instruments, even in the however, and this in spite of the fact Federal Republic of Germany (intro- that market participants were develop- duction of a „Bardepot” for foreign ing successful strategies to evade the deposits in 1971). Spain has em- loss of interest payments. This had ployed the instrument in 1992 during repeatedly forced the central bank to the peseta crisis. The best-studied adopt new measures in order to close case appears to be the one of Chile loopholes of the system. during the 1990s8, but also Colombia9 This is not the place to discuss the and Slovenia have used the instru- experiences with NNR further. It is ment. Since a part of the inflow of however conceptually helpful to stress currencies has to be kept in the form the following points with regard to a of mandatory non-interest bearing PFTT: deposits, lost opportunity costs act like a tax. This is why the measure is » NNR concern primarily the holding of stocks, not transactions (flows), often discussed in the context of a whereby stock will of course vary in response to transactions. The 7 For further variants, that are interesting basi- comparison with a tax on foreign cally under theoretical aspects, see Spahn exchange transactions is therefore (1995, Appendix 2). strictly not fitting. 8 See for instance Nadal-De Simone and » Compared to the volume of foreign Sorsa (1999). The reserve rate in Chile was at exchange transactions, the parts first 20 percent, then 20 percent, but it has been reduced intermittently to 0 percent, of the capital balance that are sub- whereby the system has however been main- ject to the tax are significantly tained in principle. smaller. This finds its reflection in 9 The experiences with capital controls in Latin a much higher “tax rate” compared America have been discussed, inter alia, in to feasible rates of a PFTT. As- Agosin and Ffrench-Davis (1996). suming that the rate of interest for

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 15 foreign capital is 10 percent p.a. an interest rate of 10 percent p.a., and the required NRR 30 percent, a tax rate of one percent would be this would give a “tax” burden of 3 equal to 10 percent of the income percent, a significantly higher rate from an investment of one year, than the rates discussed in the but put a confiscatory 125 percent context of a PFTT. charge on income from an investment of one month.10 This renders » More important is the fact that the the approach similar to the Tobin „tax burden“ (contrary to the Tobin tax. tax) is directly (and not inversely) proportional to the holding period 2. Moreover Zee wants the CBCT of the asset. For instance a short- withholding tax to be credited term investment for one week against transactions that are not would carry a charge of 3/52 per- related to capital imports. Export- cent, while the charge would be 3 ers receive the tax credit through percent for an investment over a the value-added tax11; this is a year. This proportionality of the simple administrative procedure. charge runs counter Tobin’s con- Recipients of interest payments, ceptual idea. This is why NNR are dividends, repatriated profits etc. accompanied (also in Chile) with a would receive a reimbursement host of exceptions aimed at exon- when filing for the income tax; this erating exporters and importers as is of course more complicated in well as long-term investors. These administrative terms than in the exceptions engender substantial case of VAT credits for exporters. administrative costs, they gener- I shall refrain from a more compre- ate “loopholes”, and they are still hensive analysis of the proposed in- incapable of eliminating the sys- strument. In comparison to a PFTT temic bias of tax-burden propor- however, the following points seem be tionality for short-term investors. worth emphasizing: The speculator with an extremely short-term commitment is affected » Transnational capital movements the least, while other investors are not necessarily identical with would bear the brunt of the foreign exchange transactions. charge. They could also be settled exclusively in foreign currencies (e.g. 12 the US dollar). This renders the » The „cross-border capital tax“ CBCT similar to NRR. It is not the (CBCT)—The proposal of Zee (2000) transaction as such that is subject to tax cross-border capital flows with a to the tax, but ultimately only the CBCT has not yet been tried— (positive) variations of the net contrary to the NNR. However it fulfills capital balance, adjusted for cer- the requisites of “political feasibility” tain positions of the current bal- and is therefore an interesting alterna- ance. tive. The objective of the tax is— similarly to the NNR—to fend off capi- 10 tal imports that could become an ex- See Appendix 2 for the calculation (formula change rate risks because of their (4)). short-term nature. The CBCT avoids 11 The tax rate for exports would thus be –1 the systemic bias of the NNR. It is percent rather than 0 percent under VAT that therefore a proper transactions tax. applies the destination principle. 12 The proposal consists of two parts: Within the EMU there are even transnational capital movements that are carried out in 1. At first all private capital inflows “domestic currency” (the euro). In developing into the country a fraught with a and emerging economies it is not unusual to withholding tax. Assuming again employ the US dollar as a mean of transaction.

