"Flawed" financial tax plan could raise volatility - think tank

The trading floor is pictured with a super wide angle lens at Frankfurt's stock exchange August 9, 2011.

LONDON (Reuters) - France and Germany should abandon "economically illiterate" proposals for a tax on financial transactions because a tax could make markets more volatile rather than bring stability, a free market think tank said on Thursday.

The London-based Adam Smith Institute said numerous academic studies suggest such a tax would lead to more erratic movements in equity and foreign exchange markets, falling share prices and poor liquidity.

French President Nicolas Sarkozy and German Chancellor Angela Merkel announced the tax proposal on Tuesday as part of a range of measures aimed at restoring confidence in the euro zone.

Supporters say it would make markets more stable by deterring short-term speculation and would give countries a degree of protection against exchange rate pressures. Others say it would provide governments with much-needed money for areas such as health and education.

However, the think tank's report said it could raise the cost of government borrowing as investors seek to make up the money they have lost in paying the transaction tax.

A charge on financial transactions is often referred to as the Tobin Tax after the American economist James Tobin who put forward the idea in the 1970s. Campaigners angry with the financial services industry and its role in the global downturn call it a "Robin Hood tax," a reference to the legendary English outlaw who robbed from the rich and gave to the poor.

"When something seems too good to be true, it usually is. The 'Robin Hood Tax' is as vague as it is economically illiterate," said Sam Bowman, the institute's head of research. "We can't tax our way out of this economic depression."

Describing the tax proposal as "politically motivated but economically flawed," the report said the idea might appeal to voters angry with the financial sector, but it could end up making everyone poorer.

It would be "economic suicide" for Britain or any single country to adopt the tax unilaterally, the report added. A Swedish tax on some financial transactions raised only 1/30th of the amount predicted and pushed financial activity overseas, the report said.

Anything less than a global deal would see traders move their money to countries with lower taxes and less onerous regulation, distorting world markets, it said.

"When Sweden tried a Tobin tax it was a colossal failure - why does anybody pretend this time would be different?" Bowman said.

For the full report, click on: www.adamsmith.org/files/ASI_Tobin_Tax_2011.pdf

(Editing by Susan Fenton)