Charles Beaumont has recently written on this site about the potential for the Lib Dems to go further in taxing the financial sector. In doing so, he raises two options: the Financial Activities Tax (FAT), which he favours, and the Financial Transaction Tax (FTT). For clarity at the outset, the FAT is generally understood to be an additional corporation/income tax on the excessive profits/remunerations in the financial sector. An FTT, on the other hand, taxes all the transactions of financial organisations, such as banks and hedge funds, at the point at which their deals are settled.
Whilst the overarching thrust of Beaumont’s argument – that financiers can and should pay more – is absolutely sound, the proposal that the Financial Transaction Tax (FTT) ought to be jettisoned in favour of the Financial Activities Tax is flawed.
Firstly, the FTT is the direction of travel of Germany, France and seven other European countries (which combined constitute some 90+% of Eurozone GDP) who intend to implement it on trades of equities, bonds and derivatives by December 2012. These states considered the various options for taxing the financial sector, and took the FAT off the table. If Britain wants to help ‘lead in Europe’, and Beaumont is right to suggest it should, then the FTT is the only game in town. If Lib Dems wish to be bold, they should urge their Coalition ministers to press for government policy to mirror European developments, not to adopt the compromise option such nations have already rejected.
Secondly, rather than being ‘fraught with downsides’ as his article states without making clear why, the FTT has an impressive track record as a tax that is easy and inexpensive to implement and, if designed well, extremely difficult to avoid. The UK’s current FTT on share transactions sees the Exchequer collect some £3bn per annum, and captures revenues from wherever UK shares are traded in the globe, including tax havens.
Thirdly, the FAT that Beaumont favours fails entirely to respond to the scale of risk in the current architecture of our financial system. Particularly, it does not attempt to deal with market behavior, and thereby address the issue of boom and bust. Given the worldwide profits of the 1000 leading banks (c.$700bn-$1tn) and hedge funds (c.$300-600bn) in recent years, it may well be tempting to skim extra tax from the profits of such institutions. But this does not solve the underlying problem – governments may see greater tax receipt in the short term, but if the systemic risk is not addressed this will likely be wiped out in having to deal with the consequences of some future crash. The last one has cost some £1.1tn in bank bailouts according to the Treasury, and no FAT would raise anywhere close to this, even over the medium to long term.
The tax the financial sector fears the most
By contrast, the FTT does address behaviour – incentivising longer term investment over short term speculation. By taxing each transaction, the FTT helps eliminate from the market the more corrosive type of trader whilst not crowding out those who choose to invest prudently. Surprisingly financiers themselves have broken ranks over this in recent weeks, with a number coming out in favour of the FTT. In June over 50 leading figures wrote to G20 leaders arguing that the introduction of ‘a modest transaction tax will improve the functioning of markets’. An FTT will do so, they point out, by reducing ‘technical’ trading, most pertinently high-frequency trading based on algorithims and with minimal human involvement – deemed by a growing body of opinion to be excessively risky and destabilising. This kind of financial activity operates at high volume with very thin margins, which means a modest FTT is sufficient to reduce the level of trading significantly – not something the FAT would be able to achieve. The FTT is therefore in the long-term interests of a better functioning, less risk-prone, City of London.
Finally, Lib Dems should not take a grudging acceptance of the FAT from elements within the Conservative Party as the cue to accept it as the best available option. Tories are beginning to warm to the FAT precisely because it is avoidable. In 2008 £12bn worth of corporation tax (out of a total c.£45bn intake) was avoided by various companies. Banks have proved adept at channeling profits overseas – as the Guardian showed last year, 25% of FTSE 100 owned subsidiaries are located in tax havens. Importantly, the largest contributor to this figure was the over 1600 subsidiaries owned by major banks and located in low-tax jurisdictions such as the Cayman Islands. The point is that the FTT, by capturing the tax at the point when deals are settled rather than giving institutions the chance to massage total profit into the least taxable form, is exactly the type of tax the financial sector fears the most, because for the most part it will have to pay it. We need a tax that is not mere lip service to the idea of the financial sector paying its fair share, but actually makes it do so. The way to do this, as leading European nations have realised and are about to enshrine, is by introducing the FTT.
