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Destabilizing Speculation and the Case for an International Currency Transactions Tax
Challenge, May, 2001 by Thomas Palley
Notes
(1.) Data on stock market volatility come from TIAA-CREF Participant (August 2000), pp. 2-3. Data for 2000 is through June and is annualized.
(2.) Momentum bubbles have a strong resemblance to rational-expectations bubbles. The difference is that momentum investors look ahead only one period so that a small tax may be sufficient to prevent them from buying. Rational-expectations investors look into the infinite future, and a small tax may not be sufficient to prevent them from buying if they see future prices rising by much. The momentum model, with its truncated investor time horizon, seems a better model of reality. Given this conclusion, the Tobin tax could be very effective in preventing bubbles.
(3.) The economic logic is as follows. Governments need to raise revenues, hence the need to tax. But taxes change relative prices, thereby distorting the pattern of economic activity and shifting it away from the first best equilibrium that would prevail in the absence of taxes. Public finance theory therefore tells policymakers to tax those activities that are relatively insensitive to increased prices (i.e., in which demand is inelastic), which would cause taxes to have relatively little impact on the pattern of economic activity. Such price insensitivity is often advanced as an economic justification for sin taxes--taxes on tobacco, alcohol, and gambling--because the demand for sin is relatively inelastic. The Tobin tax can be seen as a form of sin tax--the sin being currency market speculation.
(4.) This point is made in Palley 1999a.
(5.) Another consequence of the shift to multinational production concerns income distribution. By contributing to a changed structure of production, exchange-rate volatility has helped change the pattern of bargaining power in favor of capital over labor, which in turn has contributed to a deterioration in income distribution.
(6.) Baker (2000) makes similar claims about political will, comparing the problem of Tobin tax enactment and enforcement to that of money laundering. With regard to the latter, the political will exists to stop it, and governments have there-fore joined to do so.
(7.) Hirshleifer (1971) provides theoretical arguments why the activities of financial markets may be socially unproductive even though they are productive from a private standpoint. The crux of his argument is that financial markets may engage in activities that are redistributive (my gain = your loss) rather than production augmenting. Tobin (1984) also criticizes the financial system for absorbing too many real resources to the detriment of the rest of the economy.
(8.) The same market forces also operate to contain the problem of jurisdictional shopping and evasion. Moving the geographic location of transacting is costly in terms of lost business networks, ancillary markets, etc. This result dampens the incentive to move.
(9.) See Palley 1999b, p. 110.
For Further Reading
Baker, D. 2000. "The Case for a Unilateral Speculation Tax in the United States." Briefing paper, Center for Economic and Policy Research, Washington, DC.
