It is a proposal that refuses to die.
When Finance Ministers of the overactive G20 met at St Andrews, Scotland
in early November, the UK's Prime Minister Gordon Brown decided to use
what would be the last meeting under his presidency to make a case for
taxing finance. His argument was simple. Over the last two years, fragility
or failure in the banking system has necessitated using tax payers' money
to bail out banks. And the evidence seems to be that once the losses of
banks resulting from the speculative fervour of managers in search of
bonuses had been absorbed and their capital base refurbished, these managers
or their replacements have gone back to playing the same game and earning
similar bonuses, keeping the prospect of future failure alive. It is obviously
unjust and even infeasible to repeatedly call upon the public at large
to pay for the errors, forced or unforced, of the bankers. So post-crisis
financial reform, Brown had argued, must include measures that require
banks to pay for the (extremely high) likelihood that their actions would
burden tax payers with the costs of rescuing banks in future. In words
that caught the world's attention he said: "It cannot be acceptable
that the benefits of success in [banking] are reaped by the few but the
costs of its failure are borne by all of us". Impeccable logic, anyone
would say.
There were four such measures to deal with the problem that Brown had
tentatively advanced. One was an extension of the current remedy of forcing
banks to provide for potential losses in advance. World governments should
consider requiring banks whose failure was seen as being systemically
damaging to hold more capital to cover potential losses than required
of other less systemically relevant banks. However, if the crisis has
taught us anything, it is that this idea of differential levels of "capital
adequacy" would take us nowhere. If systemically risky banks are
to provision for a higher level of losses, the question that would arise
is how high is "higher"? This is because, as became clear from
banks' involvement with the shadow banking system through on- and off-balance
sheet transactions, managers seeking to increase profits would siphon
money into the less regulated and more profitable entities so as to earn
revenues they cannot legitimately seek. The higher is the pre-emption
of their resources for insurance purposes, the greater would be the desire
to indulge in such activity. In the event, if and when the more risky
banks fail the ripple effects would engulf the systemically risky institutions
as well, and whatever level of capital adequacy is specified may prove
inadequate. Therefore, as Nouriel Roubini, among others, still argues:
"The true solution to the too-big-to-fail problem requires more radical
choices. In addition to an insolvency regime, such institutions should
be broken up and unsecured creditors of insolvent institutions should
have their claim automatically converted into equity. A separation of
commercial banking and risky investment banking should also be considered.
Thus, some variant of the Glass-Steagall Act should be reintroduced."
Two other variants of the insurance scheme were advanced by Gordon Brown
and were also non-controversial, even if not likely to be immediately
taken up. One was the creation of a pool of money financed by banks and/or
their customers that could be used to finance orderly bail-outs as and
when required. And the other was mandating contingent capital requirements
or the holding of assets whose value or benefit is realised only when
an event that is uncertain occurs. These are measures similar to deposit
insurance, excepting that it is not just depositors who are insured but
the banks themselves. The difficulty with these schemes is that there
is no guarantee that they would provide adequately for the costs of a
failure. The advantage they have is that they are likely to garner international
support, since they limit, while leaving open, the burden that would be
imposed on financial institutions today to meet costs that may have to
be met tomorrow. From the point of view of finance there is ample scope
to negotiate and render these costs small enough to bear for institutions
that are too big to fail.
In the event, the really controversial of Brown's proposals was his fourth
option of imposing a tax on financial transactions that could either be
used to create a contingency fund or be spent on socially beneficial projects
so that taxpayers are compensated today for any costs they may be called
upon to bear in future. The idea is not new and was, therefore, immediately
labelled the "Tobin Tax", even though it differs significantly
from the tax on foreign currency transactions that was proposed by Nobel
Prize winning economist James Tobin. After the collapse of the Bretton
Woods agreement and the shift to floating exchange rates in the early
1970s, Tobin proposed a small levy on transactions in foreign exchange
markets to discourage speculation and endow currency markets with a degree
of stability. The proposal, which was questioned by some who felt that
it attempted to throw grains of sand in the wheels of finance when what
was required were boulders, was never taken up because it needed to be
implemented by all countries simultaneously if it was to be successful.
