Select Committee on International Development Third Special Report

Treasury Note on Tobin Tax for the International Development Select Committee

Annex A

The Government agrees that there is a continuing need to promote more stable international capital flows to avoid a repeat of recent financial crises. Over the past three years the UK and our G7 partners have consulted widely in an effort to forge consensus on the necessary reforms. The Government, in common with other G7 countries is not persuaded that a Tobin tax would be a workable tool for promoting financial stability.

On a practical level, it would be almost impossible to achieve global coverage for the tax, meaning that there would be huge scope for avoidance. Without universal application, foreign exchange transactions would gravitate to those jurisdictions, including poorly regulated offshore centres, which did not levy the tax, adding to the instability of the financial system.

The Committee raised a specific question about whether the Tobin tax could be levied at the point of settlement of a foreign exchange transaction (i.e. the exchange of value between the contracting parties on the agreed date). This is unfeasible at present because there is no single route for settlement. Even where a payment system is used to settle a transaction, its purpose is not usually identifiable to the payment system's operator. A new centralised private sector settlement service for foreign exchange, the Continuous Linked Settlement Bank (CLSB) is expected to come into operation in October this year. CLSB plans to provide foreign exchange settlement services for its members and their customers in a range of currencies (initially 7). The CLSB is welcomed by regulatory authorities as a means of reducing the considerable credit risk involved in traditional methods of settling foreign exchange.

It is unlikely that the inauguration of the CLSB will resolve the fundamental problems associated with the enforcement of the Tobin tax. As with existing payments systems, the CLSB's coverage would still only be partial. Using the CLSB to enforce the Tobin tax would discourage potential customers from using this new, more secure settlements system and undermine international efforts to reduce settlement risk, an important source of risk in international capital markets.

Even if these enforcement problems could be overcome, it is by no means clear that the Tobin tax is the best means of reducing volatility in international capital markets. A modest tax is unlikely to achieve its primary goal of preventing speculation against fixed exchange rates since successful speculative attacks yield enormous gains which are many times the cost of the tax. Indeed, by reducing market liquidity, and so diminishing price transparency and market efficiency, the tax might actually increase volatility. Furthermore, a Tobin tax could not distinguish between those currency transactions which allow economies to adjust to price shocks, and those which are purely speculative. By slowing the adjustment of financial markets, it might increase and prolong the economic damage in crisis-hit countries, with disastrous effects for the most vulnerable groups.

The Government therefore believes that the objective of greater international financial stability is better served by the programme of reforms to the international financial architecture being developed by the IMF, and other international fora such as the G7.

The UK Government has played a leading role in taking forward this ambitious reform agenda, building on the structural changes introduced domestically. In the past three years, there has been substantial progress in a number of important areas, including the elaboration of a new framework of codes and standards; the creation of the Financial Stability Forum in 1999 to tackle key areas of vulnerability in the international financial system; the development of a new framework of partnership for crisis prevention and resolution between the private and public sectors; and the establishment of the G20 in 1999 to broaden discussion and co-operation between systemically important economies on key economic and financial issues. Taken together, these changes have laid the foundation of a new international financial system for the 21st century which will enable all countries to participate in the new global economy and share in rising prosperity.

Despite these reservations , the Government supported the proposal made by the Canadians at the UN Social Summit in Geneva in June 2000 for a report on innovative sources of development finance which could include an investigation of the Tobin tax. Since then, the Secretary General has announced the creation of the Zedillo Commission whose terms of reference include sources of development financing. The Commission will be producing a report to the UN Financing for Development Conference in 2002. However, it is unclear at present whether this report will address the issue of the Tobin tax.

HM Treasury

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Prepared 9 May 2001