Opinion: Could the Lib Dems back a Financial Transaction Tax within the EU?

At Spring Conference we passed a tax motion that confirmed our manifesto pledge for support for a global Financial Transaction Tax (FTT).

The implication was that we supported the FTT but only if the entire world agreed. The usual reasoning for this stance is that if we, or Europe, unilaterally institute an FTT it would disadvantage banks within the EU and encourage them to move their operations outside our borders, losing us jobs and tax revenue from the financial sector.

The thing is, while the EU has agreed to an FTT, getting America and Asia on board seems much less likely, and perhaps impossible. At the moment, it seems that the FTT would only be possible within the EU, which would simply disadvantage EU banks and encourage them to take their business outside of EU borders and jurisdiction.

But what if we could institute it without putting European banks at a disadvantage?

Taking our call from Stamp Duty

Stamp Duty is a tax paid whenever British shares or British property is bought. That is, whether a British, or European, or American, or Asian, or even Martian bank were to trade the British asset, they would need to pay the stamp duty. That is, it’s the same for all banks no matter where they’re situated – if they trade a British asset, they have to pay the British-imposed stamp duty on their sale.

With stamp duty, British banks are put at no disadvantage because foreign banks have to play by exactly the same rules. Can you see where I’m going with this?

Making the FTT a tax on transactions linked to EU assets.

Most bank transactions tend to be linked to an asset, an asset that belongs to a particular country.
E.g. A purchase of shares of a company within the EU, or a mortgage on an EU property, or a loan with an EU asset as collateral or insurance on an EU asset.

What if the FTT only applied to transactions linked to an EU asset? That way, the same rules would apply to all banks, whichever country they were situated in. American, Asian, European; the transaction linked to an EU asset would be subject to an FTT. The EU would only recognise transactions that paid the associated tax.

Any transactions without the tax paid would be unrecognised by the EU, so potentially worthless for the buyer.

This would allow the EU to collect tax on any transactions made on its assets. It would also protect EU assets from the distorting and destabilising effects of complex financial instruments involving multiple transactions, but without disadvantaging banks within the EU, as these rules would apply to any bank dealing with EU assets – no matter where in the globe they were situated.

Potential Disadvantages

Even though our banks would not be disadvantaged by such an arrangement, there may be potential drawbacks elsewhere. Traders who like to use complex financial instruments may avoid investing in EU assets from now on. That is, shares from companies in the EU may be harder to sell and be less likely to secure essential investment.

That said, the kind of “investment” that an FTT deters is the speculative sort that uses a company’s share for its current “market value” with no regard for its future. The more valuable investments, where an investor takes a long-term stake in a company, with a view to build it up and increase its value, would be barely affected by a FTT. One might argue that only unwelcome short-term “investments” would be deterred by an FTT, leaving the market open for more of the more valued long-term investments that companies need to grow and thrive.

An EU FTT is more or less ready to go…

With the EU having largely welcomed an FTT, with only Britain resisting, we could have it implemented quickly. It’s a matter of British political will. The thing is, some of our members who were quite happy for it to be policy for an unlikely global agreement, are less enthusiastic when it becomes a realistic possibility. Questions arise on whether it will damage the banking industry that much of our tax depends on. Would such a tax cause more loss in income and corporation taxes than we’d make back from FTT takings?
Would such a tax create the stability we require or just cripple the industry?

The question we now have to ask ourselves as a party is: do we really agree with a Financial Transaction Tax, and, if so, are we ready to do what it takes to see it implemented?

* Daniel is the chair of Leicester Liberal Democrats

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22 Comments

  • What is the impact this proposal would have as regards our payments to EU coffers? If this resulted in us making any higher net contribution to the EU, this would be electoral suicide – even more, if that is possible, than the Lib Dems’ position on the EU is at the moment.

  • Daniel Henry 14th May '12 - 1:34pm

    Agreed RC. Clearly we’d also have to make sure that we get the proceeds of such a tax.

    As for party policy on the EU, or policy is actually to reform it, but we don’t seem to be very good at emphasising that message.

  • Richard Dean 14th May '12 - 1:53pm

    Thank you for a very informative and balanced article. The financial services industry is very adept at getting round any rules – as Christine Lagarde saiid, as soon as you make a new rule people start looking for ways to circumvent it. Is it possible to implement FTT is an incremental way, little by little, so that we can see its effects in practice, and change course if it turns out the the disadvantages outweigh the advantages?

  • Daniel Henry 14th May '12 - 2:14pm

    As far as enforcement goes, the EU countries would only recognise a transaction involving one of their assets if the tax was paid. That would make trades that dodged the tax worthless.

    Perhaps one way to implement it incrementally would be to start by only applying it to a few types of transaction, and then widening the scope as it became more established.

  • Daniel Henry 14th May '12 - 2:15pm

    Simon, did you read the article or just reply to the title?

    Your claim that financial institutions would just move operations outside the EU gives the impression that you didn’t actually read it.

  • toryboysnevergrowup 14th May '12 - 2:26pm

    “The implication was that we supported the FTT but only if the entire world agreed.”

