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With the European Union financial transaction tax proposals seemingly drinking in last chance saloon, in this feature we look at financial transactions taxes in general, and examine how the ambitious plan to tax most financial trades in the EU has reached crisis point.
Introduction – What's A Transaction Tax?
We tend to think of transaction taxes as a fairly new concept, something that has come along in the wake of the financial crisis in order to punish the bankers and tame the financial markets. They have, however, been around for a long time in one form or another. The stamp duty on share purchases is one of the United Kingdom's oldest taxes, having been in existence since the early 19th century. Indeed, in 2011, there were 40 countries with transaction taxes in place, and it is said that all told, they generated USD38bn in revenues.
On the one hand, transaction taxes can be quite nebulous, depending on what they are meant to achieve, and can differ markedly from country to country. They may be narrow in scope, applying just to equity trades for instance, or have a wider base and may include items such as derivatives - a term which in itself can describe any number of obscure financial instruments from currency swaps to pork belly futures. They may also apply to banking transactions, such as the withdrawal of money from a bank account.
On the other hand, however, they are quite specific, and should not be confused with a multitude of other financial taxes which have been proposed in the period since the financial crisis erupted. Taxes on banks or other financial institutions may be lumped in together with financial transaction taxes, but for the most part they are not the same unless they apply specifically to a certain type of transaction.
What are Financial Transaction Taxes For?
Bank taxes are often talked about in the same breath as 'Robin Hood' taxes i.e. the idea of taking money from 'greedy' financial institutions in the form of taxation and distributing it to the world's poor. But special bank taxes are normally levied on an institution's profits, or on the value of its balance sheet, or perhaps based on the size of its bonus pool.
Usually, transaction taxes are imposed by governments to discourage certain types of activity on the financial markets, or to achieve certain other objectives. This was the rationale behind some of the earliest transaction tax proposals. The now ubiquitous term 'Tobin tax' was coined after the economist James Tobin proposed in 1973 a tax on spot currency transactions specifically as a means to curb speculative trading, and therefore market volatility, after the dissolution of the original Bretton Woods system. The term is, however, now interchangeable with the many other types of financial taxes that have been discussed during the financial crisis.
Transaction taxes are often justified on the basis that they will generate billions of dollars in revenue to fund good causes. Successive French governments have been particularly strong advocates of these philanthropic-type 'Tobin' taxes. In January 2005, former French President Jacque Chirac suggested in a speech to the World Economic Forum in Davos a number of "experimental" measures, such as a tax on international financial transactions or airline tickets, to raise up to USD10bn in funds which would be used to fight the AIDS epidemic gripping certain poor nations. His successor Nicolas Sarkozy, took up the baton during his administration, announcing at a UN summit meeting in September 2010 that he would use France's presidency of the G8 and G20 to promote the idea of finding "innovative" sources of finance for the fight against poverty and disease in the developing world.
Transaction taxes can, of course, also generate billions in revenue for governments, and they may not always use the money for altruistic purposes. Stamp duty and Stamp Duty Reserve Tax (which was introduced to tax share trades in a 'paperless' world) generates around GBP4bn (USD5.8bn) a year for the British government, although revenue figures have fluctuated in recent years with the rise and fall of the stock market. It is applied on securities involving a UK-incorporated company, but crucially, the tax is imposed regardless of where the transaction took place or where the parties are resident. This means that roughly 40 percent of the revenues from the tax are collected from outside the UK. Still, SDRT revenues account for less than 1 percent of the UK's overall tax take.
As the financial crisis dragged on, momentum built for an international transaction tax both to tame the financial markets and narrow the wealth gap. In 2010 a group of 350 economists from around the world put their signatures to a letter which urged the G20 to set in place a financial transaction tax. These economists representing academic institutions from 35 nations including the UK and the US said that a 0.05 percent impost would have little impact on the day-to-day workings of international finance while raising as much as USD400bn a year to help alleviate third world poverty and fight climate change.
"This tax is an idea that has come of age," the letter stated. "The financial crisis has shown us the dangers of unregulated finance, and the link between the financial sector and society has been broken. It is time to fix this link and for the financial sector to give something back to society. This money is urgently needed. The crises of poverty and of climate change require an historic transfer of billions of dollars from the rich world to the poor world, and this tax would offer a clear way to help fund this."
The economists' campaign was backed by Nobel Prize winning US economist Joseph Stiglitz, who said that: "Very little social returns come from short-term trading. It results in extreme volatility and excessive trading. So anything that discourages short-termism is to be encouraged".
The letter went on to argue that the UK already levies a tax on share transactions (stamp duty) at ten times the proposed rate "without unduly impacting on the competitiveness of the City of London."
