Don't be tempted by Tobin tax, warns Edhec

Edhec-risk_institute-logoImposing a tax on speculative transactions could jeopardise liquidity, reduce the value of some securities and create a headache for regulators to enforce, according to an open letter from the Edhec-Risk Institute to European regulators.

The letter comes in response to renewed interest in this kind of tax, which is named after the economist James Tobin who proposed the device in the 1970s. In the UK, business secretary Vince Cable has hinted that a Tobin tax will be one of the ideas explored by the Kay Review, a panel established this year to investigate the stability of the UK stock market.

Proponents of the tax say it would cut down on the kind of speculative trading that generates short-term profits at the expense of long-term growth. But the Edhec-Risk institute counters that the tax “also drives away investors who provide liquidity, stabilise prices, and help in the price discovery process”.

The institute goes on to claim that most empirical studies of the tax suggest it either fails to reduce volatility or leads to an increase in volatility. Worse, the tax can cause a drop in demand for securities which leads to a drop in prices, it said.

There are also challenges in implementing the tax, because it is unclear how regulators would distinguish between speculative trades, which should be taxed, and trades relating to fundamental business, which should not be. Another hurdle would be achieving global consensus on the tax, because if it is not applied universally, speculators could simply route their transactions through a country which does not impose the tax.

©2011 funds europe