Global taxes: Consensus will continue to be elusive

As countries structure their responses to global economic
crisis, and address implications of climate change, there have
predictably been proposals to levy taxes on a global basis.

Three examples of such proposals are a global tax on banks (or more broadly, all financial institutions); tax on selected international financial transactions (so-called Tobin-tax type proposals); and for carbon taxes on use of energy.

The G20, set up in 1999 in the aftermath of the Asian financial crisis, had last year asked the International Monetary Fund (IMF), to submit suggestions for the tax on financial institutions, and on financial transactions.

Its final report, entitled “A Fair and Substantial Contribution by the
Financial Sector” (henceforth The IMF Report) was submitted in time for consideration during the group’s meeting in Toronto on June 26 and 27 this year.

The main objectives of the tax on financial institutions and transactions are to recover the fiscal costs of bailing out banks during the crisis, and to create a fund for similar future situations; and to limit volatility and speculative activities in financial transactions.

The main objective of the carbon taxes is to address environmental damage created by use of energy sources with high carbon content, and to finance renewable energy sources.

A truly global tax would require agreement among at least majorcountries on the following aspects:

1. Object of the tax: As an example, should financial institutions tax be levied only on banks or on all financial institutions?  Similarly, should global carbon taxes be confined to fossil fuels only or to all energy sources?

2. Defining the tax base: As an example, should assets or liabilities of the banks be taxed, and if one of the two is chosen, should there be exclusions?

3. Tax collection mechanism: Which body should be given statutory powers to collect global taxes? Nations guard their tax policy sovereignty and are reluctant to cede such powers to international bodies, resulting in a formidable constraint on levying global taxes.

4. How revenue generated is to be shared? Revenue from truly global taxes is likely to be substantial. Thus, the IMF Report estimates that a one basis point global tax on stocks, bonds, and derivative transactions could annually raise $200 billion. But agreement on sharing such large sums among countries; or among different uses (e.g. as a buffer against financial stability, or for assisting low income countries) would be difficult. In all the four aspects, there are no technically superior choices, which could command agreement among reasonable parties. So, tax on financial institutions could be levied either on their assets or on their liabilities, with each tax base having cogent arguments to justify the selection. These could be fine-tuned to reflect systemic risks which they pose to the domestic and international financial system.

Efficiency, revenue, and equity considerations, however, may vary considerably among the tax bases, inevitably bringing domestic and international political considerations in the choices made.

The current geo-economic and geo-strategic environment is also undergoing a flux. Even the G20 forum, which is fairly representative of the world, is finding it challenging to operate decisively and with authority on many pressing issues.

On taxes on banks, G20 are divided, with US, Germany, UK and France backing with varying degrees of enthusiasm, while Canada, Australia, Brazil and India do not see merit in such a tax.
The issues raised by the IMF Report were, therefore, predictably left for discussions at the next G20 meeting to be held in Seoul, on November 11 and 12, 2010.

Even there, no progress on global taxes on financial institutions or on transactions is expected. There may, however, be greater consensus on non-tax related aspects of global financial architecture. South Korea has already indicated that it will include development issues, including emergency loans for developing countries in the Seoul agenda.

There has also been considerable erosion of trust in most national and international institutions, including governments, businesses, domestic and multi-lateral financial institutions, media, and the NGOs, including those active in influencing environment policies. Loss of trust will not be easy to repair, making international cooperation even more difficult.

For the above reasons, truly global taxes are likely to remain elusive, whether in the case of financial institutions or transactions, or for carbon taxes to help address climate change.
It is therefore not surprising that the IMF Report uses the terms such as coordination and policy coherence, with mutual interest of countries in ensuring global financial stability and growth as primary motivations for cooperation.

It enumerates country proposals (such as by the US, UK, Germany, Italy and Sweden) for a levy on financial institutions to help pay for fiscal costs of bailing them out by the respective governments, and to create funds for better resolution of poorly managed financial institutions; a financial activities tax on “excess profits” or “economic rents”; and discusses possible financial transactions tax (FTT).The report, however, does not regard FTT as desirable in spite of large revenue potential. It therefore does not discuss how revenue from global FTT could be shared. The FTT is viewed as particularly prone to avoidance through financial engineering.

India is justified in having strong reservations about global taxes on financial institutions and transactions, and on carbon content. However, continuing challenges posed to financial stability by excessive short-term financial flows, particularly by institutions, such as government wealth funds, constituting “shadow banking system”, are real for India.

Agreement on more prudential regulation of financial actors and activities, and correcting tax advantages in favour of debt financing, are areas where there may be wider agreement among G20, and India should support such measures.

It also, however, must continue conservative monetary management being pursued by the Reserve Bank of India, and give much higher priority to substantive fiscal consolidation then the governments at the Centre and in the States has accorded in recent years. International agreement on carbon taxes is unlikely.

The World Trade Organisation has also not shown inclination to address energy tax related issues. Nevertheless, it is in India’s interest to become more energy efficient, with increasing reliance on renewable sources of energy. More rational policies towards petroleum products pricing, and subsidy structures to reflect scarcities and attain greater energy self-sufficiency are essential. Such rationalisation is also needed for the water sector.
In the final analysis, substantive progress in addressing India’s developmental, financial management and governance challenges is a pre-requisite for India to be an influential member of G20.

The writer is a professor at the Lee Kuan Yew School of Public Policy, National University of Singapore, and can be reached at sppasher@nus.edu.sg. Views are personal.