‘The Independent View‘ is a slot on Lib Dem Voice which allows those from beyond the party to contribute to debates we believe are of interest to LDV’s readers. Please email [email protected] if you are interested in contributing.
* Richard Carr is a Policy Adviser at Stamp Out Poverty. For those who wish to read further, it is worth consulting the short FTT myth-buster Stamp Out Poverty have produced: http://www.stampoutpoverty.org/?lid=11539
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15 Comments
If they can show it will “improve the functioning of markets” why is it not already happening voluntarily I wonder?
I am not in a position to debate this policy to this level of detail. However I am impressed with the list of those who support this policy and if I remember correctly it was in our manifesto so we ought to be backing it.
to lead we should follow……….. deep!
and the evidence from sweden?
The issue is that as long as the FTT is only European rather than global in scope, it will make our financial sector less competitive and drive business to emerging financial centres such as Hong Kong or Singapore. Conversely, if the FTT goes ahead in continental Europe but not in the UK, as looks likely, this will lead to more business for the City. I support the idea of increasing revenue from the under-taxed financial sector, but am pessimistic that national economic interests can be put aside and replaced with global cooperation.
There is also the risk that the burden of the tax would be passed on to the man on the street, hitting pension funds, reducing investment and slowing economic growth. It might help reduce some risky high-frequency trading, but equally a lot of useful investments and trading with small profits would be hit which are an important part of the economy. That’s why for me it seems a bit like a crude one-size fits all solution, easy to implement but difficult to predict the overall impact on the economy. I think better regulation of banks to reduce high-risk speculative trading, combined with a Financial Activities Tax and a clampdown on tax avoidance would be a more appropriate option.
Jock, because the “operators” of markets generally make more, and therefore have a vested interest in keeping markets operating in a skewed fashion (to their benefit, of course!)
The FTT is party policy and a genuinely good idea. Trouble is it exists in 2 forms that are conflated in this article. All 3 UK Parties agree that a global or even G20 based FTT would be good. Trouble is not every one in the G20 agrees and unless everyone does it, those who impose the tax will see business move to countries who do not apply it. This is why it has not been introduced so far.
In Europe it is more complicated still. As a European Union tax, the tax taken would go, not to the country where the transaction took place, but to Brussels. Thus countries with large financial services sectors would see tax taken at source move to Brussels, where it would then be distributed amongst member countries by the normal means. With the largest Fin Services sector by some distance, the current FTT proposals in Europe are essentially a tax on the UK. This is why even Lib Dem ministers (notably Vince) have said no.
If the distribution could be agreed to be proportionate to the tax taken, the plan would have some hope, but various European countries with small financial services sector are refusing to negotiate. Even with this, a FTT in Europe would see transactions taking place on London moving to more benign tax regimes.
Thus for the FTT to ever be a reality, it has to be agreed at G20 level ( at a minimum)
Will FTT be proportional to the value added by a financial transaction, or just to the value of the financial transaction?
Delighted to see this debate ignited – Richard is right that I didn’t go into details of the limitations of an FTT (but I did hyperlink to some useful material) as blog posts can easily get too long. As has been observed, the UK currently levies an FTT on share dealing (Stamp Duty) demonstrating that such a tax works in practice.
But my reasons for not supporting an FTT, even though other Europeans are set to implement it, are as follows:
By taxing transactions, certain types of activity, such as high-frequency trading, are disincentivised. Other types of activity which might be considered to be ‘casino’ finance, such as derivatives trading, would probably not be covered by the tax. Some types of high-frequency trading increase volatility and are probably unhelpful and the FTT would usefully limit them. But some very ‘safe’ types of investment, such as money market funds which invest in short tem bonds and which are popular with pension schemes, also require high frequencies of trading. These funds would probably become uneconomic to run – so a by-product of the FTT would be a safe, non-volatile type of investment being abandoned, probably to be replaced with more volatile investments such as tracker funds.
Another unintended consequence of the FTT would be to discourage hedging (because costs per transaction rise). In many cases, hedging is an important way for the market to reduce volatility, so once again the FTT would have the opposite effect intended.
