EU finance ministers – led Germany, France, Italy and Spain – approved a much-feared tax proposal, amid howls of protests from financial market players. The prospect of an EU-wide financial transaction tax (FTT) was first proposed by the European Commission (EC) in 2010. While the proposal was welcomed by a number of European nations, including France, Germany and Spain, it was resisted by others, such as the UK, Czech Republic and Sweden.
With an EU-wide FTT looking unlikely, the EC suggested the tax could be implemented only by the countries supporting the FTT, which also includes Austria, Belgium, Estonia, Greece, Portugal, Slovakia and Slovenia.
This is made possible by the principle of enhanced co-operation, under which a minimum of nine member states can move forward with an initiative even when other member states do not wish to adopt it. The proposal was approved in December by the European Parliament.
What will be taxed?
Unlike the 0.5% stamp duty the UK levies on share trades, the new tax will also apply to financial derivative transactions. The FTT is expected to tax share and bond trades at 0.1% and derivatives trades at 0.01%. While the UK has abstained, it is expected the tax will apply to any trades involving at least one counterparty based in one of the participating countries – even if the trade takes place outside of the tax zone.
“Derivatives have come into particular public focus over their role in accelerating the losses suffered by banks in the more recent financial crisis,” says Nicholas Brewer, senior analyst, Aite Group.
“The transaction tax is positioned as a way of taxing these apparently toxic instruments to produce funds which can be used for the public good – either in supporting failing banks in the future or in reducing the budget deficits of countries which are felt to have been increased by the imprudent and speculative actions of banks which lead to the 2008 financial crisis.”
Objectives and consequences
While the FTT has attracted much attention, some believe the overall purpose of the proposed tax is not clear. Is it primarily intended to increase tax revenues, or to enforce behavioural change from banks?
If the main objective is to raise revenues, the amount the FTT could raise is far from certain. While the European Commission originally estimated that an EU-wide FTT would raise €57 billion a year, other studies have suggested the tax could reduce overall tax revenues.
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If the objective is simply to make banks pay more tax, one question is how this will impact on the other pressures on the industry: to build more capital and to increase lending. It is also unclear who will end up absorbing the higher costs and what consequences might arise. If products become too expensive, people will be less inclined to buy them. While the level of tax proposed by the EU is relatively low, there might be a compounding effect for securities that pass through a number of parties during the course of a transaction.
In January 2012, a report by Oliver Wyman estimated that, under the EU-wide FTT, the cost of a €25 million EUR/USD one-week swap would rise from €279 to at least €2,779. The report also says that, according to previous studies, “as much as 90% of the additional tax burden on FIs [financial institutions] is generally passed on to end-users”.
Another concern is that the FTT will drive transactions away from the countries that apply the tax. This concern is not unfounded. When Sweden introduced a 0.5% stamp duty on financial transactions taking place within the country in 1984, the volume of trades taking place in the country fell dramatically and the tax was dropped in 1991. The scope of the FTT is different, as it will apply to transactions with parties based outside of the tax zone – however, it might still result in activity being moved to different locations.
“The way the new tax operates means that companies operating in the 11 countries will need to pay the tax – regardless of where the transactions are executed,” says Brewer.
“The effect of this is that smaller and mid-sized firms will almost certainly end up paying the tax, whilst larger multi-national corporations will more likely be able to move the affected transactions to other jurisdictions outside of the 11 countries, and hence avoid paying the tax.”
While the tax could be implemented as early as January 2014, it is likely that there will be a prolonged negotiation about its calibration and exact rate. Nevertheless, the very principle of the FTT is bedevilled by competing regulatory objectives and threatens negative liquidity- and capital-consuming consequences, market players conclude.