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 16 » The CBCT covers only capital have to pay a tax when repatriating imports, not capital exports. It their profits, but the initial import of works thus asymmetrically. The capital may have been subject to the objective is to limit capital inflows, tax. But the foreigner had of course no not to establish a “mouse trap” for possibility to credit the tax against his foreign investors. By emphasizing or her income tax.15 the destabilizing effects of capital Summarizing it can be said that the imports (and by refraining from proposal of a CBCT has a number of checking capital flight altogether), advantages compared to NRR, in par- Zee takes up an important aspect ticular because it respects the inverse that also motivated my earlier pro- relationship between the holding pe- posal of 1995 (see below).13 riod and the tax burden. In administra- » The settlement of payments (and tive terms the CBCT is however likely payments backed by borrowing) to exhibit similar complexities as the can be effected entirely outside a NRR, perhaps even more as regards currency area. They may appear the integration of the tax with the per- as changes of assets and liabilities sonal income tax. in the books of accounts of eco-

nomic agents, but never trigger any cross-border transactions.14 » The Tobin-cum-Circuit-Breaker Tax (TCCBT). My own proposal » Movements of the capital balance (Spahn 1995, 1996) can be under- are significantly smaller in volume stood to solve the basic conflict be- than the transactions (payments) tween the two objectives of a PFTT: that are targeted by the PFTT. This is explained partially by the ü Either the tax rate is too high: This fact that there may be many (li- may fend off speculators, but it exhib- quidity) transactions behind net its significant negative consequences capital movements. A CBCT will for the allocation of resources by re- only target the result in economic ducing (and even possibly eliminating) terms. It is also explained by the international liquidity trading. It is asymmetrical construction of the doubtful whether the tax would tax (there are no charges on capi- achieve the goal of exchange rate tal exports as a result of imports of stability under these circumstances, goods and services, or of income because hedging operations would transfers abroad). And finally it become more costly and pricing n-i hinges on the various exemptions formation is taken out of the market. entitling economic agents to a tax ü Or the tax rate is very low: In this credit under the CBCT. case international liquidity trading In particular the tax credits render the could continue to operate fairly unim- scheme extremely complex. For in- peded, but the tax is unlikely to deter stance foreign investors would not speculation.

13 My own proposal also aims at checking very 15 short-term capital inflows through the norma- This statement is correct only in principle, lization duty, while longer-term investments go but is more complicated in practice. Undoubt- untaxed with almost 100 percent probability. edly a tax on capital imports will not be credit- Contrary to Zee’s proposal however, my own able against foreign income tax according to approach is symmetrical in that it covers both double-taxation treaties. But one may expect capital imports and exports. the financial industry to develop products whereby the capital import tax is initially 14 Such books of account can of course be swapped onto a domestic agent (who credits kept „unofficially“ if this allows avoiding the tax the tax against income tax), and re-swapped (in particular in emerging and developing thereafter. Foreigners are thus exonerated via countries). the pricing of such swap instruments.

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 17 There are also fiscal objectives asso- foreign exchange markets), and ciated with my proposal. The idea is to this externality is charged with a avoid a contraction of the tax base tax of the Pigou-type. The aim is following the introduction of a TCCBT, to reduce the externality—similar and to bolster the revenue potential of to approaches of environmental the tax in periods of speculation. policy. The tax rate of the additional charge on the negative ex- The TCCBT consists of two integrated ternality may be very high. The parts that relate to the same tax basis, additional charge has only a regu- namely „relevant foreign exchange latory function and no fiscal objec- operations (RFXO)“, which I shall tive. On the contrary: If it achieves have to specify more precisely later its goal and holds back specula- on. tion, the charge cannot yield any 1. The first tier is a classical Tobin revenue. tax (PFTT), however with a tiny The additional charge, which I have rate. This tax rate is uniform for dubbed „exchange-rate normalization each currency pair, but it could duty (ERND)“ on another occasion eventually vary for different mar- (Spahn 1996), deserves some further kets in accordance with the size of 16 reflections on its specific features: the bid-ask spread. It is decisive that the tax rate be comparably neutral on liquidity trading. This » Which is the tax base of the tier of the TCCBT has mainly fiscal ERND? “Negative externality” has to functions, but it can also contribute be rendered operational for taxation, to stabilizing exchange rates to the and to be standardized for legal pur- extent that it eliminated destabiliz- poses. To this effect I was inspired by ing noise trading.17 the EMS (European Monetary Sys- 2. The other tier consists of an addi- tem) that was operational in the EU tional charge that is specifically from 1979 until the introduction of the tailored to discourage speculation. euro. In order to guide monetary poli- Under normal circumstances this cies, it worked with a tax is dormant, but it is triggered 1. target rate, the ECU reference automatically whenever there is 19 rate, and speculation on foreign exchange markets.18 Thereby speculation is 2. a target zone (or „corridor“).20 valued to represent a negative ex- Once the exchange rate would devi- ternality (such as a “pollution” of ate from the target zone, the central banks of the respective countries were compelled to bring the rate back 16 I shall come back to the question of the tax into the corridor by means of mone- rate, but I shall finally accept a uniform tax rate tary policies.21 in spite of varying spreads for different currency pairs.

