Raman Uppal Opalesque Industry Update - In an open letter dated July 12, 2011 addressed to the European Internal Market and Services Commissioner, Michel Barnier, EDHEC-Risk Institute has warned of the inadvisability of imposing a Tobin tax on financial transactions in order to fund the future European budget.
On the basis of a position paper* by Raman Uppal, Professor of Finance at EDHEC Business School, EDHEC-Risk Institutes recommendations are structured around the theoretical evidence on transaction taxes, the empirical evidence on transaction taxes, and implementation challenges:
The findings of theoretical models are mixed about the effectiveness of the Tobin tax to reduce volatility and improve welfare. The Tobin tax will obviously lead to a reduction in the trading of securities on which the tax is imposed. But, a reduction in the trading of financial securities also means that it is now more difficult to smooth consumption over time and across states of nature. The Tobin tax reduces speculative activity in financial markets; but, this tax also drives away investors who provide liquidity, stabilise prices, and help in the price discovery process. Thus, introducing a Tobin tax has both advantages and disadvantages, and the net effect on volatility is likely to be small.
There is a substantial body of empirical work studying the effect of a transactions tax on volatility of the price of financial securities. Most of these find that a transaction cost either fails to reduce return volatility, or leads to an increase in volatility. Moreover, the imposition of a transaction tax leads to a reduction in the demand for that financial security, and thus, a drop in its price.
Finally, imposing a tax on financial transactions presents its own challenges. For example, can regulators really distinguish between transactions related to fundamental business and those that are purely speculative? Can regulators determine the appropriate rate for the Tobin tax that would reduce the activities of investors who are not fully rational but not drive away trade by rational investors? And, from the point of view of speculators, unless every country in the world introduced the Tobin tax, it would be easy to circumvent the tax by routing transactions through countries that do not impose the tax.
* A copy of the EDHEC-Risk Institute position paper can be found here: Source
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