Why a Tobin Tax would not work

This from a Leader in Today's Times:

As bad economic ideas go, a European financial transactions tax is hard to beat in any circumstances. When the continent is mired in a crisis of indebtedness and weak growth, in which the inflexible monetary arrangements of the eurozone render any solution far more difficult, its irrationality possesses a particular grandness.

Yet EU policymakers, with President Sarkozy and Angela Merkel principal among them, are seriously considering just such a scheme. The British Government should respond that if the tax proceeds, the UK will assess dispassionately the economic benefits of belonging to the EU against the economic benefits provided by the City of London, and unhesitatingly choose the latter.

The principle of a tax on financial trading, as the European Commission envisages it, is that it might deter disruptive short-term speculation while raising money to ameliorate Europe’s budgetary needs. The reality is that it would not work. By raising the costs of trading, its main and entirely foreseeable effect would be to drive securities business out of Europe to other financial centres. Ill-judged financial regulation has a long history. The very success of London as a modern financial centre partly derives from it.

In the 1960s, the City was in relative decline in common with the rest of the British economy. The US Government then introduced legislation that limited the amount of interest payable on dollar deposits by banks in America. Investors promptly moved their dollars abroad and London became a magnet for international banks. More recently, in the 1980s, Sweden introduced a tax of 0.5 per cent on equity purchases. It raised far less revenue than its proponents had predicted, and within a few years more than 50 per cent of Swedish equities had moved to London.

A financial transactions tax applied in the EU would do the same on a bigger scale. Traders would avoid paying it by booking deals in other financial centres. Even if, with magnificent improbability, the tax were agreed also by financial authorities in the US, China and other leading economies, that would still leave offshore tax havens, which would have a huge incentive not to follow suit. Even then, the tax would have to apply to every transaction without exception, or traders would reclassify one type of deal to something else — a bond transaction might, for example, be reclassified as a foreign exchange deal. The ease with which a tax can be avoided is not always a conclusive argument against levying it. The problem with an EU transactions tax, however, is not primarily its futility but its destructiveness. Securities business would migrate from Europe to other parts of the world.

George Osborne, the Chancellor, has rightly described such a predictable outcome as economic suicide for Britain and Europe. But he is too polite. There is an implicit but unmistakable aim in the proposal to erode the importance of London as a financial centre. Mr Sarkozy has made no secret of his aversion to the “free-wheeling Anglo-Saxon” model of financial markets. This is an economically damaging aim, but most particularly for the UK. The City accounts, among much else, for more than a third of global foreign exchange turnover. Its earnings are crucial to Britain’s economic recovery. If European leaders push this tax, they are simply pushing Britain out of Europe.