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New Sources of Development Finance$

A. B. Atkinson

Print publication date: 2004

Print ISBN-13: 9780199278558

Published to Oxford Scholarship Online: January 2005

DOI: 10.1093/0199278555.001.0001

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Revenue Potential of the Tobin Tax for Development Finance: A Critical Appraisal

Revenue Potential of the Tobin Tax for Development Finance: A Critical Appraisal

Chapter:
(p.58) 4 Revenue Potential of the Tobin Tax for Development Finance: A Critical Appraisal
Source:
New Sources of Development Finance
Author(s):

Machiko Nissanke

Publisher:
Oxford University Press
DOI:10.1093/0199278555.003.0004

Abstract and Keywords

The principal objective here is to assess the potential of currency transactions taxes (CTTs) – the celebrated Tobin tax – to raise revenues that can be used for developmental purposes. Thus, though Tobin proposed and others assessed CTTs in terms of reducing exchange rate volatility and improving macroeconomic policy environments, this chapter considers the CTT first and foremost from the standpoint of revenue and treats its potential to achieve valuable double dividends (such as the promotion of financial stability and policy autonomy) as a subsidiary objective. With a view of establishing the ‘permissible’ range of tax rates to obtain realistic estimates of revenue potential from CTTs, the debate on the effects of CTTs on market liquidity and the efficiency of foreign exchange markets is reviewed, and the P. B. Spahn proposal for a two‐tier currency tax briefly assessed. Next, a number of issues raised in the debate on the technical and political feasibility of CTTs are discussed, followed by an evaluation of several new proposals, such as those advanced by R. Schmidt and R. P. Mendez. The last two sections of the chapter present estimates of the potential revenue from CTTs in light of recent changes in the composition and structure of foreign exchange markets and give a concluding assessment of the potential of CTTs as a revenue‐raising tax instrument and their ability to achieve double dividends.

Keywords:   currency transactions taxes, development finance, development funding, double dividends, effects on foreign exchange markets efficiency, effects on market liquidity, foreign exchange markets, P. B. Spahn, political feasibility, R. P. Mendez, R. Schmidt, revenue potential, tax rates, technical feasibility, Tobin tax, two‐tier currency tax

4.1 INTRODUCTION

The dramatic rise in cross-border financial flows in the post-Bretton Woods period has been associated with the unprecedented increase in financial instability and crisis.

Indeed, while economic theory emphasizes the potential advantage of global financial trading for economic development and world welfare, it is by now abundantly clear that financial globalization entails genuine costs, risks, and hazards for participating countries not only in their increased susceptibility to financial instability and crisis but in the loss of autonomy in macroeconomic management—a condition known as the ‘macroeconomic policy trilemma for open economies’ or the ‘inconsistent trinity’ thesis.1 The thesis stipulates that an open capital market deprives a government of the ability simultaneously to target its exchange rate and to use monetary policy in pursuit of other economic objectives.2

Financial globalization can also lead to a loss of fiscal autonomy, if financial openness makes it hard to tax internationally footloose capital relative to labour due to the (p.59) competition for foreign savings through tax incentives and general financial arbitrage.3 Many countries reduced or eliminated taxes on capital transactions and lessened the rate of capital gain taxes or corporate taxes considerably in this process of tax competition and in fear of asset migration and capital flight. A critical analytical work is required to examine whether or not international tax coordination is welfare increasing nationally as well as globally.4

The Tobin tax has been debated in the context of this particular historical trend towards an accelerated pace of financial globalization over the recent decades. Tobin proposed a currency transaction tax first at the Janeway Lectures delivered at Princeton in 1972 and again at the presidential address to the Eastern Economic Association in 1977 (Tobin 1974, 1978). The currency transaction tax (CTT), widely known as the Tobin tax, was initially proposed, therefore, for enhancing the efficacy of national macroeconomic policy and the operation of the international monetary system by reducing short-term speculative currency flows.

However, as Tobin himself notes (1996), his proposal did not receive serious consideration from fellow academics or policymakers in the 1970s and 1980s. It was either dismissed almost at stroke as impractical on the grounds of technical and political unfeasibility or rejected as an unnecessary intervention that interferes with the efficient functioning of markets by injecting ‘distortions’. However, in contrast to the its disappointing response in the 1970s, followed by the long silence on the subject in the 1980s, there has been a sudden surge of interest in the Tobin tax since the early 1990s.

The renewed interest in the Tobin tax in recent years certainly reflects the growing recognition that there is an urgent need for creating a new international financial architecture governing cross-border capital flows in face of the repeated severe financial crises, including self-fulfilling currency crises in a large number of European countries in the exchange rate mechanism (ERM) and emerging market economies. In particular, in developing and transitional economies, some small initial changes in perception towards their currencies could cascade into generalized financial and economic crises in no time.

For the purpose of this chapter, however, it is critical to note that the surge of interests in the scheme is also explained by its potential for generating a tax revenue of substantial size, which could more than offset the declines in official aid from OECD countries to developing and transitional economies. It has been argued widely that the revenue from CTTs has the potential to serve as an important source of finance for ‘global public goods’. Responding to these emerging interests, a number of recent studies have assessed the potential of CTTs, not only for taming exchange rate volatility and averting financial crises but also as an important tax instrument to generate revenue for global development. Many of these studies have articulated modifications to Tobin's original CTT proposal in order to address a variety of technical and political concerns.

(p.60) The principal objective of this chapter is to assess the potential of taxes on the CTTs to raise revenues that can be used for developmental purposes. Thus, though Tobin proposed and others assessed CTTs in terms of reducing exchange rate volatility and improving macroeconomic policy environments, this chapter considers the CTT first and foremost from the standpoint of revenue. Unlike other papers on this subject, this chapter treats the assessment of the potential of the CTT to achieve valuable double dividends, such as the promotion of financial stability and policy autonomy, as a subsidiary objective.

With a view of establishing the ‘permissible’ range of tax rates to obtain realistic estimates of revenue potential from CTTs, Section 4.2 reviews the debate on the effects of CTTs on market liquidity and the efficiency of foreign exchange markets, and assesses briefly the Spahn proposal for a two-tier currency tax. Section 4.3 discusses a number of issues raised in the debate on the technical and political feasibility of CTTs, followed by an evaluation of several new proposals, such as those advanced by Schmidt and Mendez. Section 4.4 presents my estimates of the potential revenue from CTTs in light of recent changes in the composition and structure of foreign exchange markets. Section 4.5 presents my concluding assessment of the potential of CTTs as a revenue-raising tax instrument. It also evaluates CTTs' ability to achieve double dividends.

4.2 THE DEBATE OVER THE EFFECTS OF THE CTTs ON MARKET LIQUIDITY AND EFFICIENCY

At the breakdown of the Bretton Woods system of adjustable pegged exchange rate regimes with capital controls, Tobin proposed an idea of instituting a currency transaction tax to tackle excessive exchange rate fluctuations, promote autonomy of national macroeconomic policies, and to improve the operation of the international monetary system by reducing short-term speculative currency flows. Acting as ‘sand in the wheels’, Tobin suggested that CTT could make short-term trades more costly and by doing so, would increase the maturity structure of international capital flows (Tobin 1994, 1996).5 In particular, it was conjectured to considerably reduce exchange (p.61) rate volatility by ‘penalizing short-horizon roundtrips, while negligibly affecting the incentives for commodity trade and long-term capital investments’ (Tobin 1996: x).

Filtering transactions by maturity on the understanding that speculators would have shorter horizons and holding periods, Tobin predicted that CTT is capable of reducing ‘noise trading’ from foreign exchange markets. In Tobin's own words, the tax is to set to ‘make exchange rates reflect to a larger degree long-run fundamentals relative to short-range expectations and risks by strengthening the weight of regressive expectations relative to extrapolative expectations’ (Tobin 1996: xii).6

The proposal has drawn strong criticism on efficiency and liquidity grounds.7 Indeed, the debate on the effects of CTT on market liquidity and efficiency is inevitably shaped by varied perceptions about how well foreign exchange markets function and whether or not short-term speculation is destabilizing. A question is raised whether speculators or traders make exchange rates excessively more volatile than warranted by fundamentals.

Critics of the Tobin tax claim that speculators would not increase exchange rate volatility as their expectations are guided by fundamentals, and that their presence tends to reduce volatility by providing necessary liquidity to markets.8 In particular, speculators, who could act as informed investors guided by their expectations about future underlying fundamentals (i.e. as traditional fundamentalists or ‘informed’ traders), are seen to keep exchange rate in line with the macroeconomic fundamentals and help to stabilize markets around new equilibrium.

From the perspective of opponents, the Tobin tax is a device that tends to decrease market efficiency by creating liquidity problems for the day-to-day operation of currency markets, adversely affecting the bid-ask spreads and hence deterring arbitrage transactions. In the ‘wholesale’ segments of currency markets in particular,9 marketmakers' position, whose act as arbitrageur provides a guaranteed counterpart, is seen to be compromised with reduced liquidity by CTT, as they need liquid markets to avoid large fluctuations in their net positions. It is thus clear that in most of the arguments against the Tobin tax, the concept of speculation is conflated with that of arbitrage, as noted by Davidson (1997).

In contrast, proponents of the Tobin tax argue that markets function inefficiently. For example, Frankel (1996) notes that speculative bubbles—a deviation from the value justified by fundamentals—are generated, as ‘noise traders’ (as opposed to ‘traditional (p.62) fundamentalists’ or ‘informed traders’) follow the herd in the face of uncertainty.10 In the analyses, a critical distinction is usually made between informed traders and noise traders: while informed traders act on homogeneous rational expectation, noise traders make their decisions on the basis of ‘fads’, which are unrelated to fundamentals.