17 See Chapter 1 and in particular the contri- 19 bution by Summers and Summers (1989). This rate corresponded to a weighted arith- metical average of 12 European currencies. 18 This process is controlled through an algo- 20 rithm within the settlement system for foreign This corridor was defined relative to the exchange, i.e. the formula pre-exists in the target rate, and was initially 2.25 percent (for form of a computer program and is recognized some currencies 6 percent), and later 15 per- by all market participants a priori. So the pric- cent. ing conditions are always known in advance. 21 An advantage of the tax is the fact that there is The system is sketched in a simplistic way no need for discretionary decisions—neither here. In fact there was an obligation for infra- on the side of legislators, nor on the side of the marginal interventions whenever the exchange actors in foreign exchange markets. rate would tend towards an intervention point, although it was still in the corridor. Moreover

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 18 I chose a similar approach to defining Different from the EMS, the target rate negative externalities that result from of the ERND is an adjustable moving speculation on foreign exchange mar- average of daily official exchange kets. It requires standardizing “specu- rates relative to a reference or anchor lation” in a technical sense. currency (such as the US dollar or the euro). The workings of the ERND are Speculation usually finds its expres- sketched in Chart 1. sion in an abrupt change of the exchange rate (see the examples in Ap- pendix 3). If there is a well-defined » How to define the corridor, the official target for the exchange rate anchor currency and the tax rate? and an equally well-defined corridor, it The EMS had defined the upper and is possible to distinguish “normal lower boundaries of the corridor in an transactions” as those that are carried ad hoc fashion, i.e. pragmatically. The out within the price corridor. These same should apply to the ERND. transactions are considered non- However the width of the corridor speculative and are exempt from the could be determined with regard to surcharge. However if there are devia- empirical data on the daily fluctuations tions from the corridor, this is consid- of the exchange rate relative to the ered to represent a negative external- target rate under normal circum- ity (i.e. “pollution”) and will be charged stances, perhaps with some safety with a Pigou tax.22 margin in order to trigger the duty not too often. These daily fluctuations the instruments of monetary policy and their could vary for different pairs of cur- coordination were regulated in a more detailed fashion. 22 exchange reserves to support the exchange This procedure could be considered ot rate, the country under speculative attack represent the „dual solution“ of the EMS that would achieve revenues with the dual scheme. operated with monetary instruments. Instead We know from environmental policies that of reacting to speculation by means of a sub- taxes and subsidies can be equivalent instru- sidy (for instance high interest rates for over- ments to cope with correcting externalities and night deposits), the dual scheme would use a a misallocation of resources. tax policy instrument. Instead of using foreign

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 19 rencies, which could lead to the con- » Must the ERND not fend off po- clusion to use different bandwidths for tential capital investors? different currency pairs. Since the The contention that the ERND would scheme operates unilaterally, this can deter potential investors—in particular be determined individually by each because of its high statutory rates— country. The same is true for the re- seems to be totally unwarranted. spective anchor currency (respectively currency basket) and the tax rate to ü On the one hand the effective tax be chosen. burden is significantly lower than the statutory rates (see previous The statutory tax rates of the ERND paragraph), although it could in- should be high, within a range of 50 to deed increase with the degree of 100 percent. deviation from the target zone.

