Destabilizing Speculation and the Case for an International Currency Transactions Tax

Challenge, May, 2001 by Thomas Palley

Reflection on the issues of enforcement, evasion, and avoidance that surround the Tobin tax raise critical technical questions. But beyond these questions, such reflection also raises deep issues of principle regarding the purpose and conduct of public policy.

One critical issue concerns the significance of problems of enforcement, avoidance, and evasion in the assessment of tax systems. Critics argue that these problems make the Tobin tax infeasible. The previous section argued that they are likely much less severe than claimed. However, beyond that contention there is the core point of principle that evasion and avoidance are not decisive in determining whether a tax is warranted. Every tax system is subject to some evasion and avoidance, and the extent of such behaviors is an appropriate concern. But such behaviors are only part of the decision calculus. Also relevant are the amount of needed revenue that the tax raises and the behaviors it discourages. This is the test that should be applied to the Tobin tax--just as it should be for all tax systems--and on this test the Tobin tax scores well.

There is an even broader principle concerning the nature of regulation in a dynamic global economy. Critics of the Tobin tax argue that financial markets will innovate to avoid it. This is undoubtedly true, yet it does not mean that a Tobin tax is unwarranted. Effective taxation places costs on profit-maximizing firms, while effective regulation imposes constraints that prevent them from doing what they would like. Firms therefore have an incentive to search out ways of avoiding taxes and regulations, and over time they inevitably succeed in doing so. Indeed, if the incentive to avoid is not there, it probably means the regulation is of little consequence. Seen from this analytical vantage, it becomes clear that good regulation always sows the seeds of its own destruction. This maxim should be the Rosetta stone of all good regulators. [9]

Over time financial markets will undoubtedly innovate in directions that evade a Tobin tax--as it might be imagined today. But this does not invalidate the case for a Tobin tax. Instead, it affirms the fact that regulation is an ongoing process--a dynamic game played between regulators and regulated--that needs to be continually updated. Sometimes regulators manage to get ahead of the game, and other times they just manage to stay even. However, there is never an excuse for capitulating and surrendering the public interest to the dictates of the market. Unfortunately, much of the opposition to a Tobin tax partakes of such a surrender. This outcome is unjustified in principle and unjustified on the particular merits of the Tobin tax. It is especially unjustified by the historical moment that has financial markets escaping earlier systems of national regulation, thereby revealing a clear need for new systems of coordinated cross-country regulation.

THOMAS PALLEY is assistant director of public policy for the AFL-CIO.

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.