On September 28, 2011, the European Commission formally proposed a plan to implement an EU-wide financial transactions tax (FTT)[1]. Unanimity is required to implement such a proposal at the EU level and this is impossible as many member states, notably the United Kingdom and Sweden, oppose it [2]. As a way around this, in Oct 2012 the Commission suggested an enhanced cooperation procedure that would allow a minimum of nine EU members to go ahead with the FTT without other member states being involved. A minority of eleven member states decided to proceed [3]. The European Parliament resoundingly approved their plan in December 2012 and the European Council assented on January 22, 2013 [4]. On February 14, 2013 the European Commission adopted a proposal for an 11-nation FFT and it will come into force after being approved by the participating member states and the European Parliament. The target starting date is January 1, 2014.
A properly designed financial transactions tax can be a sensible way to raise a modest amount of revenue. It requires some investment: an administrative organization must be set up; new software must be created; people must be hired and trained to collect the tax; financial firm employees must be educated in compliance. However, it need not be expensive collect or to comply with. The relatively small number of potential taxpayers makes registration fairly easy; for a wide range of transactions it is straightforward to calculate the amount of tax owed; financial firms already possess the required record-keeping capacity [5]. The UK’s transactions tax is an example of one that works reasonably well. This tax is a 0.5 percent levy paid by purchasers of UK shares. It is mostly assessed and collected through the UK electronic securities settlement system. It yielded revenue equal to 0.3 and 0.2 percent of GDP in 2008 and 2009, respectively. (Operational) administrative and compliance costs were estimated at a relatively low 0.1 and 1.4 percent, respectively, of revenue collected [6].
The UK transactions tax has worked because it is small enough to deter large-scale tax avoidance and having the collection done by the clearing system reduces tax evasion. An example of a less successful transactions tax is provided by Sweden. In 1984 Sweden imposed a 0.5 percent levy on both the purchase and sale of shares that involved registered Swedish brokers. In mid 1986 the rate on brokered transactions was doubled and in early 1987 the tax base was enlarged to include all transactions in shares. Small taxes on bond and associated bond derivative transactions were introduced at the start of 1989. The effect on trading volumes was dramatic. By 1991 only 40 percent of the trading in Swedish shares still took place in Stockholm. During the first week of the bond tax, trading volume fell by 85 percent from its average in the summer of 1987; trading in futures in bonds and bills fell by 98 percent over the same period. Disappointed, the Swedish authorities removed all transactions taxes by the end of 1991 [7].
Unfortunately, the Commission’s proposed FTT is a badly designed tax. The purchase and sale of shares and bonds is to be taxed at 0.1 percent and the exchange of derivatives is to be taxed at 0.01 percent. This is innocuous enough for the transfer of shares that will be held for long periods. But, for many types of transactions this is a large and capricious tax. As the tax is paid on both the sale and purchase of an asset, a transaction from one investor to another that goes through a broker, a clearing house and another broker is taxed six times [8]. Institutions that fund themselves in the overnight repo market could end up paying an annual tax of about 25 percent; under such a tax this market would likely shut down. The tax is to be paid on the notional value of a derivative contract. However, this notional amount may never be paid (if, for example, an option is not exercised) or it may differ from the amount exchanged (for example, if the transaction is an interest rate swap). The result is a potentially arbitrary and unfair tax that is open to evasion by manipulation of the notional amount.
The proposed tax covers OTC trading as well as trading in organized markets. But many types of OTC trades are not reported and are settled bilaterally. An obvious effect of the FTT will be to divert transactions off of organized exchanges and into the OTC interbank market, away from the eyes of both the tax authorities and the supervisors. The financial sector is highly mobile, is able to create new and complex financial instruments and has a demonstrated ability to outwit government officials.
A remarkable feature of the FTT is that it is to be applied to transactions outside of the participating member states. If a German subsidiary of a Chinese parent bank transacts with its parent company in Hong Kong, a tax is owed. Even more heroically: if parties to a transaction trade securities issued in a participating member state outside of that member state then they may be deemed to be residents of that participating member state for purposes of collecting the FTT. When one Malaysian company sells French government bonds to another in Singapore, they incur the FTT. By creating a tax with such extraordinary extraterritoriality that so obviously begs to be evaded, EU policy makers will promote a culture of non-compliance with all EU taxes and diminish the legitimacy of all EU institutions.