In this context, Jeanne and Rose (1999) suggest that while the volatility in exchange rates is generated both by fundamentals and noise, the source of excessive exchange rate volatility (that is, speculative bubbles) is attributed to the presence of noise traders. In particular, their model shows that noise traders are attracted to the market in search for a risk premium, and that as the number of noise traders increases, so does the volatility of exchange rates. It predicts that when the volatility of fundamentals is low, there is a single equilibrium where noise traders are not active, resulting in a low volatility in exchange rates. Conversely, when the volatility of fundamentals is high, a large number of noise traders enter the market, producing a high volatility in exchange rates. When the volatility of fundamentals is in the intermediate range, however, multiple stable equilibria are possible, depending on the number of noise traders seeking for a risk premium.

The excess volatility generated by noise traders is also analysed in the model of asset markets, advanced by De Long et al. (1990a, b), with focus on the interesting interface between arbitrageurs and noise traders. ‘Arbitrage does not eliminate the effects of noise because noise itself creates risk’ (De Long et al. 1990b: 705). That is, the unpredictability of noise traders' beliefs and expectations, which can be erroneous and stochastic in light of fundamentals, could create a ‘noise trader risk’—a risk in the price of assets that deters rational arbitrageurs from aggressively betting against them. This is because arbitrageurs are likely to be risk averse, acting with a short time-horizon. Hence, they tend to have limited willingness to take position against risks created by noise traders. As a result, ‘prices can diverge significantly from fundamental values even in the absence of fundamental risk’ (De Long et al. 1990b: 705). Moreover, bearing a disproportionate amount of risk thus generated enables noise traders to earn a higher expected return than rational investors engaged in arbitrage against noise. Clearly, their model challenges the standard proposition made by Friedman (1953) that irrational noise traders are counteracted by rational arbitrageurs who trade against them and in the process drive asset prices close to fundamental values.

Overall, these models support the view that speculators—acting on ‘fads’ or guided by extrapolative expectations at short-term horizon—can exert destabilizing effects on markets and ‘overshooting of the overshooting equilibrium’ takes place.11 Furthermore, destabilizing speculation of this type can be profitable, contrary to Friedman's reasoning. The Tobin tax is often viewed by its proponents as particularly effective to (p.63) countering such speculation and speculative bubbles in the floating currency markets on short horizons by eliminating destabilizing noise trading.12 It is also argued that the Tobin tax, by breaking the interest parity condition, could in principle allow policymakers to pursue monetary policy for domestic consideration without a fear of impending large exchange rate fluctuations (Eichengreen 1996).

Interestingly, Frankel (1996) reports survey results, which show that traders, using the ‘Chartist technical analysis’ or the ‘momentum’ models, act on extrapolative expectations at short horizon of under three months, while they act on adaptive, regressive or distributed lag expectations at longer horizons of three months to one year. Hence, he suggests that the former generates destabilizing speculations, while the latter produces stabilizing effects. Further, Spahn (2002) notes that more chartists may be found among the institutional investors such as investment fund managers than among dealers-arbitrageurs. These empirical observations point to the importance of distinguishing those who act as arbitrageurs from those whose behaviour tends to be speculative, pushing markets away from equilibrium.

On one hand, Frankel's empirical results tend to suggest that traders' behavioural pattern is a function of time-horizons over which they act, so the Tobin tax is seen as effective for moderating destabilizing speculation by penalizing trading with a short-term horizon. On the other hand, Spahn's observation implies that traders' behaviour depends upon their motivation for participating in currency trading. However, a complication arises, in my view, because the interaction between arbitrageurs and noise traders in currency markets is very complex, as the former often has to respond to the unpredictable behaviour of the latter rather than to expected changes in fundamentals (De Long et al. 1990a). Further, the market composition between the two types of traders shifts, as market conditions change because the entry and behaviour of noise traders are influenced by the level of volatility of fundamentals and the size of risk premium, as shown by Jeanne and Rose (1999). Equally, depending on market conditions, traders could switch their position from arbitrageurs to ‘destabilizing’ speculators.

Now, a critical issue is whether the Tobin tax could always be successful in distinguishing between these two types of traders. Williamson (1997) notes it is naïve to equate short-term movements with market destabilization. Spahn (2002) further remarks that the Tobin tax unfortunately cannot discriminate between destabilizing noise trading and stabilizing liquidity trading. Davidson (1997) goes a step further to suggest that the Tobin tax is more likely to be a constraint on arbitrage flows rather than on speculative flows. If this is the case, the Tobin tax could adversely affect market efficiency. Hence, critics argue forcefully that this ‘liquidity’ consideration alone provides sufficient grounds to oppose the Tobin tax.

(p.64) Certainly, the liquidity-efficiency dimension has a critical bearing on the question of what the optimal (or permissible) range of the tax rate could be, when one attempts to estimate the revenue potential of the Tobin tax.13 Liquid markets are certainly necessary for arbitrageurs to perform the important functions of reducing price volatility, settlement risk, and the cost of hedging. As discussed above, Jeanne and Rose (1999) show that markets are likely to be dominated by arbitrageurs rather than noise traders under ‘tranquil’ market conditions with a low volatility of fundamentals. Hence, the tax rate cannot be set at a very low threshold level to undermine liquidity and market efficiency. Rates that are too high certainly risk reducing unduly liquidity necessary for arbitrage operations as well as deterring international trade transactions and long-term investment.

While Kaul and Langmore (1996) set a ceiling at 0.25 per cent absolute maximum, Felix and Sau (1996) assess tax rates at less than 0.05 per cent (5 basis point) as those with no ‘sand in the gears’. Hence, these authors use tax rates between 0.25 per cent and 0.05 per cent for their revenue calculation. Although we suggest in the following the use of a much lower rate of 0.01–0.02 per cent (1 or 2 basis points) for revenue estimation on the grounds of efficiency and feasibility, some consensus in literature had emerged by the mid-1990s that the liquidity question is likely to favour 0.1 per cent or lower as the tax rate ceiling. The lower rates are favoured on the basis of the growing recognition that a loss of liquidity resulting from CTT should be kept to a minimum, so that transaction costs and spreads as well as the trade volume and market structures would not be affected adversely.

It is assumed that at a modest tax rate of 0.1 per cent or lower, CTT would not entail a discernible disincentive to long-term investments or international trade, as the tax could be a very marginal part of other larger trade- and investment-related transaction costs. It can also be argued that a tax burden at this low rate is less likely to exceed the cost of using derivative instruments to hedge against currency fluctuations (Eichengreen and Wyplosz 1996). By affecting the cost of trading with a very short-term horizon (see note 12), it has been argued that CTT at these low tax rates could still reduce currency speculation and swings at margin.14

However, the low tax rates such as discussed here would certainly not be effective in countering large-scale speculative attacks on pegged exchange rates, as observed in recent currency crises. Yet, currency crises have increasingly become ‘self-fulfilling’ in character, where substantial financial gains are assured for speculators who take a position against the viability of currency pegs as in the ERM crisis. In the self-fulfilling crises, even though a fixed exchange rate is sustainable in terms of consistency between exchange rate policy and other macroeconomic fundamentals as it stands, agents' (p.65) expectations about possible inconsistency in the future can trigger a speculative attack (Obstfeld 1996).

As in the first generation model of currency crises (Krugman 1979), the main issue at stake here is still the credibility of a government committing to a fixed exchange rate regime in the presence of market speculation. However, instead of facing a real reserve constraint as a result of a deterioration of economic fundamentals as in the first generation model, the government facing a possible attack from speculators tries to address a tradeoff between the benefits of continuing to defend the currency and costs of doing so in terms of hardships resulting from such economic costs as high interest rates and unemployment. Speculators in turn try to second-guess the government's capabilities and intentions. A speculative attack occurs when the government is not believed to be able or willing to defend the peg at high cost and is expected to devalue.

Importantly, agents' expectations about possible future depreciation feed into current economic variables and increase wages and prices. In short, speculation in itself creates objective economic conditions that make devaluation likely, while macroeconomic fundamentals determine the existence and multiplicity of possible equilibria. In the end, the government is forced to validate the expectations ex post by devaluing. Thus, the inability to maintain credibility has become self-fulfilling, as the expectations of speculators regarding the behaviour of the government in a crisis situation might per se generate the crisis. Under such conditions, a regime that could have been viable in terms of economic fundamentals collapses. In effect, crises are not precipitated so much by the actual mechanisms of the economy, but rather by the speculators' expectations of the choices that a government would make in a tight crisis situation. Thus, mechanisms of self-fulfilling crises work through market expectations.

Under these crisis conditions, the issue at stake is not merely whether speculators increase exchange rate volatility, but also whether they generate and exacerbate exchange rate misalignments in terms of fundamentals. This is because noise traders could trigger a shift of exchange rate from an equilibrium with a low volatility of fundamentals to the one with a high volatility of fundamentals, by generating destabilizing speculative bubbles, as shown by Jeanne and Rose (1999).

In this regard, Williamson (1997) raises an interesting question whether the Tobin tax would curb misalignments. Referring to the fact that transaction tax would penalize both stabilizing and destabilizing speculators, he observes: ‘if the object is to curb misalignments, it seems inefficient to penalize all transactions rather than those that are subverting policy’ (1997: 336). Hence, he regards the Tobin tax as an inferior instrument to more discriminatory types of capital controls in its capacity to stabilize the currency market.

