By Ha-Joon Chang and Duncan Green
April 18, 2011
The benefits of a tax on financial transactions are now so widely accepted that future generations will ask what took us so long
In 1816, the British parliament repealed the temporary income tax that William Pitt the Younger had introduced in 1789 to finance the Napoleonic war. The MPs hated the tax so much that they even agreed that all documents connected with it should be collected, cut into pieces and pulped.
When the income tax was reintroduced in Britain in 1842 by Robert Peel, everyone considered it a temporary measure to replenish the depleted exchequer. But despite generations of politicians after Peel promising to abolish it, the tax never went away.
It proved impossible to abandon a tax whose time had come.
By the time Benjamin Disraeli and William Gladstone kept breaking their promises to abolish the income tax (one of the few things they agreed on), the homespun capitalism of the 18th century had already given way to a more organised form of capitalism.
With economic development, the social division of labour was becoming more and more sophisticated, increasing the importance of collective inputs such as infrastructure and education. A more effective provision of collective goods required a well-financed state, for which an income tax was seen as a new vital ingredient.
As they too developed, countries such as the US and Sweden followed suit. Today, the income tax is the biggest source of government revenue in most rich countries.
The same destiny may now await the Financial Transactions Tax (FTT) – or Robin Hood tax, as it is widely known. Although the French government, which chaired meetings of the G20 finance ministers and the IMF/World Bank member states last weekend, supports a global FTT, American opposition means that initial progress is more likely within a smaller "coalition of the willing", including France, Germany, and South Africa. French and German support may ensure that the eurozone is the first international forum that agrees an FTT.
Even a decade ago, when it was doing the rounds under the alias of "Tobin tax" (named after James Tobin, the Nobel laureate economist who first raised the idea), the levy was an absolute taboo in polite society. But after the great financial crash of 2008, the case for it is looking "obvious" to many, as indeed the income tax did in the late 19th century. Its time, too, has come.
This levy on financial transactions, even at the very low level that is currently proposed (0.05%), is expected to slow down the most speculative elements of international capital flows and raise the significant sums needed to provide the newly required global collective goods – especially green technologies and development aid.
Of course, the FTT alone will not achieve much in terms of stabilising our financial system. It needs to be implemented as a part of a comprehensive package.
First, countries that cannot issue "hard currencies" should be allowed to use capital controls. The significant change of position by the IMF in this regard following the 2008 crisis is encouraging, but capital controls should be seen as normal policy tools – rather than a measure of last resort, as the IMF still suggests.
Second, we have to reform the rating agencies. Despite their incompetence and even cynicism, revealed both in the 1997 Asian crisis and in the 2008 crisis, these agencies are still deciding what is a good financial asset and dictating how governments should conduct their policies – not just fiscal policies but also monetary and social welfare policies. They need to be regulated more heavily, and a non-profit public agency should be set up to provide a credible alternative to their ratings.
Third, if we are serious about the revenue implications of our financial policy, tax havens need to be reined in, if not totally abolished. That single act would generate sums on a par with a global FTT.
Last but not least, overly complex financial instruments should simply be banned, unless they can be shown by their inventors to bring significant net benefits in the long run, in a manner similar to the drugs approval procedure. Otherwise our ability to manage the system will be outstripped and we will repeat the crisis of 2008.
What finally emerges from this new round of post-crisis tax invention may differ somewhat from the FTT, but the general principle – taxing international financial flows for the public good – looks here to stay.
Thirty, 50 years on, our children and grandchildren may be wondering how we ever thought to run the world without such tax – just as few of us can imagine how our grandparents and great-grandparents used to manage without the income tax.