French President Nicolas Sarkozy has made it quite clear he is determined to forge ahead with a controvesial Financial Transactions Tax (FTT), even if it means his country is the only one to implement it. It seems likely, then, that some form of FTT will be introduced in 2012, though it remains to be seen whether such a tax will be at the level of the EU, the Eurozone, the new “Eurozone Plus” group… or just France. The European Commission has been pushing for an eventual EU-wide tax, and its proposal (PDF) was presented to European finance ministers last year by Tax Commissioner Algirdas Šemeta. Debating Europe launched a debate on the FTT in 2011, and we’ve taken some of the comments and questions from that debate to Commissioner Šemeta to hear his response.
First, we had a comment from blogger Tim Worstall, who argued that financial institutions will just end up passing down the costs of any FTT to consumers. How does the Commissioner respond?
It is important to be clear on the scope of the proposed FTT. We want to tax the trading of financial instruments like securities, bonds and derivatives, not the day-to-day financial activities of ordinary citizens or companies. The conclusion of insurance contracts, mortgage lending, consumer and business credits or payment services will, for example, not be included in the scope of this tax. More than 85% of all the transactions to be taxed are transactions within the financial sector, where, for example, one bank trades with another one. So, there is no direct client immediately identifiable to whom the banks might want to pass on the tax incurred.
Thus, citizens, private households and SMEs will not be directly affected by the tax, unless they themselves invest on financial markets. However, they might be indirectly affected by an increase in capital costs and lower financial asset prices in case financial institutions want to recover the cost of the tax from business with their clients not linked to financial markets. But these effects will probably be limited as the tax rate proposed is low and would in the first place fall on financial companies. Even if the bank was to pass on the FTT to its client, such as a private household, the additional charge would be rather low. In case a private household was to intervene on financial markets, for example through buying or selling shares, it should only be charged an additional 0.01 to 0.1% of the transaction volume. If a private household wanted to purchase, for example, shares in the amount of €10,000 his bank might charge a €10 FTT for this transaction. Of course, the more frequently a person traded (with the help of his bank) on stock exchanges, the more frequently the investor would have to pay the tax.
It is, indeed, expected that the shareholders of the banks and the investment bankers will have to shoulder parts of the tax, for example through lower dividend payments and reduced bonuses paid out. This effect would not be unwarranted, as a golden rule of sound public policy requires that those benefiting from a public policy should also be those that should pay for its provision.
Next, we had a comment from Jeremy Baxter, who argued that introducing an FTT would just encourage financial institutions to move their operations elsewhere, such as Zurich, where there was less regulation and they could avoid paying.
The FTT proposal should be seen as a key step to making progress on a global solution to taxing financial transactions. A global FTT is the first best solution. The Commission has always been in favour of an FTT at the global level and we think that it would make sense to support this position by leading by example.
We believe that if we can show that such a tax works also at a (sufficiently broadly defined) regional level and generates substantial revenue without harming the overall economic development, then other regions of the world will follow. However, any “local” FTT needs a number of anti-avoidance and anti-relocation measures. We want to set a good example to promote the FTT at the global level – as has been asked from us by the European Parliament and the heads of state of the EU Member States. The Commission is not the only one to advocate this idea – there were many supporters at the Millennium Development Summit in NYC recently, for example, but it is true that there is no universal consensus.
We will continue discussing this with our G20 partners. I think the sounder, more solid the evidence of the potential benefits of such a tax we can provide, the greater our chances are of convincing them to work with us on a global FTT.
Nevertheless, already with the legal proposal of the Commission there are a lot of potential loopholes that have been closed. Actually, relocating a transaction (for example, from Frankfurt to Zurich) does not really help in circumventing the payment of the tax, as it is not the place where the transaction takes place that determines tax liability but the place of establishment of the parties in the transaction.
John Raven argued that “It is important to consider the experience of Sweden in the late 1980s. The imposition of a FTT on equities and bonds was a total disaster as trading simply moved overseas. Bond trading collapsed, with implications for [government] financing.” Should the experience of Sweden be a warning against introducing an FTT?
Sweden introduced a 50 basis points tax on the purchase or sale of equity securities in January 1984. A “round trip” transaction (purchase and sale) resulted therefore in a 100 basis points tax. The tax applied to all equity security trades in Sweden using local brokerage services as well as to stock options. The fact that only local brokerage services were taxed is, in the literature, seen as the main design problem of the Swedish system.
We studied different countries’ experiences and we designed the tax carefully to avoid the kind of failure Sweden experienced. The Commission’s proposal includes in particular the following features:
• It has a much broader tax base;
• It makes a link to the residence of financial institutions at EU level;
• It considers financial institutions of third countries with a branch established in the EU or even without such a branch, i.e. makes them taxable; in the latter case when they interact with EU counterparties (subject to certain conditions).
To put it in other words: Sweden covered local brokerage services whereas the EU FTT would cover transactions by broadly defined financial institutions established in the EU, including pure third country-based institutions when they interact with EU counterparties. In case of the EU FTT, an easy evasion is not possible if there is a link with the EU territory. Joint and several liability rules ensure enforceability.
In addition, a possible move from equity trades to other financial instruments would not be an option under the EU FTT as financial instruments are comprehensively covered.
Moreover, an EU framework provides for a coordinated approach in the EU which should mitigate the problem of relocation and distortion of competition.
Finally, Tim Worstall also argued against the tax on the grounds that “There will be no additional revenue! A bit comes in from the tax, yes, but it shrinks EU GDP by 1.7%. Meaning that all other tax revenues *fall*. By more than the new revenue. The FTT simply does not provide any extra revenues at all: it shrinks revenues.”
The Commission’s extensive analysis show that the implementation of an FTT at EU level, provided that the negative impacts of major risks identified would be minimized, could raise around €50 billion per year, largely depending on market reactions. Also, in case the profits of financial institutions were negatively affected, some offsetting knock-on effects on profit taxes could be expected. The tax will, thus, help to generate revenues for the public budget which could be used for different purposes.
There is indeed a degree of uncertainty on the revenue from an FTT, because it would be a new and innovative tax, and as asset prices underlying these transactions are volatile. This mainly holds for shares and derivatives thereof. Hopefully, also the market volumes for government bonds should decline once budget consolidation progresses. This risk can be managed by using cautious projections for the budget.
When it comes to estimating the effects of such a tax on GDP, a lot of uncertainty exists as well. The figure of 1.7% refers to a deviation of GDP from its baseline scenario in the long run. Thus, it describes a cumulative effect over several decades, while the revenue estimations provided refer to annual revenues. Also, some of the assumptions underlying the concrete model run (such as the design of the tax and the way how enterprises finance their investment activities or how the revenues generated will be recycled) introduced a significant bias in the estimation. Correcting for these effects, the more appropriate figure might therefore be in the order of 0.5 to 1.0%. In any case, we should not forget that such figures are derived from macroeconomic model simulations which are specifically difficult when it comes to analysing financial markets.
What do YOU think? Are you satisfied with Commissioner Šemeta’s arguments? Do you think countries like the UK (one of the most important financial centres in the world) will be able to avoid the FTT? Or do you support the tax as a way to “make the financial sector pay”? And what should be done with any revenues raised? Do they go to the Commission, to national governments or to help the world’s poor, as anti-poverty campaigners would like? Let us know in the form below, and we’ll take your comments to policy-makers and experts for their reactions.