A recent article in The Economist raises the issue of Tobin taxes applied to the Italian economy.
Italy became recently the first country in the world to extend its financial-transaction tax to high-frequency share trading. With this policy, the Italian government hopes the stabilization of markets, reduce financial speculation and raise government revenue. Such levies on financial transactions were introduced by a Nobel Laureate in Economics, James Tobin, who in 1972 first suggested taxing financial transactions. But, do Tobin taxes work?
Tobin’s original idea was to stabilize currency markets after the collapse of the Bretton Woods system of fixed exchange rates in 1971. His proposal was to curb de-stabilizing capital flows across borders. Tobin envisaged a global tax, which was impossible to avoid by moving financial markets offshore, where the proceeds would be donated to developing countries.
However, the government of Italy is implementing the tax on its own in a different context. The main problems in Italy include a debt crisis, an uncompetitive economy and a weak banking sector, rather than exchange rate instability. The aim of this tax imposition is not only to reduce stock market volatility, but to use the extra revenue to reduce Italy’s budget deficit.
Most academic studies suggest that Tobin taxes may not necessarily decrease volatility in financial markets (e.g. researchers at the University of Innsbruck found that a global Tobin tax would have little impact on volatility). And there is not much evidence at all that unilateral Tobin taxes work. Although large markets might see a fall in volatility, smaller markets would see a rise due to a fall in liquidity, resulting from less capital flows across countries.
As markets move abroad, Tobin taxes become ineffective. In the 1980s, Sweden introduced a transaction tax on shares, equity derivatives and fixed-income securities and it did not prove successfully as activity moved offshore to avoid the levies. In the first week of the fixed-income tax bond trading volumes fell by 85%; the amount eventually raised from the tax averaged only about 3% of what was predicted. By 1990 over 50% of Swedish equity trading had moved to London.
Similar difficulties may also arise in Italy. A financial daily has reported that Italian traders are beginning to move their residency to Malta, which has excluded itself from any such proposed tax. This suggests that the proceeds from such tax levies might be moderate, bringing an additional concern to the government. However, by not extending the tax to bonds, the Italians have attempted to avoid the pitfall identified by the IMF that a tax on trading government bonds might increase the cost of public borrowing. This would have been disastrous for Italy, a country faring badly in the European sovereign-debt crisis.
Furthermore, the political crisis and lack of business confidence has proved to be the main difficulties to the Italian economy. The way of collecting government revenue is still an issue that plagues the country and these concerns have been brought to the economic agenda on a daily basis. The truth is that without a solid resolution of such problems economic policy might be difficult to conduct.
Nuno Lourenço #85