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A European Financial Transactions Tax - a Cacotopian dream?
There has been renewed discussion about a European financial transactions tax (FTT) during bilateral Franco-German meetings on the difficulties facing the eurozone. In July, German Chancellor Angela Merkel and French Prime Minister Nicolas Sarkozy instructed officials to prepare a detailed proposal by September. The instruction comes on the back of proposals outlined in the European Commission’s budget proposals for the period 2014-2020, published in June of this year.
What is a FTT?
A FTT (often incorrectly referred to as a Tobin Tax after the economist James Tobin who first proposed in the 1970s a tax on foreign exchange transactions only) has long been viewed in some quarters as a way to enhance the efficiency and stability of financial markets and reduce their volatility. Proponents also see it as delivering a significant contribution to the public purse by financial institutions. Calls for such a tax have increased in frequency in direct proportion to the amount of financial support received by financial institutions during the current economic crisis.
Ahead of last year’s G-20 summit in Toronto, the European Council put forward the view that “the EU should lead efforts to set a global approach for introducing systems for levies and taxes on financial institutions with a view to maintaining a world-wide level playing field”. It was agreed that there was a need for financial institutions to contribute in a fair and substantial way towards the cost of the assistance they had received. However, a consensus was not reached that the imposition of a FTT was the best way forward.
The European Commission published its budget plans for the period 2014-2020 in June of this year. Amongst the proposals contained in the budget plans was the imposition of a FTT, which the Commission hopes will recoup up to EUR€50 billion over the seven year period, funding one third of the Commission’s overall budget. Although short on detail, the proposal gives a broad outline of how such a tax would work. The Commission proposal envisages the imposition of a levy of 0.1% on the value of transactions involving stocks and bonds and a levy of 0.01% on derivative transactions.
Reaction to the proposals
Academic opinion in relation to a FTT is mixed. Noting that the rationale for imposing such taxes has been the reduction of volatility in financial markets, empirical evidence has often shown that, far from reducing volatility in financial markets, the imposition of a FTT can in fact increase volatility, reduce demand and ultimately reduce the price of securities.
The difficulties associated with imposing a FTT have not been ignored by those proposing the measure. The European Commission, in October 2010, acknowledged the uncertain effect that a levy would have on market volatility. Furthermore, it was recognised that a FTT might distort the market, with investors being incentivised to move their trading activity to jurisdictions where transactions would not be subject to the FTT, or favouring activities which fall outside the scope of the FTT.
There is a suggestion that the imposition of a FTT would damage the financial centres of the EU. To support this view, commentators have pointed to the example of Sweden, where the Swedish Stock Exchange suffered an 85% drop in revenue following the introduction of such a tax in the 1990’s. An alternative view to this is that the operation of stamp duty in the United Kingdom, which is itself a tax on transactions, has had no such effect.
While Chancellor Merkel and Prime Minister Sarkozy have pledged to draw up a proposal, they face an uphill task in breaking the international deadlock over implementing a FTT. Their proposals drew dismissive responses from business groups which viewed the FTT as unworkable and damaging to growth.
One London-based think tank has criticised the plan as being “economically illiterate”, citing numerous academic studies which have suggested that such a tax would lead to more erratic movements in equity and foreign exchange markets, falling share prices and poor liquidity.
Although the Franco-German proposal did not provide any detail, Irish Minister for Finance Michael Noonan stated that any new proposal would have to work on a 27 member state basis and should not be limited to the eurozone countries. That would require agreement from the United Kingdom, which currently looks highly unlikely. The City of London fears that the imposition of any such tax would simply cause investors to remove themselves to more hospitable locations.
Jurisdictions do not want a first mover disadvantage in relation to a FTT and a broad international agreement from G20 countries is likely to be a pre-requisite to any EU agreement to introduce a FTT. Even Jean-Claude Trichet, president of the European Central Bank, acknowledges that a FTT would be unworkable unless it was imposed globally.
The proposal faces the same political and legal obstacles that have thwarted previous attempts to introduce such a tax or, indeed, any direct tax at EU level. An EU-wide measure would require the agreement of all 27 member states, which recent history and political head-winds would suggest is nigh on impossible. Nor is it easy to envisage more widespread support: several G-20 nations remain opposed, and the United Kingdom disapproves of any unilateral EU measure which would damage the City of London. Would the eurozone countries press ahead with a FTT in the absence of more wide-spread support? It would be unlikely as it could be economically disadvantageous for the eurozone to do so. Even achieving agreement within the eurozone would be a struggle.
Viewed in this light, the emphasis placed by Chancellor Merkel and President Sarkozy on formulating proposals for a FTT appear to be motivated more by domestic political considerations than a real belief in the likelihood of a FTT being adopted and implemented.