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 (27 August
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.
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