After 6 years of crisis, the abilityof European governments to reform the financial sector is still a burning question. For most Europeans, finance remains one of the principal causes of the economic recession. On the other hand, the financial sector plays a crucial role in the well-functioning of an economy and must be regulated with great caution. This is why the European Commission came up with a proposal of a financial transaction tax in 2011. The European Union remainshence divided on the question, and the EC has reviewed its proposal in 2013, with only 11 countries out of 28 willing to introduce this new tax.
The idea was inspired by the “Tobin Tax”, named after Nobel laureate James Tobin, who proposed it in the 1970s as a means of reducing speculation in global markets. Initially, it was a currency tax transaction. The tax project of the EU is much broader and also referred to as FTT.
The primary goal of a financial transaction tax is to curb speculative activities. High-frequency trading would strongly diminish, since this practice is made with thin margins and great leverages. According to some economists, like Stephan Schulmeister from the Austrian Institute of Economic Research, speculation leads to overshooting of asset prices, which can worsen the economy in times of crisis.
Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain have asked the European Commission to set a common approach to collect the tax. The tax would cover all financial transactions involving a party located in one or more of the 11 countries. The minimum rate would be 0.01% for derivatives, and 0.1% for every other transaction, including purchases of shares and bonds. After disagreements on the main features of the tax, i.e. base and rate, due notably to a strong anti-FTT lobbying campaign from big banks in 2013, France and Austria have called in January for progress on the tax design with a base as broad as possible. Indeed, exempting derivatives would be meaningless, since in the opinion of many economists, they are the securities which are the most speculated on. However, a launch of the tax in 2016, as planned early this year, might be too soon.
The economic threat might be greater than expected…
As discussed in the last issue, the impact of a tax on financial transactions from an economic point of view is debatable. While some benefits linked to redistribution and stabilisation cannot be denied, one should not forget the potential implications in terms of efficiency and relocation. Among the negative consequences potentially linked to the project are the reduction of EU’s long-term competitiveness and the increased cost of capital. Such a tax could also imply tax avoidance and a pass-through effect directly hitting final consumers.
Nevertheless, the European Commission seems to be conscious of the potential repercussions on the “real” economy. In fact, the EU FTT will not apply to day-to-dayfinancial activities of citizens and businesses, investment banking activities in the context of raising capital and transactions carried out as part of restructuring operations.
Another key aspect is the scope of the tax which is essential for fiscal efficiency. A higher number of participating countries reduces the possibility for financial institutions to avoid the tax by trading in other countries. In this case, only 11 countries out of 28 are willing to implement the EU FTT. This could have severe repercussions in terms of tax avoidance. A relocation of financial institutions in non-participating countries can be feared. This would imply a severe loss of liquidity and economic activity. Moreover, the asymmetry created by a partial fiscal agreement would reduce the process of economic integration and fiscal Union fostered by the EU. From an economic and political perspective, the consequences could be disastrous. To tackle tax avoidance, the 2013 proposal suggests to tax financial institutions following a residence principle. This would impede financial institutions to just move to other stock exchanges, like it was the case for the failed Swedish FTT of the late eighties where more than 50% of Swedish trading had moved to London. Additionally, the issuance principle would supplement the first principle. This means all products issued in an FTT country are taxable, whoever the trader is. European countries remain divided on the subject.
In fact, the procedure known as “enhanced cooperation” was necessary in order to safeguard the project. This procedure requires the association of 9 members which highlights the fragility of the project considering only 11 members were implied.
The European Union financial transaction tax implies a certain number of threats at a time where many countries are still recovering. Hence, the economic aspect is insufficient to explain the willingness of 11 European governments to implement such a tax. It is hard to predict whether the global economic impact of the EU FTT will be positive or negative. To understand the drivers of this project, other aspects must be taken into account.
The EU FTT also represents a double opportunity…
While many reasons can be found for the 2008 and 2011 economic crisis, the lack of regulation in the financial sector is generally seen as the main cause. The EU FTT is seen by most people as a fair and efficient measure to reduce government’s debt and to regulate the finance industry. The Eurobarometer found that 61% of Europeans are strongly in favour of a tax on financial transactions. Of course, opinions among countries differ widely, explaining the position of the relative governments. In Malta, the Netherlands, Sweden and the United Kingdom, the majority of respondents oppose such a tax, which can explain the respective position of their governments.
In this context, the EU FTT represents a double opportunity. Firstly, the tax is an opportunity to increase budget revenue. Indeed, many European countries are struggling to reduce their deficit. Taxing financial transactions would allow a total income of €30-35 billion a year. The presence of Portugal, Italy, Greece and Spain among participating countries suggests that one of the main drivers for the EU FTT is the potential increased fiscal income.
Secondly, governments facing the rise of populist and separatist parties see the opportunity to increase their popularity by implementing this policy. As discussed above, the EU FTT, despite economic concerns, raises a lot of enthusiasm among European citizens. Front National in France, Podemos in Spain, the influence of separatist and populist parties in Europe has widely increased after the crisis due to an increased resentment against the traditional political system. In this perspective, the EU FTT represents a chance to recover citizens’ confidence.
It is not for nothing French President François Hollande has recently called for a tax base as 7 broad as possible. The one who, during his election campaign of 2012 considered “Finance” as its enemy, has everything to gain from endorsing an introduction of an FTT at European level.
To conclude, it is not sure whether the EU FTT will have a positive or negative impact on the EU economy. Despite common beliefs, the impacts might be more negative than predicted. Moreover, the division of European governments on the topic can be more easily understood considering the different structures of European economies and the various perceptions of European people.
Still, the political and symbolic importance of the project is sufficient to explain the willingness of national governments to implement the EU FTT. It remains to be seen if this symbol will imply a large cost or not. This is why the design of the tax is of capital importance.
Timothy de Meester
Final year MA in Business Engineering, QTEM, Solvay Brussels Schools of Economics and Management