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The author wishes to thank Angelo Faria, Michael Keen, Emil Sunley, and Vito Tanzi for very helpful comments and discussions.
For discussions of these issues, see the many articles collected in Haq, Kaul, and Grunberg (1996) and in Hammond (1995). Shome and Stotsky (1996) advance the usual arguments against the Tobin tax. A summary of the issues can be found in Nadal-De Simone (1997).
Kirshner (1998) provides a particularly apt analogy: unregulated capital flows are a form of economic pollution.
It is worth emphasizing that the negative externality in question here refers exclusively to the adverse effects generated by capital flows not associated with economic fundamentals. Capital flows associated with economic fundamentals could, of course, also have adverse effects, but the latter would not be the target for corrective policy actions. In reality, it is, of course, impossible to differentiate ex ante between the two types of capital flows. The merit of the Tobin tax, and of the tax being proposed here, lies precisely in the fact that such a differentiation is unnecessary.
Dornbusch (1997) argues that the burden inflicted by a tax on noncapital cross-border financial flows (e.g., flows arising from trade transactions) is minor if the nominal tax rate is kept low. This assertion is, however, far from certain as it is stated without the support of empirical evidence.
These special NRRs were reduced to zero—but not technically abolished—in September 1998.
Correcting for the destabilizing spillover effects on the domestic economy of international capital volatility may not be the only possible objective of introducing such a measure. Chile’s NRRs have been introduced, for example, to also minimize the impact of a tight monetary policy (for addressing domestic policy needs) on the external current account. See Le Fort and Budnevich (1997).
The proposed withholding tax is imposed on inflows rather than on outflows because of the second part of the proposal. In any event, as argued by Eichengreen (1999), the case for taxing outflows is weaker than taxing inflows because the former merely treats the symptom rather than the cause of the problem.
These inflows would include, for example, income received by nonprofit organizations, foreign-source income not taxable under a source-based domestic income tax system, and any other tax-exempt income.
To get an idea on how the CBCT rate, t, relates to an income tax rate, τ, let i be the (annualized) before-tax interest rate and h be the length of an investment’s holding period, expressed in yearly units (i.e., h = 1/365 denotes 1 day, h = 2 denotes two years, etc.). Then the relationship between the income tax rate and the CBCT rate is given by τ = t/[(1 + i)h-1]. Suppose the annual interest rate is 10 percent (i = 0.1). For an investment with a holding period of five years (h = 5), a CBCT rate of 1 percent (t = 0.01) is equivalent to a negligible income tax rate of 1.6 percent. If, however, the holding period shortens to 40 days (h = 40/365), then the same 1 percent CBCT would be equivalent to a prohibitive income tax rate of 95 percent (an even shorter holding period than this could yield an equivalent income tax rate exceeding 100 percent).
Tax authorities must ensure, of course, that financial institutions do in fact properly withhold the CBCT—and duly remit the amounts withheld as required—on all financial inflows from abroad. This could be achieved in the normal course of tax audits of these institutions.
Note that, even in countries with source-based tax systems, the majority of recipients of (tax exempt) income from foreign sources would also have taxable income from domestic sources. They would, therefore, have to file tax returns even in the absence of the CBCT, and the marginal burden on them of imposing the CBCT would be insignificant.
For a fuller discussion of the role withholding taxes could play to combat tax evasion in a world of globally mobile capital, see Zee (1998).
One possibility to lessen this temptation would be to stipulate that part or all of the revenue from the CBCT would be shared among all financial institutions charged with the responsibility of implementing the tax on the basis of some predetermined formula. Such a sharing could be justified, for example, on grounds that it would be a form of compensation for the withholding service these institutions have been asked to render (it is a service because the withholding associated with the CBCT, unlike that on wages by employees or on interest by banks, is not imposed on any income originating from the agents carrying out the withholding).
While the Chilean practice has attracted the most attention, other countries at different times have introduced similar measures. For a discussion of these country experiences, see Ariyoshi, et.al. (2000) and Johnston, et.al. (1999). Colombia’s experience with NRRs is extensively reviewed in Le Fort and Budnevich (1997).
Vito Tanzi reminds me that this is uncontroversial only to those who agree with the statement. It is also fair to state, however, that those who agree with it are in the majority.