Belgium did subsequently pass a law to implement a Tobin-type tax, but
made its implementation contingent on a similar law being adopted in all
countries in the euro zone. But that was not to be, since such consensus
was lacking.
However, the idea was revived after the Southeast Asian financial crisis
of 1997, when it became clear that once restrictions were removed on cross-border
flows of financial capital, speculative flows seeking to profit from differentials
in the rates of return across countries and sectors could result in boom-bust
cycles with severely damaging consequences for the real economy. The idea
of the tax, while retaining the Tobin label, was extended to curb speculative
capital flows by reducing their profitability and was promoted by stating
that the revenues collected from such a tax could be used to further development
in the world's poorest countries. In the process, support for the Tobin
tax was substantially enhanced and was seen as akin to opposition to policies
and institutions (such as the World Bank and the IMF) that were for reduced
controls on private capital movements across borders. In fact, Tobin distanced
himself from the "anti-globalisation rebels" who he complained
had hijacked his name for wrong ends.
However, the wider support for Tobin-tax Mark II notwithstanding, little
progress was achieved. It was, not surprisingly, opposed by finance. It
was also opposed by countries which felt that imposing such a tax, when
others were not opting for it, would drive capital out of their countries
and/or undermine their existing role or potential role as global financial
centres. And once again the debate on the need for and feasibility of
such a tax petered out.
However, since financial crises do not disappear but only recur, often
with greater intensity, in contemporary capitalism, the idea was bound
to survive. We are therefore witnessing now the revival of Tobin tax Mark
III in the wake of the global financial and economic crisis of 2008. In
August 2009, when an effort was still underway to redirect attention from
stalling the recession to reforming finance, a person of no less significance
than Adair Turner, chairman of Britain's Financial Services Authority
and author of the much discussed Turner Review of the implications of
the financial crisis, argued in an interview published in Prospect magazine
that the debate on bankers' bonuses has become a "populist diversion"
and that more drastic measures may be needed to cut the financial sector
down to size. One such measure was a Tobin-type tax on financial profits.
"If you want to stop excessive pay in a swollen financial sector
you have to reduce the size of that sector or apply special taxes to its
pre-remuneration profit," he said.
Coming from the chief of the financial watchdog in the country that is
home to the City of London (the second most important global financial
market after New York), this was a significant statement. It showed that
at least some people responsible for the operations of the City were not
going to protect finance at all cost in order to retain the competitiveness
of the City as a global financial centre. In fact, Turner reportedly held
that the FSA should "be very, very wary of seeing the competitiveness
of London as a major aim", since the City had become a destabilising
influence in the British economy.
It was not surprising that Turner's statements generated a backlash. According
to the Financial Times (August 27, 2009): "A chief economist at a
big bank described the suggestion internally as "a stupid idea",
while an executive at one European bank said: "Global taxes don't
happen. Unless next month's G20 meeting can suddenly pull something out
of the hat, this will be largely ignored."
The London meeting did indeed ignore the proposal, even though there were
hints of support from France and elsewhere. But come November and the
Turner-Tobin proposal gained new momentum with Prime Minister Gordon Brown
weighing in for it. He, however, made it clear that Britain would consider
adopting the tax only if the initiative was global. And, as expected,
not long after Brown's speech US Treasury Secretary Tim Geithner made
clear that the US was not willing to support a financial transaction tax.
Canada, Russia and others, besides the IMF and the European Central Bank,
have joined the group of dissenters, increasing the probability that the
proposal will be shelved once again.
In the circumstance many argue that Brown's declaration of support for
a financial transactions tax move may just be his last effort to gain
populist mileage from the presidency of the G20 and shore up his waning
image at home. However, his actions have given a lease of life to an idea
that just will not go away. Turner's assessment that the logic that "more
complete markets were good and more liquid markets are definitionally
good" is no longer trusted, and that the crisis "requires a
very major reconstruct of the global financial regulatory system, [not]
a minor adjustment," cannot be easily ignored. Hence the proposal
for a Tobin-type financial transactions tax is likely to remain on the
table.