ü On the other hand will the ERND » Isn’t a tax rate of 100 percent con- be activated only in those in- fiscatory? stances when the exchange rate wreaks havoc. This is an eventual- It is important to realize that the tax ity whose probability is extremely rate is not applied to the value of the low and uncertain as to its timing. transaction as such (as for the PFTT), In relation to a future trading hour, but only on the externality, i.e. that the probability of an activated part of the price that lies outside the ERND is practically (and mathe- corridor. It means that the effective tax matically) zero. burden is variable—with a burden of 0 percent within the corridor and at its If there are investors to fear the margin, and an effective tax burden ERND, they are exclusively those with that increases with the degree of de- a short time horizon who are betting viation from the target zone. The ef- on speculative rents. It is exactly this fective tax burden for statutory ERND group of investors that schemes such rates of 50 and 100 percent are de- as NRR and the CBCT aim at deter- picted in Chart 2. ring from investing in a country. The ERND appears to be much more effective in this respect as well as more targeted, because it will be activated imme- diately and automatically (via a previously instal- led software). It thus works in the form of an auto- matic “circuit breaker” against foreign exchange speculation. The variable effective burden on a Long-term inves- transaction that is carried out at prices tors are likely to disregard the tax al- outside the corridor also conforms to together however, because its activa- the conditions for a neutral (respec- tion is improbable over a longer period tively allocation-enhancing) Tobin tax of time. (Tornell 1988, 1990).

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 20 On the contrary: One may even ex- » Which countries could benefit pect long-term investors to be en- from an ERND and what is its rela- couraged to invest in a country that tionship with the orthodoxy? employs an ERND. This is because The concept of an ERND is primarily the surcharge acts as a sort of insur- suitable for transition, emerging and ance. It guarantees practically that the developing economies that aim at exchange rate will never vary more accessing free international capital than the set bandwidth in one day. In markets. For industrialized countries comparison to the potential alternative the concept is only apposite for those without the tax (a possible “free fall” of that do not belong to one of the larger the rate) this must be considered a currency areas (US dollar, euro), but considerable advantage. The same is seek to peg their money to an anchor true for importers and exporters. They currency. The ERND does not appear should be prepared to pay even a to be reasonable for the USA or Euro- premium for this exchange-rate guar- land. Exchange rate volatility between antee either in the form of (an occa- the dollar and the euro could perfectly sional) ERND, or in the form of a cur- be controlled through the coordination rency option.23 between the ECB and the Fed.

The advantage of the ERND as a uni- » Wouldn’t the ERND lead to devia- lateral measure consist in particular in tions from the equilibrium ex- that national Legislatures can deter- change rate? mine the conditions for their own scheme at their discretion, without Given the design of the ERND, varia- having to coordinate with other au- tions of the target rate are perfectly thorities. The period for the moving possible. For instance, if the period for average, the calculation of the target the moving average consists of 20 rate, the width of the corridor, and the business days, it is possible to incor- tax rate could all vary from currency to porate in the exchange rate all fun- currency. damental data that become available over a month. Therefore the ERND Whatever the advantages or disad- does not permit a “leaning against the vantages of an ERND, it is always wind” policy because it allows the ad- appropriate to evaluate it against the justment of the exchange rate to fun- benchmark of current alternatives—in damentals in a continuous fashion. particular against the practices of the Appreciations and depreciations of the orthodoxy. Orthodox politicians prefer currency are possible and accepted. It monetary interventions by central is only in the case of abrupt exchange banks rather than tax policies.24 This rate changes—typical for periods of calls for the following annotations speculation—that the ERND works as (Spahn 2001): a circuit-breaker. 1. Tax policy is an instrument con- This defuses equally the argument forming to the market. This is true that governments could hide behind for monetary policy only if it is the scheme to carry out irresponsible long-term oriented, but not for the policies at the expense of investors. short run when it may be compelled to hectic reactions under 23 speculative pressure. An advan- It can be expected that the financial industry tage of the tax policy approach is will assume the ERND risk for exporters and importers, who are often more dependent on notably that the rules have to be short-term payment requirements than long- term investors, in the form of currency options 24 net of tax. In this way the implicit insurance There are of course also „harder“ interven- premium would become an explicit cost of the tions such as capital controls, which I shall not insurance scheme. use as a benchmark for that matter.