Certainly, if CTT is considered as an instrument for dampening speculation to avert self-fulfilling crises, the tax rate has to be set at a much higher rate than the one envisaged to deal with ‘noise-trading’ speculators operating under less volatile market conditions.15 The low range of the tax rates referred to above would not deter (p.66) speculative attacks on pegs, when much higher gains are at stake. Yet, as discussed above, a high tax rate would create severe liquidity problems for normal market operations. In order to address this tradeoff and to deal effectively with speculators' different motivations depending on market conditions, a flexible multi-tier system of taxes would be required, rather than a time-invariant uniform currency tax.

This issue is directly addressed in the two-tier tax system proposed by Spahn (1996, 2002). The two-tier structure embedded in Spahn's proposal consists of ‘a low tax rate for normal transactions and an exchange surcharge on profits from very short-term transactions deemed to be speculative attacks on currencies’ (1996: 24), as applied to a target zone.16 Under this system, ‘an exchange rate would be allowed to move freely within a band, but overshooting the band would result in a tax on the discrepancy between the market exchange rate and the closest margin of the band’, while the low transaction tax is levied on a continual basis, raising substantial and stable revenues. Importantly, this system has to be executed under a two-tier structure, since credibility of the surcharge levy is anchored in the fact that the transaction tax system is already in place. Thus, Spahn proposes that the exchange surcharge would be administered in conjunction with the underlying transaction tax. The transaction tax would serve ‘as a monitoring and controlling device for the exchange surcharge, which would be zero so long as foreign exchange markets are operating normally within a band, but would function as an automatic circuit-breaker at times of speculative attacks’ (1996: 24). Thus, the exchange surcharge would be applied temporarily on a unilateral basis at the ‘speculative end’ and would not affect the liquidity or the efficiency of market functioning in a less volatile condition.

Indeed, once such a system is seen to be operating efficiently with credibility, the threat of a surcharge levy alone may be sufficient to keep exchange rates within a target zone, without depletion of official reserves or other interventions such as high premium on overnight money deposits or excessively high interest rates as observed during the ERM crises. The system is seen as providing monetary authorities with breathing space for orderly realignment of exchange rates, which would reflect the development of economic fundamentals. In this context, it should be noted that the band in the proposed scheme would be a moving one that continuously reflects changes in fundamentals. Thus, authorities would not choose to set and defend a particular parity and its associated band, but rather their aim would be to prevent self-fulfilling panic in the currency markets.

In my view, one of interesting aspects of this scheme is that its implementation is deemed successful, when the exchange surcharge is never levied, while the background low transaction tax generates steady revenues, as the two-tier currency tax manages to drive ‘destabilizing’ speculation from the system. In particular, in relation to potential revenue estimate, which is the main objective of this chapter, it is important to (p.67) emphasize that the two-tier system proposed by Spahn allows the first-tier tax to be kept as low as 0.01–0.02 per cent (1 or 2 basis points).

Now, following on this scheme proposed by Spahn, others have proposed dual taxation as a way of increasing the ‘double dividend’ through schemes such as the ‘dual currency and securities transaction tax’. We shall come back to the issue of appropriate exchange rate regime as well as the issue of achieving effective double dividends with the use of the Tobin tax in the concluding section. However, it may be worth noting here in passing that a multi-tier CTT such as Spahn's proposal is not universally accepted as a solution for averting self-fulfilling currency crises. For example, Williamson (2000) sees no role of any variation of CTT in managing the intermediate regimes against speculative attacks, while recommending the intermediate ‘target zone’ regime, governed by the BBC rule (where BBC stands for basket, band, and crawl), as a more appropriate exchange rate regime for most emerging market economies in preference over one of the two corner solutions of pure floating or hard pegs.17 Naturally, bands are stabilizing when the credibility to defend is maintained.18 He argues, hence, that it is important first and foremost to build credibility so that expectations are formed in a stabilizing manner.

However, Williamson recommends ‘soft margins’ of the bands rather than ‘hard margins’ as appropriate policy for emerging market economies in order to build credibility over time. He endorses the soft target zone system, analysed by Bartolini and Prati (1997, 1998), in which the exchange rate is allowed to move outside the band in the short run, at times of shocks to ‘the fundamentals’, in order to diffuse tension. According to Bartolini and Prati (1998), such a softening of the target zone makes the system less vulnerable to speculative pressures, as the edges to bands provide the market with targets to attack. In their view, government interventions should instead be focused on maintaining the obligation to hold the rate within the band in the long run.

Thus, Williamson argues that during times of large speculation the soft bands would remove the source of vulnerability without losing the main advantage of the BBC arrangement. By allowing a quick, temporary exit from commitments when a crisis situation develops, it is conjectured that credibility to commitments is not eroded permanently, while the exchange rate could revert back to the parity in the process of crisis resolution. Obviously, under such a soft target zone regime, there is no role for a circuit-breaker embedded in the two-tier CTT proposal, as commitments to defend the edges of the zone are abandoned altogether.

(p.68) However, it should be recalled that in the classic model on target zones (Krugman 1991), speculators could act in a stabilizing manner at the margin of the zone precisely because of their confidence in the government's commitment and ability to intervene.19 A credible commitment to the exchange rate target would have a stabilizing effect on market expectations by discouraging the entry of destabilizing noise traders. Further, the ‘hard’ margin could avoid the large misalignments associated with the soft margin in terms of very high adjustment costs (even though they are claimed to be temporary).

Ultimately, in my view, several critical questions should be addressed in deciding which target zone system (soft or hard margins) is appropriate: (i) how credibility to commitment to the target zone can be best maintained; (ii) how costly is it to abandon the zone even temporarily in terms of macroeconomic fundamentals and adjustments; (iii) how quickly can market confidence be restored to allow the exchange rate to gravitate back towards the reference rate or the parity if a soft band option is adopted. The answer to these questions appears to vary case by case. If a soft band is too costly for the economy, a hard band incorporating the two-tier CTT system remains an attractive instrument to consider.

4.3 THE DEBATE ON THE TECHNICAL AND POLITICAL FEASIBILITY OF CTT

4.3.1 Earlier Debate on the Technical Feasibility of CTT

In Tobin's original proposal, a currency transaction tax is applied on a universal basis to spot transactions only. This raised strong scepticism on the grounds of technical and political feasibility. In particular, it has been argued that such a tax could be evaded too easily by market migration to offshore tax havens as well as asset substitutions.20

Kenen (1996) addresses these concerns in a comprehensive manner. To counter the shifting of transactions to tax-free jurisdictions, he proposes two measures: imposition of a punitive rate on transfers of funds to or from such locations,21 and taxing at the site where the deal is made (at dealing sites) rather than at the site where the transaction occurs, that is, at settlement or booking sites. The reason for the second measure is both because too many transactions are netted out before they are settled and because tax-free jurisdictions can be used for booking all transactions with minimum cost. For example, booking and settlement sites could be easily relocated by just installing computers without moving dealing rooms or dealers, whereas relocation of dealing sites is far more costly. Hence, Kenen also proposes that tax collection is made on (p.69) a market basis where the dealing site is located and each party involved in wholesale transactions would pay half the tax in retail transactions in order to equalize the tax burden across wholesale interbank transactions and retail transactions.

As regards to addressing the possibility of tax evasion by asset substitutions, Kenen points to the need to extend the transaction base to derivatives such as forward and swap contracts, which could be used as close substitutions for spot transactions.22 The case for taxing futures and options contracts is more complicated, as they are not perfect substitutes for spot transactions or forward contracts and they are not typically settled by delivering currencies. However, Kenen reckons that if substantial changes to derivative markets are to be avoided, both futures and option contracts need to be taxed as well.

However, those derivatives, which require high-frequency trading involving four or more transactions per contract instead of two transactions, should not be subject to double taxation. Further, these derivatives are risk-hedging instruments, so taxing them would make hedging very costly, as taxes would not eliminate exchange rate fluctuations from the market. At least, in order to remove the resulting bias against high-frequency trading for hedging purpose, Spahn (1996) suggests that transactions involving derivatives should be taxed at half the rate for spot transactions, which would allow the derivative markets to function for hedging purposes. In his more recent study, Spahn (2002) proposes that in addition to all spot transactions, outright forwards and swaps up to one month would be taxed, while options and other financial derivatives would not be taxed (though they are taxed indirectly through the spot and forward transactions they trigger).

Now, it could be envisaged that new ‘cash substitute’ instruments could emerge as tax avoidance mechanism. Garber and Taylor (1995) and Garber (1996) suggest that T-bills traded in liquid markets could be used for such a purpose, while Spahn (1996) foresees other possibilities involving bankers' acceptances, commercial papers, or repurchase agreements made against collateral without cash settlements. Since the use of these substitutes involve transactions costs and interest rate risks or other credit risks, both Kenen (1996) and Tobin (1996) assess that the possibility of large-scale use of these substituting instruments are rather exaggerated and could be avoided, if a low transaction tax is applied. However, a heavy tax burden may well encourage the development of liquid markets for new financial instruments and papers that could be used for cash substitutes.

Indeed, one of most efficient approaches to discourage all forms of tax avoidance, including migration and substitutions, is to keep the tax rate very low. Considering that spreads in the wholesale interbank market are well below 0.1 per cent, Kenen (1996) reckons a 0.05 per cent tax rate (5 basis point) to be the upper benchmark for CTT rather than the lower benchmark, as in the study by Felix and Sau (1996), while Spahn (1996) suggests an underlying tax rate of 0.02 per cent (2 basis point).