It is tempting to wonder how such a perverse tax proposal came about. The Commission justified the FTT on two grounds: fairness and the strengthening of the internal market. However, the comments of European Union officials suggest that it is a populist desire for retribution as well as fairness and efficiency concerns that have propelled the proposal. European Commission President José Manuel Barroso commented that ‘it is time for the financial sector to make a contribution back to society’ [9]. Commissioner Michel Barnier opined that capitalism had ‘become a caricature of itself’ and it is ‘politically and morally’ right that the financial sector should be taxed [10]. European Parliament rapporteur Anni Podimata stated that ‘it is not a solution to spare the financial sector from a tax, the very same sector which is now even benefitting from the crisis. Delay in implementing this tax is costing money which is being footed by normal people’ [11].
There is something disquieting about policy makers deciding that it is convenient to use the tax code as a tool for punishing either corporations or individuals that they do not like; it is vindictive populism masquerading as the pursuit of fairness. If EU or other policy makers believe that financial institutions or their employees behaved in a criminal manner, then they should go after them in court, where these supposed wrong doers may face their accusers, as is done in civilized societies. They should write the tax code with the aim of raising revenue in the least distortionary, least costly and least unfair way possible.
References
Bronddo, John D., “Taxing Financial Transactions: An assessment of administrative feasibility,” IMF Working Paper WP/11/185, Aug 2011, www.imf.org/external/pubs/ft/wp/2011/WP11185.pdf
Campbell, John Y. and Kenneth A. Froot, “International Experiences with Securities Transactions Taxes,” NBER Working Paper no. 4587, Dec. 1983.
CNN Staff, “Barnier: Europe’s ‘Robin Hood’ tax ‘politically and morally right,’” CNN, 25 Jan 2013.
Coffin, Joshua, “Barroso Backs Transactions Tax,” Financial Times, 28 Sep 2011.
Council of the European Union, “Financial Transactions Tax: Council agrees to enhanced cooperation,” 22 Jan 2013, http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/134949.pdf.
European Commission, “Financial Transaction Tax: Making the Financial Sector Pay its Fair Share,” press release, Brussels, 28 Sep 2011, http://en.wikipedia.org/wiki/European_Commission.
European Commission, “Proposal for a Council Directive Implementing Enhanced Cooperation in the Area of Financial Transaction Tax,” Brussels, 14 Feb 2013, http://ec.europa.eu/taxation_customs/resources/documents/taxation/com_2013_71_en.pdf.
European Parliament News, “Eleven EU countries get Parliament’s All Clear for a Financial Transaction Tax,” European Parliament, 12 Dec 2012, http://www.europarl.europa.eu/news/en/pressroom/content/20121207IPR04408/html/Eleven-EU-countries-get-Parliament%27s-all-clear-for-a-financial-transaction-tax.
Lorenzen, Hans, “European Financial Transaction Tax: No Time to Hesitate,” Citi GPS: Global Perspectives and Solutions, 11 Apr 2013.
Wiberg, Magnus, “We tried a Tobin tax and it didn’t work,” Financial Times, 16 Apr 2013.
[1] European Commission (2011).
[2] Other EU member countries opposing the FTT are Bulgaria, Cyprus, the Czech Republic, Denmark, Luxembourg and Malta. Ireland favours it at the level of the EU as a whole, but not for just the euro area. The Netherlands and Finland have not yet decided.
[3] The countries were Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain. See European Parliament News (2012).
[4] Council of the European Union (2013).
[5] See Bronddo (2011) for a discussion of the administrative feasibility of a financial transactions tax.
[6] Bronddo (2011).
[7] See Campbell and Froot (1993) and Wiberg (2013) for accounts of the Swedish experience.
[8] This example is due to Lorenzen (2013).
[9] Coffin (2011)
[10] CNN Staff (2013).
[11] European Parliament News (2012), italics mine.