Tobin Tax Definition

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Tobin Tax Definition

What Is the Tobin Tax?

The Tobin tax, named after economist James Tobin, is a fee paid on spot currency conversions with the purpose of discouraging short-term currency trading.

Unlike a consumption tax, which is paid by consumers, the Tobin tax is intended to be paid by financial sector players in order to control the stability of a particular country’s currency. It is currently recognized officially as a Financial Transactions Tax (FTT) or, less formally, as a Robin Hood tax.

Key Takeaways

  • The Tobin tax is a proposed charge on spot currency exchanges to punish short-term currency trading and disincentivize speculation.
  • The Tobin tax may be used to generate money in nations with a lot of short-term currency volatility.
  • The Tobin tax is also known as the Robin Hood tax because many people regard it as a means for governments to extract tiny sums of money from those who make significant, short-term currency swaps.

Understanding the Tobin Tax

When the Breton Woods system’s fixed exchange rates were replaced with flexible exchange rates in 1971, there was a large movement of capital between currencies that threatened to collapse the economy. Furthermore, the surge in short-term currency speculation fostered by the open currency market increased the economic expenses borne by nations transferring currencies.

The Tobin tax, developed by James Tobin in 1972, aims to alleviate or eliminate these problems. A number of European governments and the European Commission have enacted the tax in order to deter short-term currency speculation and stabilize currency markets.

Long-term investments are unaffected by the currency transactions tax. It is only enforced on the excessive flow of money that travels across financial markets on a regular basis as a result of speculators seeking high short-term interest rates. Banks and financial institutions that benefit from market volatility by holding excessive short-term speculative bets in currency markets must pay the levy.

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The Tobin tax was first proposed by American economist James Tobin (1918-2002), who was awarded the Nobel Memorial Prize in Economics in 1981.

Tobin believes that in order for such a tax to be successful, it should be implemented globally and uniformly, with the revenues transferred to underdeveloped nations. Although Tobin proposed a 0.5% tax, other economists have proposed rates ranging from 0.1% to 1%. Even at a modest rate, if every financial transaction in the world was taxed, billions of dollars could be collected.

The initial objective of applying the Tobin tax has been distorted over time by the many governments that have implemented it. While Tobin’s proposed tax on currency exchanges was intended to curb destabilizing cross-border capital flows that make it difficult for countries to implement independent monetary policies by moving money quickly back and forth between countries with different interest rates, some countries now impose the Tobin tax as a means of generating revenue for economic and social development.

Example of the Tobin Tax

For example, Italy implemented the Tobin tax in 2013 not because of exchange rate volatility, but because of a debt crisis, an uncompetitive economy, and a weak banking sector. The Italian government aimed to calm markets, decrease financial speculation, and collect money by expanding its currency transaction tax to high-frequency trading (HFT).

Since its inception, the Tobin tax has sparked debate. Opponents of the tax argue that it would destroy any profit potential for currency markets by reducing the amount of financial transactions, limiting global economic growth and development over time. Proponents argue that the levy would help stable currency and interest rates since many central banks lack the cash reserves required to balance a currency selloff.

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