(p.70) Furthermore, both Tobin (1996) and Kenen (1996) suggest that for a CTT system to be operative, the currency transaction tax has to be adopted at least by the G7 countries and a few other major financial centres such as Singapore, Hong Kong, and Switzerland. Others argue, however, that for a more effective implementation and enforcement, a universal adoption of CTT under an international agreement is necessary. In particular, the universality was initially viewed as imperative in order to deal effectively with a race-to-the-bottom approach to tax competition for highly mobile financial services (Garber 1996).23

Such an agreement should specify uniform rules and procedures for subsequent amendments, as well as for the use of the tax revenue. Tobin forwarded a proposal in which the administration of a transactions tax is assigned to the IMF, so that a CTT levy can be tied to IMF membership and borrowing privileges, and hence, ‘universality’ can be ensured. While other existing international organizations such as Bank for International Settlement (BIS) and World Bank can be considered equally as the coordinating and enforcement agencies for CTT, the establishment of a specialized new institution under the UN system for this specific purpose (e.g. an international cooperation fund such as Global Development Fund or World Tax Authority) was also discussed. It was envisaged that under such a proposal, some agreed portion of tax collected by national authorities would be funnelled to a UN sanctioned fund management system or a specially established institution.

4.3.2 New Schemes to Overcome Technical and Political Impediments to CTT

While foreign exchange markets have hitherto been organized as decentralized dealer-driven markets, there appears to be a clear trend towards more centralized automated systems. While this rationalization may entail a reduction in the gross turnover of foreign exchange transactions, it may ease considerably the problem of administration and collection of CTT, as well as that of enforcement. In fact, as Frankel (1996) argues, a CTT may indeed accelerate this centralization process. It has been suggested that automated systems, increasingly used for currency interbank settlements, could be effectively used for tax administration. Proposals made by Schmidt and Mendez fall into this category (Mendez 1995; Schmidt 1999, 2001).

According to Schmidt's proposal, CTT would be collected and enforced at the settlement site, instead of the dealing site as in Kenen's proposal.24 Currently, real time gross settlement systems (RTGS) for payment vs payment settlement (PVP) are used for eliminating settlement risk at the national level. In addition, the Continuous Linked Settlement (CLS) Bank is being developed as a global system of processing settlements involving a number of currencies. The CLS Bank's settlement operations would be linked to domestic systems to support PVP settlement for foreign exchange (p.71) transactions. Seizing this new technological development, Schmidt proposes RTGS as a mechanism for levying a Tobin tax at the national level and CLS Bank's settlement operations for the imposition of CTT for cross-border flows in offshore netting systems. The latter will be monitored and supervised by central banks participating in CTT to deal with the threat of offshore tax avoidance. Schmidt (1999) further suggests that it is technologically easy to apply the Tobin tax to foreign exchange transactions intermediated by an exchange of securities, as securities exchanges around the world operate similar netting settlement schemes through clearing houses.

Mendez (1995, 2001) goes a step further to propose the establishment of a global ‘foreign currency exchange’ (FXE) under the UN system as alternative to the CTT to involve the setting-up of an extensive administrative structure for taxation. Under the Mendez' proposal, the centralized exchange, as a public owned entity in the form of a specialized agency, would be a global network of members comprising of frequent users as well as brokers and dealers, with trading facilities in the major financial centres and branches in other small cities. Members would pay a licensing fee as well as commission on each transaction. In place of CTT, these licensing and user fees would constitute revenues. Mendez predicts that the FXE would significantly lower the cost of changing money to end users by giving them competitive rates due to increased efficiency in exchange markets. In his view, it could also generate revenues of considerable size through transaction fees, rather than a transaction tax, while offering the potential of facilitating the operation of a Tobin type of tax with a view of reducing volatility. Mendez (2001) suggests that the distinctive advantage of FXE over CTT lies in the fact that it is a more market-based approach, and would therefore garner more political support than the Tobin tax. However, under the current international climate, it may be as equally difficult as with CTTs (if not more so), to reach an international agreement for creating and organizing such a global currency market under the UN system, as proposed by Mendez.

Adopting the Schmidt proposal of collecting CTT at the settlement site, Clunies-Ross (2003) argues that a virtually universal application of CTT on wholesale transactions could be achieved through the cooperation of five or so monetary authorities who issue ‘vehicle’ currencies, since almost all wholesale transactions have one of these vehicle currencies on one or both sides. He suggests that CTT at the settlement site would simplify the formidable technical issues associated with the Tobin tax imposed on largely unregulated, decentralized currency markets at the dealing site. It is worth noting here that taxing at settlement incidentally reduces risk penalizing arbitrage transactions considerably, as a tax is applied to a trader's netted out position, rather than to each of his or her transaction flows.25 The problem associated with asset substitution can also be addressed through security exchange taxes or taxes on derivative instruments using a similar centralized mechanism, as suggested by Schmidt. (p.72) Clunies-Ross (2003) assesses further that using the Schmidt scheme, the higher tier tax embedded in the Spahn proposal could be implemented unilaterally by countries facing impeding currency crises, without having an international agreement.

While all these authors emphasize the technical feasibility of CTT, they recognize that the most formidable obstacle is political (Mendez 2001). The main political obstacle in the way to making the CTT universal is the intense opposition anticipated from the US administration/congress and financial industry. So adoption of the CTT on a regional basis has been actively considered. For example, Cecil (2001) examines the possibility of domestic or regional adoptions of CTTs, such as the European Union, with international cooperation for enforcement. Spahn (2002) advances the distinct concept of a politically feasible Tobin tax (PFTT) in the prevailing political reality. Foreseeing fierce opposition from the US administration and Congress,26 Spahn (2002) reckons with the fact that the Tobin tax cannot be introduced universally or multilaterally in the first instance, as the tax has to be legitimized first by existing parliamentary institutions, either national or regional (e.g. the European Council). In the light of the political reality faced by the international community, he actively considers the case in which the Tobin tax can be implemented unilaterally by a group of countries such as the European Union in cooperation with Switzerland.

Following on these arguments, Patomäki and Sehm-Patomäki (1999) also suggest an implementation of CTT in two phases: in the first phase, a group of countries, such as the Euro-EU, would establish an open agreement and a supranational body for tax administration. Member countries would agree to charge a small underlying CTT (e.g. 0.1 per cent) as well as high exchange surcharges, as the need arises. (Their proposed tax rate is much higher than the rates I consider realistic and permissible in the prevailing market and political conditions.) A higher CTT (e.g. 0.2 per cent) is charged in dealing with non-residents who are not in the tax regime, in order to solve the tax evasion problem as well as to exert pressure on outsiders to join. In the second phase, once all major financial centres and most other countries have joined, a universal and uniform CTT would be applied.

Patomäki and Denys (2002) develop this idea further in the ‘draft treaty on global currency transactions tax’ and propose the establishment of a CTT organization under a treaty, which will enter into force following the thirtieth ratification of the treaty or on the date on which the preparatory group has established that the contracting states, who have ratified the treaty account for at least 20 per cent of the global currency markets, whichever is later. The draft treaty has adopted the basic ideas contained in Spahn's two-tier scheme as well as the Schmidt system collection, though it stipulates that the CTT be levied on both wholesale Sand retail markets. (p.73)

4.4 EVALUATION OF THE REVENUE POTENTIAL OF CTTs

4.4.1 Recent Trends in the Composition and Structure of Currency Markets

There are several important changes in foreign exchange markets in recent years, which can have a critical bearing on our estimates of CTT revenues. As shown in Table 4.1, according to the BIS survey data conducted in April 2001, average daily net turnover was US$1.2 trillion, compared to US$1.49 trillion in April 1998, which is a 19 per cent decline at current exchange rates and a 14 per cent fall at constant exchange rates as calculated by BIS (2002).27 The decline in turnover between 1998 and 2001 is in sharp contrast to the rapid steady increase in turnover over the last two decades, found in the earlier surveys. The level of activities in currency markets in 2001 settled down to the level reported for 1995.

Table 4.1 Global foreign exchange market turnovera daily averages in April, in billions of US$

1989

1992

1995

1998b

2001

Spot transactions

317

394

494

568

387

Outright forwards

27

58

97

128

131

Foreign exchange swaps

190

324

546

734

656

Estimated gaps in reporting

56

44

53

60

26

Total ‘traditional’ turnover

590

820

1,190

1,490

1,200

Memo: Turnover at April 2001 exchanges ratesc

570

750

990

1,400

1,200

Notes: (a) Adjusted for local and cross-border double-counting.

(b) Revised since the previous survey.

(c) Non-US dollar legs of foreign currency transactions were converted from current US dollar amounts into original currency amounts at average. Exchange rates for April of each survey year and then reconverted into US dollar amounts at average April 2001 exchange rates.

Source: BIS (2002: Table B1).

The decline is largely accounted for by a sharp fall in spot transactions, and to a lesser extent, in foreign exchange swaps, while outright forward transactions showed a slight increase. Thus, there are some notable changes in the market composition by type of transactions as shown in Fig. 4.1. The share of spot transactions has steadily declined since 1992, while that of foreign exchange swaps has risen, now accounting for over 55 per cent of transactions. According to the BIS survey, 38 per cent of outright forwards and 69 per cent of swaps are with a maturity of up to seven days. Together (p.74) with spot transactions, this brings the share of transactions with maturity up to seven days to 76 per cent in 2001, close to the estimate of 80 per cent as transactions involving roundtrips of seven days or less, as noted in Tobin (1996).

Revenue Potential of the Tobin Tax for Development Finance: A Critical Appraisal

Figure 4.1. Foreign exchange market turnover at constant April 2001 exchange rates by market segment in per cent of global turnover

Non-US dollar legs of foreign currency transactions were converted into original currency amounts at exchange rates for April of each survey year and then reconverted into US dollar amounts at average April 2001 exchange rates.