Sweden – A Cautionary Tale
However, governments must be very careful in the way they design transaction taxes, and Sweden offers a cautionary tale. In 1984, the Swedish government introduced a 0.5 percent tax on the buying and selling of equities, which was doubled in 1986. This had the effect of sending 50 percent of the volume of trading in Swedish shares to London by 1990. Furthermore, in the first week after a 0.002 percent to 0.003 percent tax on fixed income securities was introduced in 1989, trading volumes in bonds plummeted by 85 percent. The government had initially expected to collect SEK1.5bn from the tax on fixed-income securities, but ended up collecting a paltry SEK50m per year on average. However, the Swedish government did not help its cause because the tax only applied to securities sold by local brokers, meaning that it could be easily avoided by using foreign brokers. The taxes were nevertheless abolished in 1991.
It could be said that the Swedish experience only strengthens the argument for an international transaction tax, providing financial institutions with less scope to avoid such a tax. And the idea is still a popular one amongst academics, campaigners and mainly left-leaning politicians. For instance, In March 2015, the Australia Institute, a think tank, said that a tax on financial transactions could raise more than AUD1bn (USD740m) in revenue per year. However, while the introduction of country-level financial transactions taxes remains eminently possible, as illustrated by the examples of France and Italy below, the chances of a global Tobin tax are extremely remote. The G20 briefly flirted with the idea during the worst days of the crisis, but with America deeply sceptical, the idea was always going to be a non-starter
It is probably fair to say that in Europe, there is more backing than elsewhere in the world for a bank-punishing financial transactions tax to represent some sort of recompense for the largely taxpayer-funded bank bail-outs the financial crisis. However, even here, opinions range from enthusiastic support to downright hostility, usually dependent on who is set to lose out the most from such a tax.
In the absence of an EU financial transactions tax, a proposal which we discuss shortly, certain EU member states have forged ahead with FTTs of their own. One of them is France, which has since August 1, 2012 imposed a 0.2 percent tax on transactions in French securities where stock market capitalization exceeds EUR1bn (USD1.13bn), although debt securities are excluded. In addition, a 0.01 percent tax is levied on credit default swaps and on speculative "automated" trading. This additional tax applies to all entities, incorporated in France or abroad, carrying on high frequency trading in France. Market makers are expressly exempt.
The following year, Italy introduced a 0.2 percent tax on the value of transactions on over-the-counter markets in shares issued by Italian-resident companies (or other equity instruments linked to those shares, no matter where they are issued), reduced to 0.1 percent for such transactions on regular stock markets (although for 2013, those rates stood at 0.22 percent and 0.12 percent, respectively, to reflect the delayed application of the tax to March 1). The tax is payable even if the transaction is concluded outside of Italy and if both parties to the deal are also located abroad. On September 1, 2013, the Italian FTT was extended to include financial derivatives, and a high-frequency trading tax of 0.02 percent was introduced on trades lasting less than half a second.
The real goal of the European Commission and a core group of member states is the introduction of an FTT at EU level. However, this project, as we shall see, has been fraught with difficulties.
The European Union Financial Transactions Tax
A draft directive for an EU FTT was presented by the European Commission on September 28, 2011. The intention was to harmonize the tax base and set minimum rates for all transactions on (secondary) financial markets, once at least one EU party (financial institution) was involved in this transaction. As originally proposed, the exchange of shares and bonds would be taxed at a rate of 0.1 percent and derivative contracts at a rate of 0.01 percent. The proposal took a "triple A" approach, i.e. the tax should apply to all markets (such as regulated markets or over-the-counter transactions), all instruments (shares, bonds, derivatives etc.) and all actors (banks, shadow banks, asset managers, etc.). This was intended to minimize potential distortions across different market segments and reduce the risk of tax-planning, substitution and relocation. It would also ensure that 85 percent of all financial trades were captured by the FTT.
To prevent financial institutions from avoiding the tax by simply relocating to jurisdictions where it doesn't apply, the FTT's proposals include deemed residency and issuance principles. The idea behind this is that, because financial companies are less mobile than financial transactions, taxing institutions on the basis of the residence principle mitigates these geographical relocation risks compared with taxing transactions at source or at the place of issuance. Thus, under the FTT directive as proposed, liability for the tax hinges on the location where the financial instrument was issued, rather than where the instrument was traded. Problematically, this is likely to mean that in practice, financial institutions based outside of EU FTT zone will also pay the tax.
By mid-2012, EU Finance Ministers decided that they could not reach unanimous agreement on the proposal for an EU-wide FTT in the foreseeable future. Nonetheless, a number of member states expressed a willingness to go ahead with the FTT. The door was therefore open for a subgroup of member states to engage in the little-used procedure of "enhanced cooperation" on a common Financial Transaction Tax harmonized amongst themselves.
By the end of September 2012, the Commission had received a request to this end from a group of 11 member states, including Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia, and Slovakia, who asked to be allowed to introduce a common system of FTT based on the scope and objectives of the Commission's initial proposal.
The EU FTT – Illegal And An Economic Wrecking Ball?
According to the Commission this request was analysed taking into account the interests of non-participating member states, and to ensure its compatibility with EU law. However, judging by the reaction of legal and economic experts, it has clearly misjudged the situation.
