Why Tax Foreign Exchange? Comments on a Proposed Tobin Tax

At various times since Tobin floated the idea of a tax on foreign exchange transactions the concept has been revisited - particularly in times of financial market turmoil when it has been proposed as a means of reducing exchange rate volatility. Recently, Harcourt (1997) suggested a further refinement of the Tobin tax to apply only to 'speculative transactions'. This paper identifies three types of foreign exchange transactions - informed trades, liquidity trades and speculative trades - and highlights the difficulties in differentiating between these types of transactions. It is not clear whether some (or what) proportion of speculative trades is of benefit to the economy. Further, the undesirability of exchange rate volatility itself has not been established. In particular, the costs and benefits of exchange rate volatility have not been compared with the alternatives of interest rate volatility under a fixed exchange rate regime or the market innovations resulting from the imposition of a Tobin tax.