Source BIS (2002: Graph B.1).

There are also some changes in the relative market share accounted for by the different counterparties. As shown in Table 4.2, trading between reporting dealers declined sharply, bringing its share in total turnover from 70 per cent in 1992 to 59 per cent in 2001 (Fig. 4.2). A marked decline in trading between banks and non-financial customers is reported here, which now accounts only for 13 per cent of transactions. This may have reflected the acceleration of the consolidation process observed in the non-financial corporation sector. The increased transactions between banks and other financial institutions are accounted for by the increasing role of asset managers (BIS 2002: 2). At the same time, the role of hedge funds in foreign exchange transactions has declined since their debacle in 1998.

Table 4.2 Reported foreign exchange market turnover by counterpartya daily averages in April, in billions of US$

1992

1995

1998b

2001

Total

776

1,137

1,429

1,173

With reporting dealers

540

729

908

689

With other financial institutions

97

230

279

329

With non-financial customers

137

178

242

156

Local

317

526

657

499

Cross-border

392

611

772

674

(a) Adjusted for local and cross-border double-counting. Excludes estimated gaps in reporting

(b) Revised since the previous survey.

Source: BIS (2002: Table B3).

Revenue Potential of the Tobin Tax for Development Finance: A Critical Appraisal

Figure 4.2. Foreign exchange market turnover by counterparty as per cent of total reported turnover

Source BIS (2002: Graph B.2).

(p.75)

The marked decline in global foreign exchange market turnover in the 2001 survey undoubtedly reflects the general slowdown of the global economy and world trade as well as the increased economic and political uncertainty of recent years. However, a reduction of this scale as well as the significant changes in market structures is also an indication of the growing trend towards the centralized, automated systems in the settlement of wholesale currency transactions discussed above.28 Thus, BIS (2002) also notes the growing role of electronic brokers in the spot interbank market, reducing the need for dealers to trade actively. The decline in wholesale interbank transactions is also explained by the steady trend towards concentration in the banking sector, observed in the major currency markets as well as globally, thus decreasing the number of trading desks (BIS 2002: Table B.5).29

The introduction of the euro has also reduced gross foreign exchange market turnover, as it eliminated the need for intra-EMS trading (Table 4.3). Dollar/euro trade constitutes 30 per cent of the global turnover, followed by dollar/yen with 20 per cent and dollar/GBP with 11 per cent (Table 4.4).

Table 4.3 Currency distribution of reported foreign exchange market turnovera percentage shares of average daily turnover in April

1989

1992

1995

1998b

2001

US dollar

90.0

82.0

83.3

87.3

90.4

Euro

37.6

Deutsche markc

27.0

39.6

36.1

30.1

French franc

2.0

3.8

7.9

5.1

ECU and other EMS currencies

4.0

11.8

15.7

17.3

Japanese yen

27.0

23.4

24.1

20.2

22.7

Pound sterling

15.0

13.6

9.4

11.0

13.2

Swiss franc

10.0

8.4

7.3

7.1

6.1

Canadian dollar

1.0

3.3

3.4

3.6

4.5

Australian dollar

2.0

2.5

2.7

3.1

4.2

Swedish kronad

1.3

0.6

0.4

2.6

Hong Kong dollard

1.1

0.9

1.3

2.3

Singapore dollard

0.3

0.3

1.2

1.1

Emerging market currencies(d,e)

0.5

0.4

3.0

5.2

Other

22.0

8.5

7.9

9.3

10.1

All currencies

200.0

200.0

200.0

200.0

200.0

(a) Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%. The figures relate to reported ‘net-net’ turnover, that is, they are adjusted for both local and cross-border double-counting, except for 1989 data, which are available only on a ‘gross-gross’ basis. More details about emerging market and other currencies are provided in BIS (2002: Annex Tables E.1.1 and E.1.2).

(b) Revised since the previous survey.

(c) Data for April 1989 exclude domestic trading involving the Deutsche mark in Germany.

(d) For 1992–8, the data cover home currency trading only.

(e) For 1992 and 1995, South African rand; for 1998 and 2001, Brazilian real, Chilean peso, Czech koruna, Indian rupee, Korean won, Malaysian ringgit, Mexican peso, Polish zloty, Russian rouble, Saudi riyal, South African rand, Taiwan dollar, and Thai baht.

Source: BIS (2002: Table B.4).

Table 4.4 Reported foreign exchange market turnover by currency paira daily averages in April, in billions of US$ and percentages

1992

1995

1998b

2001

Amount

% share

Amount

% share

Amount

% share

Amount

% share

US dollar/euro

354

30

US dollar/mark

192

25

254

22

290

20

US dollar/French franc

19

2

51

4

58

4

US dollar/ECU

13

2

18

2

17

1

US dollar/other EMS

43

6

104

9

172

12

US dollar/yen

155

20

242

21

256

18

231

20

US dollar/sterling

77

10

78

7

117

8

125

11

US dollar/Swiss franc

49

6

61

5

79

5

57

5

US/Canadian dollar

25

3

38

3

50

3

50

4

US/Australian dollar

18

2

29

3

42

3

47

4

US dollar/other

48

6

72

6

167

12

195

17

Euro/yen

30

3

Euro/sterling

24

2

Euro/Swiss franc

12

1

Euro/other

21

2

Mark/yen

18

2

24

2

24

2

Mark/sterling

23

3

21

2

31

2

Mark/Swiss franc

13

2

18

2

18

1

Mark/French franc

10

1

34

3

10

1

Mark/ECU

6

1

6

1

3

0

Mark/other EMS

21

3

38

3

34

2

Mark/other

20

3

16

1

20

1

Other EMS/other EMSc

3

0

3

0

4

0

Other currency pairs

23

3

30

3

38

2

27

2

All currency pairs

776

100

1,137

100

1,430

100

1,173

100

(a) Adjusted for local and cross-border double-counting. Data in this table are not directly comparable with Table 4.4 for currency groups.

(b) Revised since the previous survey.

(c) The data cover home currency trading only.

Source: BIS (2002: Table B.6).

Major trading locations such as London, New York, and Tokyo continuously dominate foreign exchange transactions, accounting together for 56 per cent of global transactions (Table 4.5). London remains the largest centre, larger than New York and Tokyo combined. The ten trading centres listed in Table 4.5 handle 85 per cent of global currency transactions.

Table 4.5 Geographical distribution of reported foreign exchange market turnover daily averages in April, in billions of US$ and percentages

1989

1992

1995

1998

2001

Amount

% share

Amount

% share

Amount

% share

Amount

% share

Amount

% share

United Kingdom

184

25.6

291

27.0

464

29.5

637

32.5

504

31.1

United States

115

16.0

167

15.5

244

15.5

351

17.9

254

15.7

Japan

111

15.5

120

11.2

161

10.2

136

6.9

147

9.1

Singapore

55

7.7

74

6.9

105

6.7

139

7.1

101

6.2

Germany

55

5.1

76

4.8

94

4.8

88

5.4

Switzerland

56

7.8

66

6.1

87

5.5

82

4.2

71

4.4

Hong Kong SAR

49

6.8

60

5.6

90

5.7

79

4.0

67

4.1

Australia

29

4.0

29

2.7

40

2.5

47

2.4

52

3.2

France

23

3.2

33

3.1

58

3.7

72

3.7

48

3.0

Canada

15

2.1

22

2.0

30

1.9

37

1.9

42

2.6

source: Compiled from Table B.7 in BIS (2002).

(p.76)

Despite the marked decline in market turnover between 1998 and 2001, the relative size of foreign exchange markets is still staggering, as shown in Table 4.6. Annual world exports stood at US$6,121 billion, compared to the annualized global foreign exchange market turnover of US$300 trillion. This means that the ratio of global exports to global foreign exchange turnover is 0.02—an increase from the low level of 0.015 in 1998, but far less than the ratios observed in the 1970s. Felix and Sau (1996) report that these ratios for 1977, 1980, and 1983 were 0.29, 0.09, and 0.06, respectively.

Table 4.6 Foreign exchange trading, world trade and global official reserves, in billions of US$ and percentages

1989

1992

1995

1998

2001

Annual world exports

3,027

3,762

5,130

5,444

6,121

Annual exports of developing countries

899

1,112

1,661

1,779

2,252

% share of developing country exports

29.7

29.6

32.4

32.7

36.9

Global official foreign exchange reserves

715

925

1,385

1,638

2,039

Foreign exchange reserves of developing countries

262

434

729

968

1,260

% share of developing country reserves

36.6

46.9

52.6

59.1

61.8

Annual global foreign exchange turnover (250 trading days)

147,500

205,000

297,500

372,500

300,000

Exports/foreign exchange turnover (%)

2.05

1.83

1.72

1.46

2.04

Reserves/exports (%)

23.6

24.6

27.0

30.1

33.3

Reserves/daily turnover (days)

1.21

1.13

1.16

1.10

1.70

source: Author's calculation, based on data in International Financial Statistics (IMF) and BIS (2002).

Critically, global official foreign exchange reserves, which have been increasing steadily since the ERM crises in 1992, are equal to merely 1.7 days of global currency transactions. This reveals the meagre capacity of monetary authorities to intervene (p.77) (p.78) (p.79) in foreign exchange markets in the face of speculative self-fulfilling attacks on their currencies. Monetary authorities have been trying to improve their defence capacity by raising official reserve holdings from 25 per cent of global exports in 1992 to 33 per cent in 2001. Table 4.6 shows clearly that developing countries, which are more likely to face currency crises, are forced to hold larger reserves in relation to the size of their economies at very high opportunity costs. The share of developing countries in global reserve holdings has increased consistently from 37 per cent in 1989 to 62 per cent in 2001, in contrast to their share in world exports of 37 per cent in 2001.

