A popular feature of short term capitals flows (movement of international investable money) is that they are often speculative and are highly unstable flows. Their quick inflows and outflows are creating management problem for many emerging market central banks like the RBI.
Countries in the past have used a wide range of measures to regulate the flow of speculative or short term capital.
One such instrument is the use of tax-like measures on capital inflows. The simplest example of such a tax is Tobin tax.
Tobin tax is a tax on international flow of short term capital. The tax is known after economist James Tobin who proposed it in1972 in the form a currency transaction tax.
Basically, Tobin tax aims to discourage volatile short term capital flows or hot money which are very speculative. Tobin has advocated the imposition of tax on cross border flow of short term capital as these are the sources of volatility and risks in the host economies. According to Tobin, the role of tax on short term capital flows is to ‘‘throw some sand in the wheels’’ of speculative activity.
The burden of a Tobin tax is inversely proportional to the length of the transaction, i.e., the shorter the holding period, the heavier the burden of tax. Variants of Tobin tax are imposed by many countries to discourage short term capital flows or hot money.
After the global financial crisis, many developing countries including Chile, Brazil and Thailand have imposed capital controls especially taxes on short term capital flows. The following are the main merits of the Tobin tax in restricting the adverse effects of hot money flows.
1. It discourages the inflow of hot money or short term speculative capital because of the tax burden.
2. The government and the central bank get a gestation time to get the required adjustment to counter the destabilizing effects of both outflows and inflows.
3. The time taken to pay taxes slows the process of entry and exit of capital.
4. The revenue obtained from capital tax or Tobin can be used for social development purposes.
Countries that have introduced Tobin tax are using it to finance social expenditure. In India, the RBI’s stand on Tobin tax is that we may impose it if circumstances warrant it.