As the global battle heats up over Tobin Taxes, opponents will have a tough time arguing that their 'leave the market alone' mentality is anything more than hot air. Sony Kapoor argues that Tobin Taxes, or Financial Transaction Taxes, are a good idea and will soon be blooming around the world.

Proponents of Tobin Tax(es) or, more technically, Financial Transaction Taxes, are happy that these have been in the news a lot lately. The so-called "Tobin Tax" on capital flows was originally proposed in 1971 by Nobel laureate James Tobin as a way to address speculation in global markets. Today, everyone from Sarkozy and Merkel to the head of the UK Financial Regulator has been positive about levying such a tax. Even the former Senator Obama had voiced support on the campaign trail. Does it mean that we will get some form of a Tobin Tax, finally? Or are the proponents set for yet another disappointment? Signs are that that they are likely to get their way...well sort of.

The financial crisis, the biggest in living memory, has massively titled the political and financial landscape in a direction that makes such taxes not just more desirable also much easier to implement.

Keynes was an early proponent of FTTs, and the idea got a new lease on life when James Tobin extended it to currency markets. The Asian crisis helped revive the discussion, and after falling off the agenda again, the idea was brought back once more as a potential source of revenue for funding poor country development. Each time it died a slow death. The opponents of FTTs won those battles, but they are about to lose the war. Here is why.

Even before the crisis hit, the ‘markets always work efficiently and know best' school of thought was losing the battle of evidence. Those that believed that while financial markets mostly worked well, they were often prone to excesses and sometimes failed with bad social consequences were clear frontrunners. The crisis has picked the winning side in a dramatic way. It's time for those who opposed FTTs with the argument that any interference with what they regarded to be well-functioning markets to shut up. Many have done so already.

Everyone agrees that even a small tax would penalize short term transactions and favour longer investment horizons. At a 0.01% rate, those trading 100 times a day will end up with a tax rate of 240%/year, and those that hold onto their stocks for 5 years will pay 0.002%. Automated computer trading based on mechanistic rules which sometimes buys and sells the same security hundreds of times a day would become untenable. Given the risk such trading poses to the financial system as highlighted by its total breakdown in August 2007, that would be no bad thing. Such High Frequency Trading is also dubious because the fact that it allows large actors access to markets a fraction of second before others and raises serious questions of fairness at a time where the little people are getting screwed all around. A reduction in trading patterns which threaten financial stability and skew the playing field without delivering much in the form of social benefits would reduce the likelihood of financial crisis. This appeals both to regulators and politicians.

It is good policy to tax polluting activities which have a negative footprint on society. An increasing number of financial transactions served no underlying social purpose and in the case of trades in complex derivatives and credit default swaps significantly increased systemic risk. Ever higher volumes of financial trades (churning) have been driven by the prospect of increasing fee based incomes. Ever increasing complexity was driven by the prospect of juicier profit margins. While privately profitable to the financial sector, both trends have imposed costs on the wider economy. It is good public policy then to impose a sin tax that penalizes churning and complexity. Financial Stability regulators are taking serious note.

This systemic risk which has crystallized in the shape of the ongoing crisis necessitated the allocation of trillions of dollars of scarce taxpayer funds to bail out the financial sector. Recovering the costs of these bailouts from the financial sector is not only fair but is also the only sensible policy option in line with the ‘polluter pays' principle. The many existing transaction taxes raise substantial amounts of tax revenue. Extending these taxes to recover bailout funds from the financial sector is an idea that has snowballing political support behind it.

The crisis depressed tax revenues and necessitated stimulus spending. Governments are now saddled with the highest debt and deficit levels seen in a generation. These debts need to be repaid and the money will need to come from higher taxation. While no tax is perfect, the FTT stands heads and shoulders above other feasible options such as increasing Sales Tax, Value Added Tax or social security contributions. In contrast to these taxes, a FTT will have a highly progressive incidence and will tax activities that at best offer little social utility and at worst pose serious systemic risk. Increasing the tax burden on ‘the little people' while ignoring the role of the under-taxed financial sector in facilitating tax avoidance by rich individuals and corporations would be political suicide. Politicians have already taken note.

For those sceptical about the dual revenue and stability goals of the tax, it might be instructive to look at sin taxes on smoking or pollution which marry substantial revenues while at the same time depressing harmful activities. To address the concerns of those who think the tax may harm markets, tax rates could start out very low and ratchet up annually once it is clear that the markets can bear the load. The regulatory response to the crisis has settled any remaining doubts about feasibility for good. The G-20 response of driving derivative transactions on to exchanges, making centralized clearing compulsory, introducing enhanced registration and reporting requirements and expanding the regulatory boundary to include hedge funds as well as off shore jurisdictions has all made it cheaper and easier to collect financial transaction taxes and will make it impossible to avoid them.

While international co-ordination is desirable, the success of existing taxes such as the UK Stamp Duty, a 0.5% tax on share transactions in the London Stock Exchange indicates that it is not necessary. This Stamp Duty nets the UK more than $8 billion every year. The US imposes a much smaller section 31 fee on stock transactions which funds the operations of the Security Exchange Commission. Increasingly electronic audit trails, greater cross-border regulatory co-ordination, action against tax havens and greater oversight of derivatives has only made implementation much easier both at a unilateral and multilateral level.

Under pressure from the French and Germans, the G-20 has finally asked the IMF to look into various options to get the financial sector to put in a greater contribution - the Tobin tax was on the top of their minds. There are also strong suggestions that some of the revenue could also be put to use savings lives in poor countries. Even then, expect the financial sector to cry bloody murder and send their lobbyists out in full force - surely one cannot expect the big banks to take a new tax lying down!

Proponents take heart...while it remains unlikely that the G-20 will agree to a ‘global tax'; the world will nonetheless still see a mushrooming of new unilateral transaction taxes in several financial markets and countries around the world. Little Tobin Taxes will bloom all around - and that would be a good thing!

Sony Kapoor is an ex-investment banker and Managing Director of Re-Define (Re-thinking Development Finance & Environment), an international Think Tank dedicated to improving the footprint of the financial system.

*This piece is based on an Op-Ed in SuedDeutsche Zeitung, Germany's leading daily newspaper.