4.4.2 Revenue Potential and Tax Implementation

Previous studies produced various estimates of potential revenue from the Tobin tax, predicting a very considerable tax revenue, as tax rates of 0.25–0.05 per cent are commonly used for calculation. For example, Frankel (1996) estimates that the 0.1 per cent tax applied to the 1995 global foreign exchange would generate an annual tax revenue of US$176 billion, after taking into account that the 0.1 per cent tax would reduce transaction volume by 45 per cent and allowing for a 20 per cent deduction for exempted official trading and tax evasion. Applied to the volume reached in 1995, Tobin (1996) reckons that the revenue is more likely to be US$94 billion maximum. His estimate is based on the assumption that only 30 per cent of the gross volume of transactions constitutes a taxbase if banks' end-of-day open positions only are taxed with a 0.1 per cent one-way tax. He concedes revenue could be less than US$50 billion if the tax-induced reduction of volume is taken into account.

(p.80) Felix and Sau (1996) produce a range of potential revenue estimates, applying varying assumptions with regard to: (i) tax rates of 0.25, 0.1, and 0.05 per cent; (ii) pre-tax transaction costs, ranging from 0.1 to 1 per cent; and (iii) elasticities of trade volume in response to tax-induced changes in transaction costs, ranging from 0.3 to 1.75.30 According to their estimates, the 0.1 per cent tax applied to the 1995 global foreign exchange would generate tax revenue of US$148 billion and US$180 billion, under the assumption of pre-tax transaction costs of 0.5 and 1.0 per cent, respectively. The 0.05 per cent tax rate, suggested by Kenen (1996), is estimated to produce tax revenue of US$90 billion and US$97 billion.

Felix and Sau are correct in estimating revenue potential on the basis of the elasticity of the volume with respect to currency transaction costs, which should absorb a tax burden. They note, ‘by adding to transaction costs, a Tobin tax not only reduces the foreign exchange volume by an amount determined by the weighted average elasticity of volume with respect to costs, but alters its composition by squeezing hardest the low-unit-profit, high elasticity transactions such as covered interest arbitraging’ (Felix and Sau 1996: 228). However, their estimated pre-tax transaction costs of 0.1–1.0 per cent appear to be too high in relation to the wholesale segments of foreign exchange markets as observed today.31

Transaction costs are reflected in the bid-ask spreads observed in markets.32 The more liquid markets are, the lower spreads can be. Spahn reports that the spreads currently observed in highly liquid interbank wholesale markets are 0.011 per cent for the US dollar/euro transactions, 0.023 per cent for the US dollar/yen transactions, and 0.021 per cent for the US dollar/GB pound (Spahn 2002: appendix 4). However, reflecting a more fragmented nature with less competition because of asymmetric information disadvantages affecting retail, non-financial customers, spreads observed in retail segments are much larger and vary widely across markets.33

While CTT is supposed to reduce the transaction volume in short-horizon roundtrips or to affect the speed of traders' responses, it is unable to differentiate between destabilizing noise trading and stabilizing liquid trading in the wholesale markets. Given the substantial changes taking place in market structures in the wholesale interbank segments as a result of the new technological development discussed above, it is now unwise to impose a high tax rate to trigger further significant disturbances to market liquidity in the wholesale segments. Indeed, as many argue, it is best to adopt a (p.81) phase-in approach, whereby markets would have time to respond to the introduction of CTT gradually and in a stable manner.34

This line of thinking would set an upper limit to the CTT levied on interbank transactions at 0.01–0.02 per cent (1 or 2 basis points) as a ‘permissible rate’ in the light of the spreads in the wholesale segments reported above.35 Hence, these very low tax rates, much lower than those used in previous studies, are selected and used in the revenue estimation produced below with a view of minimizing the adverse effects on the liquidity of the wholesale dealer markets, where also profit margins are known to be very thin. Indeed, for this very reason, the transaction cost reflected in the prevailing bid-ask spread in the wholesale segments is used as a yardstick for setting the permissible tax rate. At the same time, I conjecture that, based on calculations made by Frankel and Spahn,36 the tax rates considered here could still provide enough disincentives to traders not to engage excessively in noise trading.

As mentioned above, the spreads are higher in less liquid retail foreign exchange markets, where transactions are much less cost-elastic. From this point of view, retail markets can in principle absorb a higher tax rate in transaction costs. However, the tax imposed on wholesale trading is more likely to be passed to less competitive retail transactions in the form of higher spreads, especially given the cost-inelastic demand. Since a single retail transaction typically gives rise to a chain of subsequent interbank transactions until a dealer closes his or her ensuing open position, an effective tax rate resulting from the 0.01 to 0.02 per cent tax imposed on wholesale transactions could be translated into additional spreads of 0.04–0.1 per cent or more in retail market segments. This suggests that there may be a heavier tax burden on international trade transactions than hitherto acknowledged and tax incidence of CTT may go far beyond financial institutions, contrary to the claim made otherwise.37 For this reason, the scale of the rise in the spreads as result of the CTT at 1 or 2 basis points proposed here would, in my view, approach the maximum level that could be introduced to retail segments. This transfer of burden across segments eliminates, at least partially, the need to levy differentiated tax rates to wholesale and retail segments, as suggested by Kenen (1996).

Hence, in my calculation of potential revenue from CTTs, two estimates are produced: (i) one estimate is based on the assumption that the tax rate to wholesale transactions is one-half of that applied to retail transactions; and the other estimate (ii) on the assumption that a unified tax rate is applied across the two segments of foreign exchange markets. It is further assumed that a tax applied to all derivative (p.82) transactions will be one-half of the rate applied to spot transactions, as derivative dealings are high-frequency trading by their nature and function. The taxbase is assumed to be virtually global in my estimate.

In my calculation I have also made the assumption that both retail and wholesale transactions are taxed at the dealing site on a market basis, as suggested by Kenen (1996). This assumption was adopted simply because the turnover at the settlement site is not made available in the BIS survey. Hence, I assume that the major trading cites listed in Table 4.5 would agree to participate in CTT. I also conjecture, for the purpose of simplifying revenue estimates, that the very low tax rate used in my estimate will produce a light tax burden on all transaction parties and considerably reduce the incentive for tax avoidance through migration and asset substitution. The latter possibility is minimized particularly if CTT is adopted universally, as assumed in the estimates produced here.

My estimates presented below are based on the assumption that alternative tax rates of 1 or 2 basis points are applied to the global taxbase as described earlier. It is also assumed that the share of official transactions carried out by monetary authorities in global turnover is about 8 per cent.38 Hence, this amount and other possible leakages, amounting to 10 per cent of total turnover, are deducted from the taxbase as non-taxed instruments. At these moderate tax rates, retail transaction volume is assumed to be virtually unaffected, while excessive noise trading in wholesale segments would respond to an introduction of CTT at these rates.

In this respect, my approach differs from the assessment by Felix and Sau, who regard tax rates of less than 5 basis points as tax rates with no ‘sand in the gears’. Instead, I reckon that tax rates of 1 or 2 basis points would still act as ‘sand in the wheels’ in the environment with equally low transaction costs and profit margins as observed in interbank markets today. Naturally, a reduction in volume would be much less at these low rates than the 33 per cent obtained with the elasticity about 0.32 used by Felix and Sau (1996) and Frankel (1996). In my estimates, it is assumed that a 0.02 per cent tax and 0.01 per cent tax would reduce the volume of wholesale transactions (i.e. excluding transactions with non-financial customers) by 15 and 5 per cent, respectively. These are somewhat arbitrary numbers as was the case in other estimates, since no estimate on the cost-elasticity of foreign exchange trading volume is known a priori. I have also proceeded with the calculations on the basis of additional information available in the BIS survey on the share of transactions with non-financial customers in outright forwards transactions (29 per cent) and foreign exchange swaps (9 per cent).

My estimates of the CTT revenue potential under alternative tax rates applied to different modes of transactions are shown in Table 4.7. My estimates show that CTT (p.83) at 2 basis points applied to wholesale transactions would generate a annual revenue of about US$30–35 billion, while CTT at 1 basis point would produce US$17–19 billion. My revenue estimates are much lower than the US$53 billion suggested by Clunies-Ross (2003). My lower estimate of US$35 billion at 2 basis points under the scenario of no volume reduction is accounted for by the half rate applied to derivatives transactions. I have taken a view that CTT should not discriminate against high-frequency transactions conducted for risk-hedging purposes, unless it could greatly reduce exchange rate volatilities. In general, I applied an estimation procedure, so that the estimate could provide us with a clue of the revenue size that the global community could expect from CTT at the prevailing level of foreign exchange trading activities.