Ultimately, I’m not anti-FTT and certainly I don’t like Osborne’s proposal that we should let the rest of Europe embrace it in order that more volatile trading activity moves to the City – that just compounds the UK over-reliance on the wrong kind of financial industry. But I think that an FTT will not solve the problem it sets out to address – which is why we should be working constructively with the rest of Europe to develop a better tax – as opposed to the obstructive stance that Cameron and Osborne are currently adopting.
Thanks for all the comments, and particularly Charles for his. As I say, we clearly agree on the concept that the financial sector can pay more, and that Britain should take a more positive stance in Europe than hitherto.
At the risk,of testing collective patience, I’ll go through some of the comments made so far point by point. They often come up in relation to FTT, so are worth addressing. As I say, I do recommend going to the myth buster document flagged up at the bottom of the piece: it’s downloadable from http://www.stampoutpoverty.org/?lid=11539 – some of what followed is pasted from there, but its very much worth reading in full.
On a couple of the technical questions, whilst this would need to be clarified in any future UK legislation, the FTT would be on total value of the trade, not merely its profit. The collection point is important – but by including both a residence (where does the trade place) and issuance (i.e. what nationality of company had issued the share) principle this would be addressed. UK stamp duty collects revenue from all over the globe. An important recent development is also the increased activity in the Contract for Difference markets – essentially derivative bets on the value of an underlying share – which, because they do not involve any actual purchase of an equity, are not liable for stamp duty. Investors are already finding ways around the existing tax net, and it is time to increase the range of what can be taxed.
So, why hasn’t it happened already? As Tim suggests, its rare that a sector comes forward and pleads to be taxed more. It is the job of governments to proactively take appropriate measures, rather than sit back and wait for a sector to come forward and state what tax it is prepared to pay.
Sweden, as hinted at, implemented a very poorly designed and easily avoidable tax in the late 1980s. However, the existence of successful FTTs in many other countries proves that the Swedish experience is the exception and not the rule. It is now widely acknowledged that the problems with the Swedish FTT were related to design flaws, not the general concept of financial transactions taxes.

A report by the International Monetary Fund to the G20 in September 2010 highlighted two major problems with Sweden’s level. Firstly, that it was only levied on trades conducted through Swedish brokers (thus seeing many trades simply move to London). In contrast, the UK Stamp Duty falls on the purchase of shares in UK-‐registered companies wherever they are traded in the world, because it’s payment is connected to the legal transfer of ownership, and can therefore not be avoided. Most investors are willing to pay a modest tax to ensure legal title to their asset. Secondly, the tax on fixed-‐income trading activity, in effect from 1989-‐1990, resulted in a shift to other financial instruments that were not subject to the tax, such as corporate loans and swaps.
The IMF’s conclusion from the Swedish experience was not that FTTs should be rejected, rather they advise that the tax base “should be set as comprehensively as possible in order to deter avoidance, and should also take advantage of legal and administrative handles … to ensure compliance.” So the advice is still to do it – but, if you’re going to do it, do it better.
The notion of an FTT being a Brussels tax is also often brought up, but the revenues from any Enhanced Cooperation FTT would go to national budgets rather than the EU. Countries might choose to invest revenues in European projects, but that is up to them. The UK might well choose to use such revenues to protect public services, create jobs, and help meet out international developments. But that debate could be had in due course.
Will the tax be passed on to ordinary people? Well, the financial sector is highly competitive, which makes it less likely that institutions will pass on the costs to customers because they will lose business to others who don’t. For instance, some banks engage in financial activity that would attract the FTT far more than others. If they were to, for example, pass on their FTT costs by introducing a fee at their ATMs or charging more for their mortgages, but other banks didn’t, this would place them at a competitive disadvantage with the consequent risk of losing market share. There is a mantra trotted out to scare which is ‘the banks will always pass on the costs to their customers’ but in a competitive market place this may not always be as simple as it might first appear or as the financial sector would have us believe.
The pensions versus HFT point is important – but it is important to stress the difference in scale. Pensions turn over their portfolio about every two years, whilst HF traders can do it more than once a day. Paying 0.01% on a derivative which allows long term hedging would certainly be manageable, particularly given the costs most funds are already passing onto their consumers. Private sector employee pension schemes alike fell by around 30% in value due to the economic crash of 2008, and the various Local Government Pension Schemes suffered similarly high losses of up to 28% over the 2007-2009 period. Pension funds, and their contributors, would be wise to seek more stable revenue streams – including equities certainly, but also assets like infrastructure which can provide secure, if less spectacular, long-term wins.
