Sweden’s failed Tobin tax experiment

 
Allister Heath
BAD ideas have a habit of never really going away. There were renewed calls at the weekend for a Tobin tax on financial transactions, a deeply flawed concept which remains popular in influential circles. Supporters should acquaint themselves with an excellent study published in the mid-1990s by the Canadian government’s depository services programme, which remains the definitive article on the subject.

Its author, Marion Wrobel, shows that the Swedish Tobin tax was an unmitigated disaster. The rise and fall of the only known case of a real life Tobin tax began in the 1980s, when Sweden was going through one of its extreme socialist phases. In January 1984, Wrobel recounts, Sweden introduced a 50-basis-point tax on the purchase or sale of equities, applicable to all trades (and to stock options). A round trip (purchase and sale) meant a 100-basis-point tax. The rate was doubled two years later; by 1987, a tax at half the normal rate was also slapped on trades between dealers. In January 1989, fixed-income was also targeted for punishment: the tax was 0.2 basis points for bonds with a maturity of 90 days or less, rising to three basis points for maturities of five years or more.

Two years on, all of the taxes had been swept away. As Wrobel recounts, the government’s estimates of how much revenues would be raised by the tax proved to be laughably over-optimistic; the whole episode could have been a chapter in one of Arthur Laffer’s books on how higher taxes kill economic activity and reduce tax receipts. Instead of bringing in 1.5bn kroner for the levy on fixed income securities alone, as predicted by officials, the tax collected an average of just 50m kroner a year. The cost of government borrowing also went up, as investors demanded greater compensation to hold a security on which taxes had just been hiked, further eroding the miniscule revenues collected. It all went downhill after that. The number of transactions in shares collapsed, triggering substantial declines in capital gains tax receipts which offset gains from the Tobin tax (stock prices also fell as a result of the tax, further eroding gains as well as making it harder for firms to raise capital for expansion and jobs).

The equity, bond and derivative markets were decimated by the taxes; business flocked to London, to the delight of City institutions. When the tax was doubled in 1986, 60 per cent of trades for the 11 most traded Swedish stocks moved to London. By 1990, over half of all Swedish equity trading had moved to London. During the first week of the Tobin tax on bonds, trading slumped 85 per cent, even though the tax on five-year bonds was only three basis points. Futures trading collapsed by 98 per cent and options trading stopped altogether. Trading in money market securities, which faced the lowest tax rate, collapsed by a fifth.

No wonder the Swedes eventually saw sense. There are two lessons here: the obvious and the not so obvious. A Tobin tax will decimate the financial sectors of any country or groups of countries that impose it; only a full, 100 per cent global tax in every country in the world would avoid this. That is evident. But even were the tax to be imposed globally, it would still kill transaction volumes, make markets less liquid, increase the cost of raising finance for all firms and punish companies that operate in more than one currency. No sane British government should even dream of imposing a Tobin tax.

allister.heath@cityam.com