FTT: To tax, or not to tax?


5 December 2011


Simon Lewis of the AFME investigates the proposed European financial transaction tax, its pros and cons, and what it means for businesses and consumers alike.


In the run-up to November's G20 summit in Cannes, a number of eminent figures, including Bill Gates and the Archbishop of Canterbury, lent their support to a proposal for a global financial transaction tax (FTT). In doing so, they joined the European Commission, and the leaders of France and Germany, who are advocating a European FTT as a precursor to a global tax.

In the event, the language that the leaders of the G20 agreed in their communiqué was notably lukewarm on the issue. This should not be surprising, since the balance of opinion among the member governments is firmly against the global tax proposal. With the chairmanship of the G20 passing to the Mexican Government (which is sceptical), the immediate momentum behind a global tax is likely to slow.

Nonetheless, the proposal for an FTT in Europe retains significant support, and EU member states will examine the proposed legislation over the coming months.

A taxing issue

It can be credibly argued that, in the face of a stalling economic recovery and real difficulties in the sovereign debt markets, Europe's leaders have more immediate concerns to address. However, it is not merely a question of timing. An FTT would be the wrong choice for Europe at any time - and particularly now.

To really understand the impact of an FTT, we need to answer four essential questions: Is it an efficient means of raising tax revenue? Would it enable the creation of economic growth and jobs? Would it benefit the end-users of the financial markets, both businesses and consumers? And would it make financial markets more stable?

Firstly, on the efficiency of the proposed tax and its impact on the tax base: transactions in Europe's financial markets. Financial services is a mobile, global and highly competitive sector. Accordingly, the European Commission's impact assessment of the FTT suggests that Europe would lose 10% of its securities market, 40% of its spot currency market and 70-90% of its derivatives market.

These are alarming numbers, economically very damaging - and they are not mere conjecture. Take the example of Sweden's financial transaction tax (from 1984 to 1991), resulting in between 90-99% of traders in bonds, equities and derivatives moving from Stockholm to London.

"The European Commission and the leaders of France and Germany are advocating a European FTT as a precursor to a global tax."

"It was a very, very badly functioning tax," Swedish Finance Minister Anders Borg says of his country's experience. This was an expensive lesson for Sweden. But its experience should prevent Europe from making a similar mistake.

Secondly, what would be the impact of FTT on the real economy, in terms of jobs and economic growth? The European Commission estimates that in the long run, the tax would reduce Europe's total output by between 0.5% and 1.8% - and reduce total EU employment by up to 0.2%, or nearly half a million jobs.

Moreover, the big gaps in the Commission's economic modelling - which, for example, does not take account of the financial services and ancillary jobs that would leave Europe - suggest that these projections are likely to be significant underestimates.

Market impact

Thirdly, what will be the impact on users of financial markets? Economic theory suggests that a transaction tax would largely be passed on to end-users, whether they are savers, investors or businesses. The European Commission itself makes this point.

The European proposal for an FTT seeks to shelter firms and consumers from the direct effects of the tax, but it cannot avert the indirect effects. While individuals would not pay the tax directly when they sign a contract for car insurance, take out a mortgage or invest in their pension, they would bear the impact of the tax resulting from the enabling financial transactions earlier in the chain, which would be subject to the FTT.

"Sweden's financial transaction tax resulted in between 90-99% of traders in bonds, equities and derivatives moving from Stockholm to London."

Similarly, pension funds across Europe would pay the tax when they buy or sell investments or use derivatives to hedge against inflation. So an FTT would reduce the value of pensions for Europe's citizens. Borrowing costs would also increase, since the providers of credit to households and small and medium-sized businesses would pay the tax when accessing the financial markets to secure funding.

Finally, there is the impact of the tax on financial stability. The evidence suggests that an FTT risks exacerbating the volatility that some of its proponents seek to address. Having reviewed the evidence, the European Commission concludes that "many studies show that a financial transaction tax could aggravate volatility (due to a reduction in the number of transactions), creating more room for speculators".

Hedging your bets

We should also be clear about the impact on companies across Europe, many of whom purchase financial products such as derivatives in order to hedge important business risks. For example, airlines use futures contracts and derivatives to hedge their exposure to the price of jet fuel.

A transaction tax would simply penalise companies for basic transactions, such as hedging against fluctuating raw material prices or exchange rates. This effect, in turn, could result in reduced levels of hedging, exposing companies to greater financial risk. The onus is on the advocates of a financial transaction tax to demonstrate a clear benefit to financial stability, but the evidence does not support such a claim.

Taking into account the negative consequences that would flow from an FTT - in terms of growth and jobs, financial stability, and the cost burden on business and consumers - the case for the FTT simply cannot be made. We urge Europe's leaders to focus instead on completing the necessary process of regulatory reform, and taking real steps to promote growth and recovery.

To really understand the impact of an FTT, we need to answer four essential questions...
Simon Lewis was appointed chief executive of the Association for Financial Markets in Europe in October 2010.