    Is this similar to the implications that you only supported a 50% tax rate if everyone else agreed or only supported no increase in tuition fees if everyone else agreed. Now I understand why Clegg & Co have been such pushovers!

  • toryboysnevergrowup 14th May '12 - 2:29pm

    It is also worth pointing out that banks/anyone are likely to take steps to avoid paying additional taxes if you don’t take measures to stop such avoidance – that isn’t an argument for not levying the tax in the first place.

  • Daniel Henry 14th May '12 - 3:14pm

    Disagree with the analogy there.
    We’ve been forced to compromise on issues like the 50p rate and tuition fees due to not getting a majority in the last election. Had we gotten a majority without compromise then we’d have implemented those policies in full.

    With the FTT, even if we’d gotten a majority we’d still be waiting for Asia and America to agree before we implemented it. It’s almost like promising to buy your mate a car if you won the lottery – a promise you don’t expect to ever have to keep. I feel it’s time we dealt with this issue properly, decide once and for all whether we’re in favour, and if so then having a serious look at whether it can be implemented at an EU-wide level.

  • Simon McGrath 14th May '12 - 10:36pm

    @daniel – yes . but you ignore the majority of london trade is from outside the EU

  • Richard Dean 14th May '12 - 10:54pm

    If a FTT reduces GDP, as indicated in Simon McGrath’s contribution, then it looks like a bad idea. Is it possible for someone to explain how this reduction happens? Thanks in advance!

  • Daniel Henry 15th May '12 - 2:36am

    @ Simon
    I misunderstand how this would affect trade from outside the EU?

  • Richard Swales 15th May '12 - 6:26am

    Ok, but given that you as a party (not “we” as I’m not renewing membership for exactly this type of reason) think that banking adds nothing to the economy and is the cause of the financial crisis, then surely you should be counting the gain rather than losses from pushing it overseas, or not? Or were you just surfing public hate and jealousy when you said that?

    For those particularly interested, the way round this tax for people outside the EU is to trade cash-settled futures on the price of the underlying asset on a specified future date. In my time (and possibly now) Japanese government bonds were not tradable outside Japan so there was such a futures market in operation .

  • Of course banks don’t want a FTT and say that it will drive business elsewhere. They also say that about regulation generally. Take JP Morgan for example, lobbying against regulation one minute, losing $2Bn (and $19Bn off their own stock value) the next due to poor internal controls.

  • Euan Davidson 15th May '12 - 8:15am

    It is the same thing every time a new tax or regulation is proposed; the big corporations claim it will force them to flee the country. They said it about the fifty pence tax which despite Tory claims did not damage the economy and they say it about every piece of regulation proposed.

  • I suspect another economic issue which has a faultline right down the middle of our party. The Tories, with their 60% of MPs from financial backgrounds, are never going to agree with FTT or anything like it. Labour just might go for it, leaving us as a potential honest broker. If our policy is “only if everyone agrees” then it will never happen. Any meaningful counter to austerity, and the rich paying their way in the world, has to start with something like this.

  • Daniel I would just like to correct you, you wrote, “with only Britain resisting” which is far from the truth. Sweden is just as opposed as Britain is after all ready having had a disastrous experience introducing an FTT in the 80’s, which they soon scrapped after mass capital flight. Luxembourg and the Netherlands are also against. Ireland, Czech Republic, Slovenia and Estonia are also hesitant.
    Also in regards to a comment suggesting an FTT could bring down the UK’s annual EU contribution is also misleading. An EU wide FTT would bring in 57 billion euros to the EU coffers according to the European Commissions own figures, 75% of which would come directly from the UK, roughly 42.75 billion euros. Now the UK’s net contribution to the annual EU budget is roughly 12 billion euros, so in effect the UK would be giving the EU far, far, more than we ever have i.e 42.75 billion euros from an FTT, plus a reduced budget contribution, totaling 50 billion euros maybe!!
    Also if an EU wide FTT was introduced why does the money raised need to be sent to Brussels and then shared out throughout Europe? This would be at Britain’s expense as we would be raising most of the capital. National governments should be allowed to keep all the capital that it raises if such a tax ever was introduced.
    Lastly I’m sure that the costs of such a tax would be passed on to the public one way or another.

  • Alex Sabine 19th May '12 - 4:16am

    Agree with Stephen W. As part of a broader tax reform package we should look at equalising the tax treatment of financial services with a Financial Activities Tax, as proposed by the IMF. This would act as a surrogate VAT and ensure that financial services are treated like other products. Crucially it would avoid taxing intermediate production in the same way as VAT does. (Financial services provided by one business to another would automatically be taken out of tax.)

    If insurance were included in the tax then we should obviously abolish Insurance Premium Tax, which is a proxy for VAT.