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 21 established a priori. They are sure.26 known to all participants and are ü Finally, the greater independ- therefore predictable. This does ence of the central bank from ex- not apply to an extemporizing change rate turbulences will also monetary policy. render the country less dependent 2. The unpredictability of monetary from foreign capital investors and policy in times of speculation has the support by international or- a number of severe drawbacks ganizations such as the IMF. If that even encourage speculation: there is need to intervene in currency markets beyond the loss of ü At first will hectic interventions currency reserves, it tends to in- signal policy distress to market crease the foreign indebtedness of participants. Tax policy is a proce- the country, which renders its cur- durally neutral measure that acts rency all the more vulnerable to automatically as a built-in stabi- speculation because the confi- lizer. dence in the economy is dwin- ü Then will monetary interven- dling. Moreover the country is bur- tion encourage speculative behav- dened with debt service, and—if ior if market participants can rea- devaluation is ultimately unavoid- sonably expect the central bank to able—it looses additional net be politically compelled to bail out. wealth because its foreign indebt- The ERND will procure the neces- edness, measured in domestic sary room for monetary absti- currency, will increase in propor- nence by the central bank and al- tion to the rate of devaluation. low it to focus mainly on domestic 25 Given these considerations and policy objectives. against the background of reoccurring ü Moreover it is not negligible currency crises, which are tackled in that the ERND will produce reve- vain with orthodox instruments over nue during periods of exchange and over again, it is incomprehensible rate turbulences, whereas mone- why tax policy interventions in foreign tary policy intervention is tanta- exchange markets should have such mount to subsidizing foreign ex- a bad reputation. change trade—as mentioned be- The TCCBT possesses significant fore. This is true for its ni terest allocative and distributive advantages rate policy, which aims at render- compared to orthodox instruments as ing domestic assets more attrac- long as negative repercussions on tive, and for its direct interventions international liquidity trading can be in foreign exchange markets, avoided. How this could be achieved whereby valuable reserves are will be discussed in the following sacrificed just to stabilize the ex- Chapter. change rate. Monetary policy interventions—preferred by the orthodoxy—also entail a negative impact onto the real economy of countries under speculative pres- 26 This is true in particular for interest-rate policies "... as with simply raising interest rates to defend a weak currency, it is virtually im- 25 This was one of the most important goals of possible to burn the speculators without simul- Tobin with his tax on foreign exchange trans- taneously affecting other sectors of the econ- actions. Monetary policy abstinence during omy" (Garber and Taylor (1995), p. 178). As periods of an activated ERND is even manda- has been argued previously, monetary policy tory for its effectiveness, because traders interventions may also lead to a transfer of net would otherwise attempt to shift the burden of wealth at the expense of the countries con- the tax onto the central bank. cerned.

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 22 » Summary. This Chapter has dis- plex administrative problems however, cussed the basic conditions for a po- which will render its realization less litically feasible tax on foreign ex- likely. Both instruments are however change transactions, and developed significantly different from a tax on an effective set of instruments. foreign exchange transactions and will no longer be examined in the remain- The scope for decisions is politically der of the report. constrained in that the tax has to be introduced and be accounted for by “Politically feasible” appears to be a existing decision-making bodies such combination of a unilaterally acting as national and supranational parlia- Tobin tax with a low rate as a “true” ments. The tax works therefore unilat- tax on foreign exchange transactions, erally and partially, not multilaterally in combination with a surcharge that and universally. Moreover the tax reacts on speculative variations of the yield will fall to whoever will be re- exchange rate. Both are technically sponsible for legislating the tax, not to intertwined. international institutions. They could The proper Tobin tax could be used get hold of the tax revenue only in a by groups of OECD countries, for in- second step—via budgetary transfers. stance by the EU. The surcharge Among the measures that are “politi- should be used unilaterally only by cally feasible” in this sense range the transition, emerging, and developing going practice of mandatory non- countries as well as those industrial- interest bearing deposits on foreign ized countries that remain outside the exchange transactions (respectively major currency areas, but aim at peg- foreign exchange positions) and a ging their currencies to an anchor proposal by Zee, who would levy an currency (or a basket of currencies). asymmetrical tax on capital imports. The combination of two taxes in the Both instruments are interesting as form of a Tobin-cum-circuit-breaker parts of an arsenal aimed at combat- tax has significant allocative and dis- ing currency speculation. In particular tributive advantages over an ex- mandatory deposits are likely to con- change rate policy that is based on stitute an important element within a orthodox monetary policy. future global financial architecture. The proposal of a tax on capital imports appears to be laden with com-

Paul Bernd Spahn ® [email protected] On the feasibility of a tax on foreign exchange transactions ® Chapter 2 ® Page 23