Anyway, particularly given the manifesto commitment last time round and in the run up to 2015/carving out a distinct appeal for the Lib Dems versus the Tories, a debate worth having.
Transaction taxes are financially illiterate. Taxes should always levied on value added i.e. profits and wages, never on just the monetary value of the deal that was made. That way you can raise the tax without ever making a profitable transaction itself unprofitable.
This desire to prevent financial transactions bears no real relation to the causes of the crisis. The crisis was caused by long term increases in the total quantity of debt and the extension of massive amounts of debt to at risk groups. These were long term trends, not caused by fast paced, short term trading. All this will do is hit liquidity and depress asset prices. Contrary to the claims that the article makes it will not reduce risk in the financial sector, because it will encourage larger more speculative single trades, each with significantly more risk in rather than many small trades each of which is not particularly risky.
Moreover any tax revenue it does produce will come from a disproportionately large fall in profits in the financial sector. As much as people don’t like banks causing a significant fall in our GDP at a time when the economy is struggling, when there are more efficient and sustainable ways to raise more tax money from the financial sector is not actually a good idea.
Oh, and we should abolish Stamp duty. The increase in share prices that would result would almost certainly lead to more tax taken by capital gains and by income tax than we gain each year through stamp duty. Even ignoring the beneficial impact on pension funds, investors and general confidence.
This is not just my ramblings, this is the position supported by the IFS and the IMF. Listen to them.
Stephen W is absolutely right – by reducing the number of transactions and increasing their size (necessary to still make a profit) a transaction based tax would actually make the markets LESS stable.
But, I have to ask the same question I always ask when this comes up: you are planning to extract very large amounts of money – who actually pays?
A financial transactions tax is NOT a “tax on bankers”; it is a tax on the money that they play with, and therefore a tax on anyone with savings, investments, pensions or insurance. In short, a massive new tax on you.
If you make it harder for pensions and insurance companies to trade their portfolios profitably, you will inevitably increase the amounts paid in fees. A financial transactions tax makes the bank MORE powerful, not less.
Perhaps we could move on from this urge to punish the bankers for their past sins and instead try to devise a way of harnessing their greed to power the economy, rather than leaving ourselves in thrall to these too-big-to-fail institutions.
@Richard.
It’s called a Financial Activities Tax. Making sure financial services pay the same taxes as non-financial companies.
We had a financial transaction tax until some time in the 1950s, when every cheque and receipt had to bear a 2d stamp. (The stamp on cheques was embossed and the banks paid for them in bulk. If you wrote a receipt you affixed a 2d postal stamp bought from Post Office – then a Government department. ) Abolition of the system paved the way for “free banking” and the banks seeking to grow the profit centres of selling other services and devising sneaky charges for unwary customers.
Just as well that what is proposed here has different mechanisms!
But seriously though, for such a transaction tax to be benign, it needs to concentrate on very large, very short-term and very casino-type transactions. Um, begins to sound a bit like Stamp Duty on fixed Property….
This whole financial mess when you look just below the surface is caused by derivative trading. From the breaking of Barrings Bank in the 1990s to RBS of today, trading derivative (which is not real capital investment but leveraged debt) is skewing the markets. Just look at JPMorgan the biggest operators of derivatives.
Does anybody know if the banks are really properly capitalised with so many open derivative contracts (yes, silver is so attractive now).
– It is just reckless gambling and even by size of big bank trades are sometimes completely skewing the market!!
For banker-traders the number of trades equals their bonuses. That is why high frequency trading is the norm.
Yes, lets tax the derivative trades. FTT should be concentrated on derivative and highly leveraged trades.
@ Ernest
“For banker-traders the number of trades equals their bonuses. That is why high frequency trading is the norm.”
No, absolutely not. No traders (regardless of whether they work in banks or elsewhere) are paid on the profitability of all trades (the risk is how accurately the profit is measured).
High frequency trading is not one activity it can be doen for different reasons, from market making to minimising the impact of indovidual trades on the the market price to ensure the best price.
Also Derivatives are far more diverse than you give them credit for. for example most hedging instruments are derivatives.