    The purpose of a FAT or a cash-flow VAT on financial services would not be to take vengeance on evil bankers but to address the serious economic distortions caused by the current exemption, which include:

    – Under-taxing financial services to households while over-taxing financial services to businesses. Thus it has been too cheap and easy for households to borrow, but too expensive and difficult for businesses to obtain finance.
    – A bias towards vertical integration
    – Distortion of international trade
    – Creates awkward boundaries between differently taxed activities, difficulty identifying each firm’s untaxed outputs and non-creditable inputs

    This would be a radical change and the implementation would have to be handled carefully. One issue is how the transition to a new system would deal with existing financial positions – deposits and loans already made, insurance contracts already written, and so on. And as the Mirrlees Review argued, “international coordination would be desirable to minimise the risk of financial services being actually or notionally relocated in response to the tax”.

  • Alex Sabine 19th May '12 - 4:30am

    The FTT, by contrast, is a really bad idea even if it could be introduced on a global basis.

    The main objection is that, as Peter Diamond and James Mirrlees argued back in 1971, transaction taxes are damaging because of the way they multiply and then cascade through the economy.

    As our VAT system recognises, the taxation of intermediate inputs is to be avoided if at all possible; it is much better to tax final consumption. (Thus, rather than a series of sales taxes which accumulate as one company sells to another along the production chain, we levy a value-added tax which amounts to one single rate at the final point of consumption.)

    Our tax system already features a limited form of FTT via stamp duty on share transactions. When the IFS studied the impact of this tax in 2004, they found that the empirical evidence supported the theoretical case against stamp duty. Stamp duty on shares depresses share prices, particularly for firms whose shares are frequently traded, increasing the cost of capital faced by firms and thus deterring investment and retarding economic growth. (It also distorts the signals that share prices send about the profitability of firms, since share prices are also affected by expectations of future turnover volumes and stamp duty rates.)

    Scrapping stamp duty on shares would unambiguously improve economic welfare and a rational tax policy would do away with it (and stamp duty on property while we were at it, but this has been hiked so much by recent governments that there would be a big revenue gap to plug.)

    Among the other reasons an economy-wide FTT should give its supporters pause for thought:

    – It would be likely to reduce, rather than raise, overall tax revenues given the acknowledged negative impact on economic growth. As the European Commission noted in a recent paper: “With a tax rate of 0.1% the model shows drops in GDP (-1.76%) in the long run. It should be noted that these strong results are related to the fact that the tax is cumulative and cascading which leads to rather strong economic reactions in the model.”

    It added: “[A] stylised transaction tax on securities (STT), where it is assumed that all investment in the economy are financed with the help of securities (shares and bonds) at 0.1% is simulated to cause output losses (i.e. deviation of GDP from its long-run baseline level) of up to 1.76% in the long run, while yielding annual revenues of less than 0.1% of GDP.”

    Taking into account the impact on tax revenues of the lower GDP associated with the FTT, it would be likely to cause a net depletion of revenue. The reason why the European Commission has nonetheless shown an interest in it is that alluded to by RC – the revenues from the FTT would be designated as the EU’s ‘own resources’ rather than flowing to national Treasuries. The Commission thus has a strong bureaucratic interest in supporting an EU-wide FTT.

    – We need to think about the incidence of taxes, about who ultimately bears them rather than the legal entity on which they are charged or who hands over the cheque. For example, employers’ NI is theoretically a tax on employers but is in reality a tax on workers; it lowers their wages, and in inflexible labour markets raises unemployment. Similarly, corporation tax falls not on impersonal companies but on human beings: on some combination of workers (in lower wages), shareholders (in lower returns) and consumers (in higher prices).

    As regards the incidence of a FTT, the one place it cannot fall is on the banks. For banks are corporations and corporations cannot bear the burden of a tax; it must be some human being.

    As the IMF argued in a comprehensive demolition of the idea in 2010: “Its real burden may fall largely on final consumers rather than, as often seems to be supposed, earnings in the financial sector. No doubt some would be borne by owners and managers of financial institutions. But a large part of the burden may well be passed on to the users of financial services (both businesses and individuals) in the form of reduced returns to saving, higher costs of borrowing15 and/or increases in final commodity prices. … It is far from obvious that the incidence would fall mainly on either the better-off or financial sector rents.”

    Moreover, an FTT “is not focused on core sources of financial instability. An FTT would not target any of the key attributes—institution size, interconnectedness, and substitutability— that give rise to systemic risk”.

    Before he became Vince Cable’s SpAd, Giles Wilkes had an excellent blog called ‘Freethinking Economist’ on which he regularly destroyed the arguments of those advocating a ‘Robin Hood Tax’. You can still access his blog and, as he put it succinctly in one post: “An FTT is a bit like a higher price of doing something – a higher commission, say. You don’t need a massive regression analysis to work out that higher wholesale commissions tend to end up in higher retail prices.”

    And: “1. The tax will be on transactions, not bankers. 2. Transaction taxes tend to hit end users – they don’t zero in on wicked people like bankers with the unerring accuracy of some sci-fi weapon. 3. Hitting transactions hits liquidity, which passes itself on in higher costs of capital, which damages productivity. 4. It causes attention to be focussed on the wrong thing. The right thing gets away, be it complexity, over-high leverage, off-balance-sheet jiggery-pokery, tax evasion, whatever.”

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