Table 4.7 CTT revenue estimate applied to 2001 foreign exchange trade volumes

Daily average transactionsa

0.02% Tax applied to wholesale transactions

0.01% Tax applied to wholesale transactions

Daily turnover

Adjusted by trad volume reduction at:

Revenue with no volume reductionb

Tax rate

Revenue with volume reductionb

Revenue with no volume reductionb

Tax rate

Revenue with volume reductionb

0.02%

0.01%

A

B

A

B

A

B

A

B

Total turnover

1,200

BIS adjusted turnover

1,173

less non-taxed instruments

-117

Taxable base of which:

1,056

1) Spot transactions

348

304

333

69.6

0.02

60.8

34.8

0.01

33.3

wholesale

296

252

281

0.02

50.4

0.01

28.1

retail

52

52

52

0.04

20.8

0.02

10.4

2) Outright forward

118

105

114

11.8

0.01

10.5

5.9

0.005

5.7

wholesale

85

72

81

0.01

7.2

0.005

4.1

retail

33

33

33

0.02

6.6

0.01

3.3

3) Foreign exchange swaps

590

510

563

59

0.01

51.0

29.5

0.005

28.2

wholesale

536

456

509

0.01

45.6

0.005

25.5

retail

54

54

54

0.02

10.8

0.01

5.4

Daily revenue

140.4

141.4

122.3

70.2

76.8

67.2

Annual CTT revenuea

35.1

35.4

30.6

17.5

19.2

16.8

Notes: (a) Billions of US dollars.

(b) Millions of US dollars.

Case A refers to the estimates made on the assumption that the tax rate to wholesale transactions is one-half of that applied to retail transactions.

Case B refers to the estimates made on the assumption that a unified tax rate is applied across two segments of currency markets.

Source: Author's calculations based on BIS data.

These revenues would be collected on a market basis by monetary or tax authorities of the countries where these markets are located (see Table 4.5 for geographical location of major market sites).39 Clunies-Ross (2003) regards CTT as ideal for global use, since the burden would be borne more or less proportionately to a country's income, adjusted by the degree of openness. He continues to suggest that ‘whereas those that would be collecting it would be rich countries, and even among those countries themselves, the revenue collected would bear little or no relationship to the burden borne’ (2003: 7). Hence, he concludes that revenue retention by the tax collecting governments would be highly objectionable in a moral/political sense.

While CTTs should be carefully evaluated according to economic criteria set out by Atkinson (Chapter 2, in this volume), CTTs present the potential of generating approximately US$15–28 billion for global public use, if the national retention rate from CTT revenues is agreed at 20 and 70 per cent for developed and developing countries, respectively (Patomäki and Denys 2002) (though many argue that the retention rate for developing countries could be 100 per cent).

4.5 CONCLUDING REMARKS

In this chapter, I have argued that the currency transaction taxes should be implemented in an extremely cautious manner, starting with a very low tax rate. This is deemed necessary in light of the recent structural changes in foreign exchange markets as well as considerations of market efficiency, liquidity, and technical and political feasibility. According to my preliminary estimates and assessments based on these considerations, the contribution that CTT could make towards generating innovative sources for global finance may be much smaller than those derived from earlier studies. If CTT is collected and enforced on the netting settlement sites with the use of new technology such as the CLS Bank's operations, revenue from CTT may even be smaller than those presented here. In my view, therefore, the very high expectations raised with respect to CTT's revenue-generating capacity on its own are not as yet warranted, in light of the prevailing economic and political reality today.

(p.84)

(p.85) Nor does CTT by itself, implemented at low rates, have sizeable effects on restoring macroeconomic policy autonomy. However, if CTT is successfully administered in the two-tier structure as stipulated by Spahn or in conjunction with other measures such as capital controls or security transaction tax (STT) in a coordinated fashion, potential benefits in double dividends from these measures would render support to the debate over its implementation. The revenue generated by CTT and STT combined could indeed far surpass the currently stagnating flows of official aid from OECD countries to developing and transitional economies, which in recent years has been running at the level of US$50 billions (see Atkinson, Chapter 2, this volume).40 At the same time, these measures combined may create a new condition, in which many emerging economies would no longer be forced into a two-corner solution of either ‘fearful floating’ with high, variable interest rates or ‘hard pegs’ such as full dollarization or monetary unions at the cost of involuntarily losing an independent monetary policy.41

Indeed, the two-tier CTT structure proposed by Spahn or other dual taxation schemes could have the potential of achieving what the unified single transaction tax at a low tax rate alone would fail to deliver—the restoration of credibility to intermediate exchange rate regimes and some autonomy of macroeconomic policy. That is, the ‘impossible trinity’ could be mitigated with the application of this system, as three objectives—financial openness, exchange rate stability and monetary independence—become more compatible in the triad.

Furthermore, the coordinated approach considered here would curtail the potential for leakages from these policies, such as might result from asset substitution, market migration, or tax evasion. Indeed, there are substantial economies of scale to be gained from the combined application of CTTs and STTs with the use of centralized settlement mechanisms, as discussed above. The coordinated approach also increases the political feasibility of these measures by substantially lowering further the tax rate necessary on any single tax measure. Finally, the cross-border harmonization of these tax measures would reduce the potential for leakages.

The official development aid available today is vastly inadequate for the needs of developing countries.42 The currency transaction taxes considered in this chapter could serve as one critical innovative financial source for development finance. In this context, possible merits of taxing capital transactions should be evaluated against the historical background of the progressively reduced tax burden on capital income, relative to labour income, in the current era of financial globalization.

The CTT may be regarded more as a new additional source for development finance, rather than as a possible substitute for (or alternative to) official development assistance (p.86) (ODA). Naturally, this may not be the case if the availability of vast revenues from CTT would make ODA less generously available.

The technical feasibility of implementation and enforcement can be substantially enhanced, and the cost of tax administration of CTT can also be reduced correspondingly, with the introduction of automated clearing and settlement mechanisms adopted globally, such as the CLS Bank settlement scheme discussed here. However, the cost of reaching a political consensus and commitment towards the universal adoption of CTT remains high. In light of this high political (and administration) cost, many regard CTT as a ‘leaky bucket’, to use Atkinson's terminology. Dodd (2003) argues, for example, that the Tobin tax cannot be achieved politically, and hence the pursuit wastes much effort and resources.

Furthermore, an introduction of CTT will trigger a further change in foreign exchange market structures as well as in the structure of the financial industry. With their small profit margins, smaller traders and dealers may be hurt more, leading to a further consolidation of the industry.

Whether or not a flexible geometry—considered the practical way forward with a subset of countries (Chapter 2, this volume)—can be successfully applied to this politically contentious tax instrument has been debated, and several schemes in this regard have been proposed, though yet to be carefully evaluated. The fiscal architecture emerging from such an analysis would certainly involve not only tight coordination of the taxbase, but also close cooperation in the implementation and administration of CTT under an international agreement, such as envisaged in the treaty proposal by Patomäki and his associates.43

Naturally, CTT implemented partially on the basis of regional tax coordination alone is a second-best solution compared to global implementation, and would produce a negative effect akin to ‘trade diversion effect’ found in literature on custom unions. Indeed, Fuest et al. (2003) find that there are welfare gains from regional tax coordination, but that these gains are lower than those from worldwide coordination. Further, the application of CTT, for example, for the euro-zone only would certainly induce changes in the relative position of the euro versus the US dollar, as the vehicle currency used in international trade and financial transactions as well as in official reserve holdings. However, the direction of these changes may not necessarily be uni-directional as often predicted by the financial community. The euro may—as result of CTT and despite the penalty of transaction tax—become the more stable (and hence preferred) currency for holding in agents' portfolio. If the tax rate is kept small as considered here, the positive effect of CTT on the euro may, indeed, outweigh the negative effect vis-à-vis the dollar or yen. While the fears expressed by the financial community would justify the lower end of the tax rate, the euro may emerge stronger rather than weaker after an introduction of CTT.

It should also be noted that the tax incidence of CTT could be much deeper and wider than hitherto suggested. An impact of CTT on real economic activities, as (p.87) opposed to purely speculative financial activities, could be greater than what has been acknowledged so far in literature. Hence, this is an additional factor for considering a very low tax rate. CTT could become indeed a leaky bucket in this aspect, if it discourages people from participating in international trade and investment. However, these possible negative effects of CTT on the cross-border trade of goods and services and direct investment should be assessed and balanced carefully in light of the sizeable negative effects that excessively volatile exchange rates can have on international trade and investment flows. The welfare loss from a currency or financial crisis that is endured by the affected emerging economies and the global community at large is immeasurably large. Hence, in assessing CTT as a tax instrument for global finance, it is important to keep in mind that its benefits for achieving a global double dividend for the world economy may not be negligible, particularly if CTT is successfully implemented in conjunction with other measures of capital controls or in a multi-tier system.

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Notes:

The author gratefully acknowledges invaluable comments and suggestions received on early versions of the chapter from the project director, Tony Atkinson. She has also benefited from helpful comments received from Tony Addison, Anthony Clunies-Ross, Ilene Grabel, John Langmore, George Mavrotas, Alice Sindzingre and participants at the UNU–WIDER project meeting in May 2003 and conference in September 2003. She extends her gratitude to anonymous referees for their detailed comments for improving the clarity of the chapter.

(1) See Obstfeld (1998) for a summary exposition how economic theory weighs costs and benefits associated with financial globalization. For a more critical literature review of economic propositions concerning the effects of financial globalization on economic development and welfare, see Nissanke and Stein (2003).

(2) Interestingly, the very constraints that financial openness places on the policymakers of emerging market economies in macroeconomic management are often treated as beneficiary, since the international capital market is seen to play the role of ‘disciplining’ policymakers ‘who might be tempted to exploit a captive domestic market’ (Obstfeld 1998: 10).

(3) This also means less freedom for providing social safety nets to people adversely affected by globalization (Rodrik 1997).

(4) See Boadway (Chapter 11, this volume) and Fuest et al. (2003) for a detailed discussion on this issue.

