Pros and Cons of financial transaction tax

Taxes on capital flows have been debated recently both by governments and the UN. Governments see the swift flow of capital as a threat to economic stability, while the UN mainly wants more funding to achieve its development goals.

The volatility of global stock markets and exchange rates has been caused by the swift flow of capital. Small and open economies like those of Thailand and other Asean countries are very concerned.
Prasarn Trairatvorakul, governor of the Bank of Thailand, expressed his concern about dealing with capital inflows and outflows. He said the monetary policies implemented by the US Federal Reserve and the European Central Bank had impacts on other countries.
As the central banks in the US and Europe inject huge liquidity into the market, a large amount of money flows to Asia, where investors seek higher returns. Then when market sentiment changes, they pull their money out swiftly. Such flux of capital has the potential to destabilise exchange rates and could have an impact on the export sector or the whole economy. The local currency appreciates amid large inflows, making exports more expensive. High volatility of the exchange rate makes it harder for businesses to manage risk caused by foreign exchange. “The greatest challenge is how to deal with capital flows and how to use capital inflow productively,” Prasarn said.
The BOT, under then governor ML Pridiyathorn Devakula, imposed capital controls in 2006 in an attempt to stem rapid appreciation of the baht, but the had to abandon them two years later.
Academics and economists at the UN have recently proposed that all nations introduce a financial transaction tax (FTT) or currency transaction tax (CTT). The aim is to raise sufficient resources to finance internationally agreed development goals and global objectives such as combating climate change, since the contribution from developed countries under Official Development Assistance or funds from existing sources is not adequate.
Estimates of the potential revenue from a CTT have been as high as US$400 billion (Bt12.7 trillion) per year, with estimates of broad-based FTT as high as $1 trillion annually.
The UN’s “World Economic and Social Survey 2012: In Search of New Development Finance” study said a CTT rate of half a basis point (0.005 per cent) on major currencies – the US dollar, euro, yen and sterling – would generate revenue of $40 billion a year. The same rate of FTT would raise about $75 billion.
Oliver Paddison, economic affairs officer of the macroeconomic policy and development division, UN Economic and Social Commission for Asia and the Pacific, said the financial tax could help reduce volatility of the financial market.
Pracha Koonnathamdee, an economist at the faculty of economics, Thammasat University, said he agreed with the proposal but added that there should be a mechanism to compensate countries that may be adversely affected by such taxes, as they could increase borrowing costs. The tax might scare off capital that they need for investment, he said. Some economists propose a tax on dirty industries, but Pracha said this could promote manufacturing in “pollution haven” countries.
To make it effective, an FTT must be imposed by all countries and revenue transferred to the UN or other international bodies. But national policy-makers are unlikely to support this scheme, as they want the revenue for their own country’s development, he said. Kobsidthi Silapachai, head of market and economic research at Kasikornbank Group, said capital-control measures could backfire, since investors in the future may not be willing to bring in funds for fear of high costs to take money out. This could adversely affect local market liquidity.