In his first idea, the Nobel prize-winning economist James Tobin had in mind the aim of limiting the undesirable effects of speculative activities through the levying of a small tax on foreign exchange transactions. The purpose was to penalise short-term speculators in favour of investors, whose transactions are longer-term oriented. In that sense, “throwing sand into the wheels of foreign exchange markets” was intended to discourage speculative behaviour and stabilise markets, by reducing overall market volatility. The implementation of such tax, nowadays known as the financial transactions tax (FTT), is advocated by Jose M. Barroso on the grounds that it would „create appropriate disincentives for overly risky or purely speculative transactions” and would „address concerns about excessive profits” in the financial sector. The tax is set to be levied at 0.1% on shares and bonds transactions and 0.01% on derivatives, and believed to raise €57bn a year. This would act as a contribution of the financial sector to the costs of government bailouts caused by the financial crisis. A lot of opponents predict this Robin Hood tax will not only impact financial services but instead would have a knock-on effect on the economy as a whole. In a nutshell, such a tax is likely to hamper the EU’s long-term competitiveness, as world’s leading exporter of financial services; to have a chilling effect on growth (reduction by 1.76% of the annual GDP according to the EC’s cost-benefit analysis); to increase the cost of capital, driving businesses to lower cost destinations outside Europe (70% to 90% of European transactions could be pushed to America and the Far East); to cost hundreds of thousands jobs and would end up being passed on to consumers.
We can go further in bringing to light the various side-effects of a Tobin tax…
We cannot talk about a financial transaction tax without thinking about London, the largest and most international financial centres in Europe, constituting a huge asset to the European Union. According to Stuart Fraser, a Tobin tax would put London at a competitive disadvantage, with financial firms likely to leave the country if the tax is not introduced globally, while the smaller financial centres, as
Frankfurt and Paris, would escape relatively lightly.
…as actor’s behaviours change : tax avoidance
We know that policy makers cannot distinguish informed traders from noise traders when implementing a tax and that higher transaction costs discourage both fundamental based and noise traders. As a result, speculators would get disproportionally more hurt by a transaction tax, because they tend to trade much more frequently. Given the high degree of mobility of financial markets, we will inevitably assist to tax avoidance due to relocation of markets and migration to non-taxed products.
One important role financial markets play is making asset prices reflective of real-world conditions. High-frequency trading adds volume and liquidity to markets. According to recent researches, the number of transactions, especially short term ones, declines in markets where a transactions tax is levied; so lowering high-frequency trading would lead to a reduction of liquidity which will, in turn, most probably increase volatility. However the latest empirical evidence shows that the tax has volatility-reducing properties only in immature markets, prevailed by speculative activities.
Among others, the aim of a Tobin tax is to impose a tax upon the banks. Nevertheless, the legal taxpayers are often not who really carry the economic burden of a levy: this could at first fall on traders, on companies and governments (via higher capital costs) but will end up by passing on to final consumers, via higher prices for financial services (e.g. increased mortgage costs). Hence, there is great scepticism about the financial sector carrying the burden of the tax.
From a revenue viewpoint, the tax will have an asymmetric effect: while eleven countries in the EU will introduce the tax and carry its burden, the benefit of the tax in terms of revenue would come from the few countries with large financial centres.
With regards to the distributional aspects, the tax presents progressive properties9, since rich people
are supposed to hold and trade more than poorer ones. However, under such a tax, all short- and long- term transactions would be taxed; hitting also middle- and lower-income earners, because short-term financial transactions are often related to trade or other commercial transactions but also because the larger parts of financial transactions are:
- Lending and savings
- Transactions related to pension funds
The tax will bite much more heavily in countries with funded pension schemes as the UK and the Netherlands; hitting disproportionally nation’s citizens and creating discrimination among nations.
Furthermore, rich investors can escape taxation by relocating their trades to other markets while the average Joe has no choice but remaining in the market subject to taxation. So there is a need to put discrimination among concerned transactions in order to avoid deregulations in the stability of efficiency of these transactions.
Taking a look at the legal aspects, the imposition of such a tax can come up against some barriers, among which the free movement of capital and payments between Member States and between Member States and third countries or the General Agreement on Trade in Services (GATS)10.
When looking at the multiple impacts on the economy, financial transaction taxes, even imposed globally, could be seen as bad and inefficient in stabilising the financial sector. Especially when funds could be raised through alternative means: tax on bonuses, levies on leverage and risk-taking, fee based on the size of banks’ balance sheets. At last, the Commission’s argument that FTTs would make financial institutions contributing to recovering the costs of the crisis takes no account of existing national measures, such as the UK bank levy or taxes on assets in Belgium.
One may not be convinced by these reasoning when comparing it with the decisions made by The E.U. to apply the Tobin tax to only some member states. We will therefore analyse those decisions in further détails in our next issue.