The idea of a tax on financial transactions, specifically on foreign exchange transactions, was first suggested by the Nobel Laureate James Tobin as a means of damping down exchange rate volatility following proposals initially formulated by Keynes. In the wake of the recent financial crisis, despite initial encouragement from some key G20 countries, the idea of a global financial transactions tax (FTT) failed to gain full support. However, European leaders, in particular former French President Nicolas Sarkozy, German Chancellor Angela Merkel and Algirdas Šemeta, EU Commissioner for Taxation and Customs Union, took up the idea, calling for a specific EU tax.
The explanatory memorandum to the European Commission’s draft directive suggested that such a tax would:
- avoid fragmentation of the internal market by coordinating national FTTs
- ensure a fair contribution by the financial sector to the costs of the recent crisis
- ensure a level playing field between the financial sector and other sectors
- remove certain distortions from the financial markets
- provide a source of own revenue for the EU.
From the start, therefore, there were conflicting motives for introducing an FTT. Unlike the original Tobin proposal, which had the single policy objective of discouraging speculation, the original EU proposals were more broadly directed. In particular, it was not clear whether the primary motive was to penalize and so discourage the kind of financial behavior which was felt to have caused the crisis; or whether it was to ‘punish’ the financial services sector for their role in the crisis by ensuring they paid a ‘fair contribution’ to the costs. Furthermore, while Tobin suggested the proceeds of his tax could flow to the IMF or World Bank, the EU sees it in part as a revenue source for itself. Original indications were that the tax could generate revenues of around EUR57 billion of which two-thirds would flow to the EU budget, with corresponding reductions in the contributions made by member states. These confusions over intent have bedeviled the issue since.
The EU FTT would be imposed on transactions involving financial instruments where at least one EU-based financial institution is involved. It would cover a wide range of financial transactions, including the purchase and sale of financial instruments such as shares and bonds but also the entry into and close out of derivatives agreements such as options and futures relating to securities or commodities. The draft directive proposed a minimum level of FTT of 0.1 percent for financial transactions other than those related to derivatives agreements and 0.01 percent in the case of derivative agreements.
The FTT is explicitly aimed at taxing transactions between financial institutions rather than those carried out by ordinary individuals or businesses. Financial institutions are broadly defined to include banks and investment entities, but also holding companies and special purpose vehicles, such as securitization vehicles.
Despite the overt limitation of the proposal to tax financial institutions, it is obvious that the costs would be passed through in one way or another to companies and consumers, and therefore there is a risk of creating a drag on GDP and economic growth. The European Commission initially estimated a negative GDP impact of between 0.53 percent and 1.76 percent, although the assumptions underlying these estimates are complex and controversial, and these estimates have since been revised downwards.
There has been considerable concern about unexpected and undesirable side effects. The European Federation for Retirement Provision has argued that pension funds, Institutions for Occupational Retirement Provisions (IORPs) and companies managing assets on their behalf would be severely affected; current and future pensioners would end up paying even more of the costs of the financial crisis. Other criticisms leveled at the tax are that it would reduce market liquidity, increase volatility and, by penalizing the hedging of corporate risk, it would perversely increase risk in the system.
The original European Commission proposals for an FTT understandably excited considerable public and political discussion. A significant number of member states are particularly concerned that unilateral action by European governments would simply have the effect of driving financial sector businesses to relocate outside the EU to jurisdictions that do not impose such a tax. Many argue that an FTT could only be practical and acceptable if it were introduced on a global basis as originally proposed.
The British government, conscious of the contributions of the financial services industry in London to national GDP, is particularly concerned that an FTT would have a detrimental impact on growth within Europe and have a disproportionate impact on the UK. George Osborne, Chancellor of the Exchequer, has said “Proposals for a Europe-only financial transactions tax are a bullet aimed at the heart of London … a tax on mobile financial transactions that did not include America or China would be economic suicide for Britain and for Europe.”1 European opposition to the tax has become so extensive that an informal KPMG survey in January 2012 found only three member states: France, Germany and Spain fully in favor.
The original Commission proposal is therefore effectively dead for the time being. Nevertheless, the two most powerful European economies, Germany and France, are committed to introducing some form of FTT. France, in particular, has already legislated to introduce such as a tax. The French government said that it hopes by taking the lead in this way to push reluctant states to participate after all: “This tax will allow us to show to those that are reticent, that an FTT is feasible, does not have perverse effects and responds to two issues: the excesses of finance and the financing of development.”2
As long as significant uncertainty continues over the form and scope of an FTT, it is difficult to assess accurately the practical implications for financial services companies. Certainly the original Commission proposals were complex, unclear and likely to impose major administrative and management costs on companies; significant IT investment would be necessary to track and record qualifying transactions and remit tax arising.
However, it is now beginning to look as if these might be replaced with more restricted proposals for individual member states or groups of member states. The current French proposal is in effect limited to a variant of the ‘stamp duty’ on share trading, which has long been in existence in the UK. It will apply to capital instruments (‘titres de capital’ ) and assimilated securities (mainly equities) listed on a French or foreign-regulated market, issued by companies whose headquarters is located in France and whose capitalization exceeds EUR1 billon.
A form of stamp duty is also emerging as a possible Europe-wide compromise deal, with Germany reportedly saying that it would support such an option if it applied to derivatives and was accompanied by tighter regulation on high-frequency trading (HFT). The British government may continue to oppose a tax which is extended to derivatives and HFT, but it would find it very difficult to oppose a stamp duty tax broadly equivalent to the one which has applied in the UK for many years. Apart from perhaps the UK, others might consider harmonization a good thing the boost it would give to Europewide tax harmonization.
Despite the uncertainty regarding the French FTT (the rate enacted last March is 0.1 percent on acquisition of stocks and it could be increased to 0.2 percent as included in the recent Draft Amending Tax Bill), it looks at least possible that some form of Europewide tax will be agreed: the British position will be key to whether this extends to all 27 member states or is confined to the euro-zone members or another sub-group. If these taxes are based on a form of stamp duty on share transactions, then the administrative burden on individual companies should not be excessive. In France, for example, Euroclear has been tasked with managing the system and collecting the tax receipts.
However, the policy confusion at the heart of the debate means that the inevitable detriments such as negative GDP impact and perverse impacts will be suffered without any clarity on compensating benefits. There is a risk that the financial system will end up neither less risky nor less volatile. A significant missed opportunity indeed.
1London Evening Standard, 14 November 2011
2Prime Minister François Fillon, quoted Financial Times 30 January 2012