02/11/2011 09:23 GMT | Updated 02/01/2012 05:12 GMT

UK Economy: Would A 'Robin Hood' Tax Actually Work?

The Archbishop of Canterbury is the latest to add his voice to calls for a so-called "Robin Hood" tax on financial transactions. The proposals have gained traction, with everyone from Bill Gates to the Vatican backing the idea. The EU, and in particular the French government, are major supporters.

The idea was first proposed in the 1970s by the economist James Tobin, who said that introducing a levy on transactions made in the currency markets would reduce volatility by introducing disincentives for trading. The tax was designed to discourage "hot money" investors from taking short term, speculative positions in the market by reducing the amount of profit that they would make on small transactions. This in turn would mean that prices were more reflective of the real long-term value of assets, rather than by the crowd behaviour of speculators.

Since then, the "Tobin Tax" has evolved into a more general tax across asset types, and its intention has changed from a block on volatility and speculation to a revenue-raising exercise, forcing markets to pay a social levy on their activities - hence the "Robin Hood" label.

"As far as the advocates of this tax go, there's a kind of confusion over what the aim is," the Institute of Economic Affairs' Steve Davies said.

"There are two quite different goals which are mutually exclusive. One is to make the financial system less volatile by reducing the amount of churn, the other is to raise large amounts of revenue for public spending, particularly international development.

"Now, the two are contradictory, because if it reduces the amount of transactions then it's not going to yield a lot of revenue. On the other hand, if it yields a lot of revenue it's only going to have a marginal effect on the market… you can't have your cake and eat it."

The Archbishop of Canterbury seems to fall into this camp - suggesting that both outcomes are feasible in his argument that the financial system as it stands needs dramatic reform. Referencing the Vatican's Pontifical Council for Justice and Peace's report from last week, Williams said that the "modest" rate of taxation - 0.05% per transaction - could raise up to $410bn (£256bn) globally.

"The objections made by some who claim it would mean a substantial drop in employment and in the economy generally seem to rest on exaggerated and sharply challenged projections – and, more important, ignore the potential of such a tax to stabilise currency markets in a way to boost rather than damage the real economy," Williams wrote in the Financial Times.

This is the main reason for the UK's hard stance on the financial transaction tax (FTT). The argument goes that a tax implemented unevenly across the world would see trading - and the financial sector - move away from the UK towards jurisdictions which did not enforce the levy.

The only "successful" implementation of a FTT was in Sweden, and critics say that this prompted a rapid shift in trading away from the country, with much of its volume relocated to London. While rhetorically compelling, it is very difficult to compare the situation with the modern day. Sweden was not at the time a major financial market, and some European volume was already shifting to the UK.

"Business of this kind can be done pretty much anywhere in the world, and unless it can be done on a global basis its main effect is going to be to shift financial transactions from one part of the world to another. Let's say that this was done in Europe and North America, the main effect would be to shift a large part of those financial transactions to the Far East," Davies said.

This has been George Osborne's public position going into Thursday's G20 meeting - that unless a tax is implemented globally it would damage existing financial centres, such as London, and give emerging centres an unfair competitive advantage. However, CityAM reported this morning that the chancellor's private belief, revealed in a leaked letter to banks, is that he remains unconvinced that an FTT is viable, even if agreed internationally.