The Independent View: Liberal Democrats should support Financial Transaction Tax

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?

  • Geoffrey Payne 18th Jul '12 - 1:18pm

    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.

  • 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!)

  • Richard Dean 18th Jul '12 - 2:23pm

    Will FTT be proportional to the value added by a financial transaction, or just to the value of the financial transaction?

  • Charles Beaumont 18th Jul '12 - 2:46pm

    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.

  • 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.

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