A view of the financial district of the City of London in this photo from 2011.TOBY MELVILLE/Reuters
Robin Hood, meet the Sheriff of Nottingham.
Bank of Canada economist Anna Pomeranets has penned a tale that will discourage the many proponents of financial transaction taxes, or "Robin Hood" taxes.
The idea of throwing just a little grist in the wheels of global finance has an impressive intellectual pedigree. John Maynard Keynes, James Tobin, Joseph Stiglitz and Lawrence Summers all have argued that a micro levy on currency trades and the like would make financial markets a calmer, safer and fairer place.
But that's never been enough to bring about broad acceptance of financial transaction taxes. For example, Brazil is the only country in the Group of 20 that levies a fee on foreign-exchange transactions, and only India taxes the trading of futures contracts. However, this could be changing. Eleven members of the euro zone, led by Germany and France, agreed last month to impose a fee on financial transactions, although a final arrangement remains unfinished.
Ms. Pomeranets's article in the latest Bank of Canada Review suggests the Europeans are on the verge of making a mistake – at least if the goal is cooling hot money and improving financial stability.
"Little evidence is found to suggest that the FTT would reduce speculative trading or volatility," Ms. Pomeranets concludes. "Countries considering imposing FTTs should be aware of their negative consequences and the challenges involved in implementation."
As Bank of Canada Review articles go, that's a rather concrete assertion. Ms. Pomeranets did a broad survey of the existing research on financial transactions taxes. And most of the research suggests FTTs don't work.
For example, in 1986, Sweden increased a tax on equity transactions to 2 per cent from 1 per cent previously. The change did nothing to ease volatility – but it did lower stock prices, according to a Swedish study that Ms. Pomeranets cites. Also, 60 per cent of the trading volume of Sweden's 11 most active stocks migrated to London. Revenue from capital gains taxes dropped, offsetting the four billion Swedish kronor that the government collected from its transaction tax in 1988.
"The evidence presented suggests that FTTs harm market quality," Ms. Pomeranets says. "FTTs have been shown to increase volatility, reduce volume and liquidity, and increase the cost of capital."
Of course, the new champions of the Robin Hood tax may care less about distorting market behaviour than they do about raising revenue. It's no coincidence that financial transaction taxes are gaining serious traction in the euro area at the same time those governments are desperate to reduce their debts.
Ms. Pomeranets doesn't address this issue. She raises important technical questions about the difficulty of designing FTTs. Essentially, no one yet has figured out how to do it effectively. There's no conclusive evidence on the proper rate, the financial instruments that should be targeted and when and where the tax should be collected. These questions matter. For instance, if the tax is applied at the location of the trade, it's quite likely that trading will migrate to tax-free havens. Since theoretically all that's needed to become a financial centre these days is access to the internet, this could hamper efforts to reduce the amount of financial transacting that is done in the shadows.
It seems likely that a financial transaction tax will distort market behaviour in Europe. But so is the debt crisis. Politicians are facing drastic unemployment rates, crippling budget deficits and a recession. Under those conditions, the financial industry is an obvious target as a source of revenue.
For the Robin Hoods of Berlin, Paris and Madrid, the unintended consequences are a concern for later. They just need the money.