(5) See Frankel (1996) for a mathematical model illustration of how a Tobin tax discourages short-term destabilizing speculation without discouraging investment and trade flows with longer maturities. Indeed, Frankel identifies the ability of the Tobin tax to penalize short-term roundtrips relative to transactions with longer maturities as their most attractive attributes. Davidson (1997) argues, however, that the effect of the Tobin tax on speculative flows is overstated when it is derived from calculations based on annualized rates. He suggests that the Tobin tax, like all transactions costs, is independent of the roundtrip time interval and therefore its deterrent capability is not a function of the time period. He argues instead that investors/traders base their decisions in relation to transaction costs and that as long as the Tobin tax rate is an insignificant addition to transaction costs and very marginal compared to expected gains from speculation, it does not deter short-term roundtrip transactions. In my view, so long as a trader's/investor's decision on asset portfolio is made in relation to a certain asset-holding period, calculation on relative returns based on uncovered interest parity condition is relevant in measuring the effect of the Tobin tax on short-term interest arbitrage. However, since traders' decisions are also based on the relative cost–benefit configuration in the immediate future, transaction costs are undoubtedly a critical parameter against which the tax rate has to be evaluated (see Section 4.4).

(6) In this connection, it is also worth noting that in Dornbusch's overshooting model, the assumption of regressive expectations plays a critical role in ensuring a return of short-run overshooting exchange rates to the long-run equilibrium level dictated by the purchasing power parity (Dornbusch 1976).

(7) See Dooley (1996), Davidson (1997), Habermeier and Kirilenko (2003), and Dodd (2003), among other numerous papers.

(8) Habermeier and Kirilenko (2003), emphasizing the informational role of liquidity in the price discovery process, argue that taxing financial transactions introduces additional friction into this process.

(9) Interdealers and interbank transactions are referred to as ‘wholesale’ transactions, as opposed to transactions involving non-financial customers in ‘retail’ segments. See Section 4.4 for the composition of currency transactions by counter-party and its recent shifts in markets.

(10) Keynes (1936) uses a ‘beauty contest’ analogy to describe fund managers' herd behaviour, in that they must guess in an instant how other market players will interpret a new event and follow them accordingly.

(11) In this context, it is worth noting that in Krugman's model of the target zone (1991), the result that speculators could have a stabilizing effect at margins of the target zone depends critically on two assumptions: (i) speculators' expectations are guided by macroeconomic fundamentals; and (ii) the government's credible commitment to intervene prevails.

(12) Applying the interest parity condition, Frankel (1996) estimates that even at the very modest rate of transaction tax rate of 0.001%, for traders with a one-day time horizon to engage in speculative transaction, the foreign yield would have to rise to 46.5%, compared to domestic yield of 10%. Similarly, Spahn (2002) estimates that at a tax rate of 0.1%, foreign yields would have to rise to 50.7%, 18.5%, and 10.7% compared to domestic yield of 5%, for traders with one-day, three-day, and one-week time-horizon, respectively.

(13) It has been suggested that the Tobin tax could be set as a percentage of spreads, which can eliminate the need for setting a tax rate as a percentage of trade turnover. However, in our view, because of the fragmented nature of the retail segments of currency markets, this would simplify neither tax administration nor revenue estimation as such. We shall return to this question in Section 4.4.

(14) Responding to Davidson's arguments that the effect on trade volume of Tobin tax at a low rate is minimum, Korkut (2002) suggests that the stabilizing effect of the Tobin tax is realized more through its negative impact on the speed of reaction of market traders to price changes.

(15) Davidson (1997) emphasizes this problem, noting that to avert the speculative surge of the Mexican peso crisis of 1994–5, Tobin tax exceeding 23% would have needed.

(16) Spahn (2002) refers the exchange surcharge as an exchange-rate normalization duty (ENRD). Further, Grabel (2003) classifies potential measures managing cross-border capital flows into ‘trip wires’ and ‘speed bumps’. An exchange surcharge in the Spahn proposal is an example of a speed bump measure that might be activated whenever trip wires reveal that a currency is vulnerable to speculative attack.

(17) In the recent literature on the appropriate exchange regime for emerging market economies, the term of ‘two-corner solutions’ is used to refer to a freely floating exchange rate or hard pegs such as currency boards, dollarization, or regional monetary union in the context of discussing the ‘impossible trinity’ thesis (see Frankel 1999, for example).

(18) Williamson (2000) lists the fundamental reasons found in literature for preferring a band system over floating: (i) the band performs the function of crystallizing market expectations of where the equilibrium exchange rate may lay, thus making expectations stable at the time-horizons relevant for influencing market behaviour (Svensson 1992); (ii) a band has a pronounced effect in limiting exchange rate variability by preventing noise traders, particularly stop-loss traders, from making money by introducing noise into the exchange market (Rose 1996).

(19) The empirical rejection of this model is usually explained in terms of imperfect credibility and intra-marginal interventions (Garber and Svensson 1995; Sarno and Taylor 2003).

(20) Tobin (1996) remarks that the concerns about tax evasion may be generally overblown. Baker (2001) also argues that the ‘evasion issue’ has got too much attention in relation to CTTs and even capital controls. However, though this may be the case, a possibility of evasion can affect the efficacy of any tax as well as the cost of enforcement, so the evasion issue should be carefully examined. See Umlauf (1993) for the asset migration effects of transaction taxes on the Swedish stock market.

(21) Kenen suggests imposing a 5% punitive tax on transactions with a new dealing site, rather than one-half of the standard rate of 0.05% (i.e. 0.025% for wholesale trading).

(22) While spot transactions are settled in less than three days, forward transactions take three or more days and swap transactions pair either a spot transaction with an offsetting forward transaction, or two forward contracts with different maturities. Hence, if only spot transactions are taxed, forward and swap contracts could easily be used as substitutes. Tobin acknowledges the need for this modification to the taxbase (1996).

(23) For a more recent proposal on CTT coverage, see discussion below.

(24) This means that tax revenues generated by the Schmidt scheme would be substantially lower than the estimates based on CTT imposed at the dealing site, as many foreign exchange transactions are netted out.

(25) Thus, taxing at the settlement site would mitigate, to a certain degree, the criticism against a transaction tax imposed on the flow in view of the understanding that speculative threats originate from an overhang of a stock of short-term claims. I am grateful to John Williamson for pointing to the need for drawing sufficient attention to this question.

(26) In the Second Session of the 104th Congress of the United States, Senator Bob Dole and three other politicians introduced a bill to prohibit the UN and UN officials from developing and promoting Tobin's idea or any other international taxation scheme.

(27) Forty-eight central banks and monetary authorities participated in the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activities conducted by the Bank for International Settlement in 2001. The geographical coverage of the BIS survey has steadily expanded from the twenty-one countries in 1989.

(28) However, as CLS Bank became operational only in autumn 2002, the trade volume revealed by the BIS survey conducted in April 2001 could not be affected by this new technology applied to settlements in global foreign exchange trade.

(29) BIS (2002) suggests the decline in turnover can also be explained by the decrease in the risk tolerance of banks after the financial crises in 1998, which led to a reduction in credit limits and proprietary trading.

(30) Felix and Sau (1996) allow a 35% reduction for exempted official trading and tax evasion, compared to the 20% allowed in Frankel's estimate.

(31) Especially, it is not correct to assume uniform transaction costs across different market segments in their model and estimation, where Felix and Sau use the weighted average size of pre-tax transaction costs.

(32) The spreads also include risk premium and premium arising out of asymmetric information.

(33) For this reason, the revenue calculation presented here is not based on an alternative method of calculating tax revenue as a unified percentage of spreads (see note 13 above). Indeed, a unified CTT calculated as a percentage of spreads across the two market segments could make tax effects on real cross-border trade and investment more (not less) in most cases.

(34) Felix and Sau (1996: 230) suggest that as ‘the increments to the Tobin tax rates are phased in, the reduced annual global foreign exchange will become more stable, at least regarding further changes in transaction costs’.

(35) Spahn (2002) suggests that given that spreads in interbank transactions were in the range of 0.04-0.05 in 1995 when the traded volume was roughly similar to that observed in 2001, the 0.02% tax would not damage market liquidity too much.

(36) See footnote 12.

(37) Considering this possibility, Davidson (1997: 679) suggests that ‘a Tobin transaction tax might throw larger grains of sand into the wheels of international real commerce than it does into speculative hot money flows’.

(38) This figure is derived from the information in Table 4.4, where the share of the pair transactions between US dollar and others is reported as 17% in 2001. It is assumed that about one-half of this was carried out by monetary authorities of emerging markets and transitional economies who typically exhibit ‘fear of floating’ (Calvo and Reinhart 2002), whereas interventions by monetary authorities in transactions between vehicle currencies were less in relative terms. With a view that a half leg of the US dollar/other currencies would constitute 4% of global transactions, it is assumed that the share of official transactions globally is about 8%.

(39) Since banks and exchange transactions are under the supervision and regulation of the monetary authorities, CTTs could be administered by monetary authorities rather than by tax authorities. Alternatively, tax authorities could administer and collect CTT in cooperation with monetary authorities and with access to information generated by CLS Bank as suggested by Patomäki and Denys (2002).

(40) UNCTAD (United Nations Conference on Trade and Development) estimates that in 2000 the total value of world stocks, bonds, securities amounted to US$50 trillion, while total global equity market capitalization is estimated at US$37 trillion.

(41) See Frankel (1999) and Nissanke and Stein (2003) for a critical literature review on the exchange rate policy regime choice faced by emerging market economies.

(42) In particular, an allocation of bilateral aid tends to be at least partially used by donor countries as a foreign policy tool or for their economic gains (Maizels and Nissanke 1984).

(43) See Boadway (Chapter 11, this volume) on the economics of global taxation and Sandmo (Chapter 3, this volume) for similar issues facing environmental taxation.