Tobin tax for Australia?

But I see offhand no other way to prevent financial transactions disguised as trade

In 1972, after the collapse of the Bretton Woods system (where currencies where pegged to the USD, which itself was backed by gold), economist James Tobin proposed a tax on the conversion of currencies. As he says - 

The tax on foreign exchange transactions was devised to cushion exchange rate fluctuations. The idea is very simple: at each exchange of a currency into another a small tax would be levied - let's say, 0.5% of the volume of the transaction. This dissuades speculators as many investors invest their money in foreign exchange on a very short-term basis. If this money is suddenly withdrawn, countries have to drastically increase interest rates for their currency to still be attractive. But high interest is often disastrous for a national economy, as the nineties' crises in Mexico, Southeast Asia and Russia have proven. My tax would return some margin of manoeuvre to issuing banks in small countries and would be a measure of opposition to the dictate of the financial markets. (here)

A 1978 article where Tobin reflects on global monetary reform is here, and well worth a read. The relevance to Australia in 2011 is quite clear when he says -

National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exhcanges, without real hardship and without significant sacrifice of the objective of national economic policy with respect to employment, output and inflation.

While Tobin originally suggested that all countries cooperate to implement a standard tax rate, with revenues raised pooled centrally, the idea is equally valid for a single currency-issuing nation to tax conversions of its own currency.

The logic behind the tax is quite sound. An influx of foreign funds only provides domestic benefits when it backs real investment in productive enterprise. And investing in a real business takes time. As Canadian economist Rodney Schmidt noted in 1994

In two-thirds of all the outright forward and [currency] swap transactions, the money moved into another currency for fewer than seven days. In only 1 per cent did the money stay for as long as one year

A currency exchange tax reduces the gains from short term currency trades, and for a single country, allows them to reduce distortionary taxes elsewhere in the economy leading to productivity benefits. It also means there is a strong incentive for national savings to be invested locally, and a cost to banks seeking offshore funding to support their capital requirements. It also provides local governments some degree of control over their economy, rather than being at the mercy of global conditions. These are all good things.

Of course, like any tax, the risk is that governments simply spend this extra revenue unproductively and do not reduce distortionary taxes elsewhere in the economy, which greatly reduces its potential benefits.

In 2009 Brazil implemented a similar financial transaction tax regime that applies to foreign investment in stocks and fixed-income securities at a rate of 2%. And it seemed to work -

Brazil's currency and stocks fell sharply yesterday after the government imposed a 2 per cent tax on foreign portfolio investments to stem the rapid rise of its exchange rate.

But only for a while. The chart below shows the Real regained its strength fairly quickly. 

(This is not to be confused with Brazil's former Contribuição Provisória sobre Movimentação ou Transmissão de Valores e de Créditos e Direitos de Natureza Financeira, or CPMF, which was a transaction tax levied at 0.038% on all bank transactions from 1993 till the end of 2007) 

Of course the empirical macroeconomic problem arises once again here - would the Real have been even stronger if not for the tax? Who knows? My gut feeling is that because economic agents adapt very quickly to new taxes, their offsetting behaviour can greatly reduce the intended effect. 

Since that time, the global battle to devalue domestic currency has resulted in many calls to implement Tobin taxes, from the British Prime Minister to the French President, with all political leaders seeking input from the IMF. The IMF is now coming around to the idea (recently releasing this working paper), and with DSK's likely replacement Christine Lagarde being a fan (here), chances have improved that this tax will be supported globally.

There is even strong support from the economics profession, with1000 economists writing a letter in support of the idea earlier this year. A good summary of the breadth of support (and not) for such a tax is here. Even economists at the Australian Treasury are talking about it. 

The cynic in me says that such a tax is unlikely because those who benefit from fast and cheap currency exchange are those with the most money, while those who bear the burden of a high domestic currency are usually the workers in marginally competitive industries.

For Australia I see only upsides to this tax. A lower Australian dollar and reduced foreign investment will help to slowly rebalance our economy to become more diversified and stable again. While the Henry Tax Review overlooked this type of tax, at least we have a backdrop of tax reform to accompany a Tobin tax.

The outcome of this political battle with the global financial elite is anyone's guess.