For starters, the European Council's own legal team considers that the FTT as proposed "infringes upon the taxing competences of non-participating member states," and is therefore incompatible with the EU treaty. The opinion by the Council's legal services, which was leaked to the media in September 2013, goes on to warn that imposing "deemed residency" on financial institutions in non-participating states amounts to the exercise of jurisdiction over entities outside the zone, in contravention of customary international law, and that the proposals therefore go beyond what is allowable under enhanced cooperation.
The UK, home to Europe's largest financial center is strongly opposed to the FTT as proposed, warning that the City of London, where the majority of Europe's financial transactions take place, will bear the brunt of the tax despite the UK having no say in its design. Indeed, according to the UK's House of Lords EU select committee, the residence and issuance principles could leave the UK liable even for tax claimed against companies in foreign jurisdictions, particularly those in the US. For example, under these principles, a financial transaction involving German shares between a US and a UK institution would give rise to an FTT liability for both parties, payable to the German tax authorities.
What's more, countless reports commissioned by the finance industry, and analyses by independent economists, suggest that the FTT will cause at least some damage to European economies. A major concern is that the FTT will inhibit inter-bank lending activities, which itself will curtail lending in the wider economy, thus potentially ushering in another credit crunch. This was flagged up by French and German business associations Medef and BDI, and Paris Europlace, which said in a joint communique in 2014 that EU FTT proposals "would severely hurt non-financial corporations by worsening their financing terms and this precisely at a time where bank loans are constrained by Basel III rules as well as European banking regulations."
Another major concern is that the FTT could drive up the costs of sovereign debt at a time when this is a sensitive issue for many heavily-indebted EU economies. For example, consultancy firm London Economics has found that the cost of issuing UK government debt would rise by GBP3.95bn under the FTT regime.
In a report produced for the City of London Corporation, London Economics concluded that a greater negative impact will be felt on returns for corporate bonds from those states outside the core eleven, although returns on sovereign bonds will be more adversely affected than on corporate ones. The report maintains that this demonstrates that, contrary to its objectives, the FTT could therefore distort competition between financial instruments.
Even some central banks are cautious about the EU FTT, including the Dutch central bank, which in 2012 described the tax as "undesirable," at the same time doubting whether it will counteract risky market behavior. It argued that the Commission's proposal will merely slow down economic growth, and it estimated that the FTT would set Dutch banks, pension funds, and insurers back EUR4bn per year.
In a similar vein German Bundesbank President Jens Weidmann warned of the negative implications of the FTT, explaining that in its current form, the tax would include money market or so-called "repo" transactions. This will significantly impact upon the repo market, which plays a central role in liquidity balance between commercial banks, he pointed out. The consequences of this market not functioning properly will be that the transactions are then deflected into the European system of central banks or Eurosystem, meaning that central banks will be heavily involved in maintaining the liquidity balance between banks for a long time after the crisis.
The End Of The Road In Sight For The FTT?
In spite of all the criticism, the FTT group have ploughed on with regular negotiations in order to finalize the final version of the tax. Things haven't progressed smoothly, however.
In May 2014, Slovenia refused to sign a joint statement after a meeting with other participating states on the development of the FTT, citing concerns with the way the talks were going. Explaining the Government's decision, Slovenia's Prime Minister, Alenka Bratušek, told Parliament on May 19, 2014, that Slovenia had supported the FTT on the basis that it would apply to a broad tax base, be set at a low rate, and be simple to administer. However, the current proposals were going in the opposite direction, she said. What's more, the Government expects to collect just EUR3m from the EU FTT, but spend EUR2m on administering the tax.
By the end of 2015, the FTT group was apparently no nearer to concluding the negotiations, with participants unable to agree on tax rates and the FTT's scope, particularly with regards to derivative trades. Another major stumbling block was how FTT revenues should be used and distributed. However, perhaps the most serious development was Estonia's growing opposition to the proposals, and like Slovenia in the previous year, the Baltic state refused to put its name to the outline agreement drawn up at the end of the December 8 meeting.
Since then, things have gone from bad to worse for supporters of the FTT. Having given themselves another six months to arrive at an agreement, June arrived with the negotiators still apparently at loggerheads. More worryingly, it has come to light that Belgium now has serious reservations about the FTT, while others are wavering. If these three countries – or more – decided to quit the negotiations, it would be impossible for the remaining member states to proceed with the FTT on the basis of the enhanced cooperation, since a minimum of nine countries are required to implement European legislation using this procedure.
With the FTT proposals now seemingly hanging by a thread, Austrian Finance Minister Hans Jörg Schelling said on June 16, 2016, that unless an agreement was reached by September 2016, "then we probably won't get one." Taking into consideration all of the issues raised with the FTT, and the difficulties that member states are having coming to a consensus on the tax, this would seem a likely outcome.
Nevertheless, the idea of taxing financial trades remains a popular one, not just in the EU but worldwide with the financial crisis still relatively fresh in the memory and the gap between rich and poor growing wider. Thus, we will continue to see pressure for the implementation of Tobin taxes, Robin Hood taxes and FTTs etc, even if the political will to implement them isn't quite there.
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