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Topical Focus - Transaction Taxes

By Editorial
October 23, 2012

With the European Union - less than half of it at any rate - having reached a momentous agreement to forge ahead with a tax on financial transactions, in this article we give an overview of transaction tax initiatives past, present and future.

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 four years or so 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. 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 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% of the revenues from the tax are collected from outside the UK. Still, SDRT revenues account for less than 1% of the UK's overall tax take.

As the financial crisis has dragged on, momentum has 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 say that a 0.05% 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 states. "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 is 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 goes 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." 

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% tax on the buying and selling of equities, which was doubled in 1986. This had the effect of sending 50% of the volume of trading in Swedish shares to London by 1990. Furthermore, in the first week after a 0.002% to 0.003% tax on fixed income securities was introduced in 1989, trading volumes in bonds plummeted by 85%. 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. However, 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.

The European Union is also deeply divided on the issue, but a core group of 11 member states are forging ahead with proposals advanced by the European Commission in September 2011 regardless. Under the plans drawn up by the Commission, a 0.1% tax would be imposed on the trading of shares and bonds, while a 0.01% rate would apply to other types of transaction, including derivatives. To mitigate the risk of relocation, the levy would be imposed on the financial institution at its place of residence.

Algirdas Semeta, European Commission for Taxation, confirmed on October 9 that commitment letters have been received from Germany, France, Belgium, Austria, Slovenia, Portugal and Greece with regard to the proposed tax, while "clear assurances" were given during the meeting that Italy, Spain, Estonia and Slovakia will send theirs very soon. 

Semeta triumphantly declared that: "We have received a clear - and very welcome - signal that there will be enough member states on board for an EU Financial Transactions Tax. I proposed this tax as a source of new revenue from an under-taxed sector, and a means of encouraging more responsible trading."

Interestingly, Semeta also said that the FTT "would also prevent a patchwork of national bank taxes from creating difficulties for businesses in the Single Market". At the moment however, it is hard to envisage this being the case. 

When it looked like Germany and other key member states were backing away from an FTT encompassing the EU, or even just the Eurozone, earlier this year, the French duly forged ahead with their own transaction tax under the presidency of Nicolas Sarkozy. Effective August 1, 2012, and supposedly prefiguring the introduction of a mechanism at European level, the 0.2% tax is imposed on transactions in French securities where stock market capitalization exceeds EUR1bn (EUR1.23bn), A 0.01% tax is to be 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. High frequency trading is defined as dealing with orders through an automatic device, provided the interval between such orders does not exceed half a second. Devices aimed at optimizing the fulfilment of orders are specifically deemed not to be an 'automatic device' for the purpose of this tax. The tax also applies when the rate of cancellation/modification of all orders in a trading day exceeds 80%, according to a circular issued by the tax authority. By law, this rate is not allowed to be below two thirds. It is perhaps too early to say how this will affect the French financial services industry. However, due to its territoriality this tax certainly leaves the door open for relocations as French firms may set up a company overseas specifically to avoid the tax. There are few indications though, that the French government will scrap the levy in light of Semeta's statement. Indeed, one of President Francois Hollande's first acts was to double the tax from 0.1% to 0.2%.

Transaction taxes have also sprung up in various other EU countries. In Hungary, a financial transactions tax will apply at a rate of 0.1% on bank and post office transactions, capped at HUF6,000 (USD2,800), from January 1, 2013. A separate rate of 0.01% was also to be applied to overnight deposits with Hungary's central bank from next year, although the government recently dropped this measure.

Hungary's transaction tax has earned admiration from neighbouring Austria. Addressing a conference in Vienna on October 19, Finance Minister Maria Fekter professed that Hungary's idea of imposing low rates of income tax on its citizens, and making up the revenue shortfall with transaction taxes was an "exciting" one.

A domestic FTT is currently being discussed by the Italian government as part of the latest budget package. It is believed that the tax will take the form of a stamp duty on the value of share transactions at a rate of 0.05%. It will also apply on the notional value of derivatives. It is expected that the tax will target shares and derivatives issued by Italian companies, and will apply when the sale takes place within Italy, regardless of who the contracting parties are; and when the sale takes place outside of Italy, provided one of the contracting parties is Italian. At this stage, the proposals are subject to change, but it is thought that the Italian FTT will be effective from January 1, 2013. 

As part of the austerity budget announced on October 16, the Portuguese government is also planning to implement a national financial transaction tax. It is proposed that the tax rate on equities and derivatives will be 0.3%, and the rate on high frequency trading will be 0.1%. If approved, the tax could be in place by 2013. 

While the actual rates and scope of these tax may change, it is clear that Portugal and Italy, which both support the EU FTT, clearly intend to introduce some form of financial transaction taxes of their own, and other countries with transaction taxes of one sort or another in place, which include Belgium, Finland, Greece and Poland, are clearly hanging on to them, despite Semeta's assertion about a level playing field.

More fundamentally though, there are many who feel that the EU, or at least a part of it, is about to commit economic suicide. 

Earlier this year, British Prime minister David Cameron suggested that an EU FTT would be "simply madness", driving away the financial services industry from Europe and leading to a reduction in EU gross domestic product of EUR200bn (USD260bn).

The Dutch central bank has also warned that an EU FTT would be "undesirable", casting doubt over whether it will counteract risky market behaviour, as intended by the Commission. "It is questionable whether an FTT would be successful in counteracting speculation and other undesirable market behaviour, thus enhancing financial stability," the bank said. "While an FTT might for instance counteract forms of arbitrage, such as high-frequency trading, it may also cause traders to relocate or to increase their risk appetite. Pursuing a riskier trading strategy to protect one's margins would run exactly counter to what the Commission's proposal aims to achieve. Which of the two possible effects would win out is unpredictable. Moreover, it is questionable that an FTT would be effective in counteracting market volatility - which is one of the frequently cited benefits of an FTT."

According to the Alternative Investment Managers Association, the Commission's own studies concluded that the FTT would leave the EU worse off by tens of billions of euros annually, presumably if rolled out across the whole bloc. It estimated that the FTT's annual revenues would be approximately EUR25bn-EUR43bn (USD32-55bn), but there would also be a reduction in EU-wide GDP of between 0.53% (EUR86bn) and 1.76% (EUR286bn). Even that considerable cost may have been underestimated, AIMA said, because it did not fully take account of the "cascade" effect of taxes being applied to every constituent part of a particular trade.

Only time will tell how the FTT will affect the EU and its constituent parts. What is clear though, is that transaction taxes are rapidly becoming a new reality for investors.


Tags: tax | trade | France | Hungary | Italy | stamp duty | G20 | Belgium | budget | Germany | Greece | European Commission | financial services | Portugal | Austria | currency | services | Finland | Poland | law | Slovakia



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