The financial transaction tax: Panacea, pathogen, or just a bitter pill?
Argentina and China have done it for years, with little apparent harm to their economies. The French say they’re doing it too, and they want the Germans to bring the rest of Europe along. The Brits have been doing something similar for centuries, but they aren’t going to join this one.
In the United States, President Barack Obama is noncommittal on a transaction tax (despite reports to the contrary), but Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio – both Democrats – have embraced the idea of doing it here.
We’re talking, of course, about the imposition of a financial transaction tax (FTT) on trades in financial instruments. The specifics are vague, but most proposals are in the neighborhood of a 0.25% tax on equities and a 0.01% tax on the notional value of derivatives, with the money going into a pot to cover everything from regulatory costs to the next bailout of the financial sector to remuneration for the last one. Various FTTs have been either proposed or implemented in more than 20 countries to date – most recently in France, where President Nicolas Szarkozy has promised to unilaterally implement one beginning in August.
Szarkozy says that the French FTT will eventually blend into an EU-wide FTT, and has implied that he’ll abandon it if other countries don’t follow suit. It’s not yet clear, however, whether his transitional FTT will cover transactions that take place within the country or be extended to transactions that French banks execute around the world. He also hasn’t said much about how the FTT will be assessed or how the income it generates will be spent.
All of these are critical issues that go to the heart of what an FTT can or cannot accomplish – in part because if one country implements an FTT on its domestic exchange and its neighbors don’t, then trading can simply migrate cross-border. That’s what happened to Sweden in the 1980s, but their massive 100-basis-point tax on every purchase or sale of equities was many time higher than the FTTs currently being proposed. Despite the difference, much of the push back against such a tax is expected to come from countries like Sweden, who had a very bad experience in the past with it and don’t want to go through it again.
Still, the flight risk remains, and that means any tax, to be effective, must at least be built on generally-accepted principles. Former JP Morgan Managing Director John Fullerton supports an FTT, but adds that it’s more important to remove perverse incentives that reward irresponsible risk-taking – including, for example, laws that let people write off interest payments for debt.
“More important than the details of the FTT are the importance of fixing capital gains so that it encourages some things and discourages other things, which in itself would be difficult to do,” he says. “That’s more important than whether the FTT is x basis points or y basis points.”
Most practitioners say that it’s impossible to get the world’s nations to agree on a transaction tax, leaving the issue dead in the water.
“The G-20 couldn’t agree on a bank levy, and half the Asian countries said, ‘No, we’re not going to have anything to do with it, but if you guys want to go ahead, then please do. In fact, we’d like it if you did,’” says Anthony Belchambers, Chief Executive Officer of the UK’s Futures and Options Association. “Frankly, the same argument applies to a financial transaction tax. The moment you bring it up, those same countries will say, ‘We understand you have a problem and we understand why you want to introduce [a financial transaction tax], but don’t expect us to do it also.’”
He adds, however, that if both France and Germany get behind something, the rest of Europe will at least stand up and pay attention. Indeed, many European legislators are exploring the possibility of imposing such a tax as a block, perhaps on euro-denominated transactions. If that flies, the UK will end up participating whether it wants to or not.
But that still leaves unanswered the larger question of whether a financial tax can act as a remedial action for markets. The structure of the tax is, therefore, just as important as the geographical area over which it’s implemented and the way it’s spent.