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23 April 2014

Will A Tobin tax lead to higher evasion and arbitrage?

 - Sunday, 19 February 2012, 00:00 , by George M. Mangion

This article will examine the pros and cons of the proposed introduction of a financial transaction tax aka Tobin Tax. Malta along with Ireland, UK and The Netherlands strongly opposed the idea of such a fiscal tool, which some are saying is needed for the European Commission to meet its obligations in the next budget. In late September 2011, the Commission launched a proposal for the introduction of a financial transaction tax (FTT) in the European Union. This tax would be levied on the purchase and sale of nearly all securities, including shares, debt securities and derivatives. The rate on shares and debt securities would be 0.1 per cent and on derivatives 0.01 per cent.

With the FTT, the Commission aims to discourage risky trading (including speculation) and to make the financial sector pay for part of the damage caused by the banking crisis. Many economists agree that any trade off between its favourable monetary effects and the adverse impact on the economy can only be balanced if the tax is introduced on a global scale. This is of course utopian. During such financial turbulence, it is next to impossible to reach a global consensus for its introduction. Knowing that global acceptance is unlikely, the argument arises that if a tax is introduced unilaterally in the European Union, it could be easily evaded by moving business operations out of the EU. Thus the FTT might potentially act as a barrier for foreign parties to establish themselves or do business here. The negative effects would be further reinforced if the tax were introduced in only part of the EU, such as the eurozone. So who are the proponents of such a tax? Definitely the Commission, which feels that about €60 billion can be collected annually and such extra revenues will come handy when drafting its next seven-year budget.

France is keen on pursuing a tax within the eurozone and President Nicolas Sarkozy announced that France would, if necessary, go it alone and impose 0.1 per cent levy on financial transactions. Equally in favour is Germany, as Chancellor Angela Merkel found backing from her party to introduce such a tax within the eurozone if it is impossible to launch it in the European Union as a whole. This is of course only a compromise solution since Britain has been vociferous in its opposition and vows to block this tax. Lawmaker Michael Fuchs of Merkel’s CDU said at the party conference that introducing such a tax only in continental Europe and not in the UK would be wrong because this could be a boosting programme for the City of London. Quoting Fuchs, he said, “The English must display European solidarity because otherwise they would get into a splendid isolation, which they should prevent.”

But not all northern countries are in favour, as The Netherlands wishes to protect its budding financial services industry and therefore are against the FTT. Recently, the Dutch central bank said it opposed plans for a financial transaction tax in the EU as it will cost banks, pension funds and insurers in The Netherlands billions of euros and discourage growth. At this stage we must try to understand the historical background behind the FTT concept, which was previously called the Tobin Tax and used extensively in Sweden where it was introduced in 1984. The Swedish experience has been fully documented and studies have been carried out to assess the merits of its brief history.

In July 2006, analyst Marion G. Wrobel examined the actual international experiences of various countries in implementing financial transaction taxes. Wrobel’s paper highlighted the Swedish experience with its brand of financial transaction taxes. It was almost 28 years ago that Sweden introduced a 0.5 per cent tax on the purchase or sale of an equity security. Thus a purchase and sale transaction resulted in a one per cent tax. In July 1986 the rate was doubled. In January 1989, a considerably lower tax of 0.002 per cent on fixed-income securities was introduced for a security that matured in 90 days or less. On a bond with a maturity of five years or more, the tax was 0.003 per cent. One could say that this tax was based on consumption or proportional to business activity and therefore was not regressive. However, studies reveal that it did not function well and revenues were below expectations. To start with, revenues from the tax on fixed-income securities were initially expected to amount to 1,500 million Swedish kronor per year. They did not amount to more than 80 million Swedish kronor in any year and the average was closer to 50 million. In addition, it was found that it discouraged trading and in some instances caused volume to capsize

On the day that the tax was announced, share prices fell by 2.2 per cent. But there was leakage of information prior to the announcement, which might explain the 5.35 per cent price decline in the 30 days prior to the announcement. When the tax was doubled, prices again fell by another one per cent. Studies show that the taxes on fixed-income securities led to more expensive bonds and when the government borrowing requirements increased so did the cost of debt.

Notwithstanding that the tax on fixed-income securities was much lower than that on equities, the impact on market trading was much more dramatic. With such a history of sluggish investment growth it did not take long for changes in the tax code. Thus, early in 1991, the rates on the remaining taxes were cut in half and by the end of the year they were abolished completely. This means the honeymoon was over in less than seven years and the marriage was on the rocks. But Tobin tax apologetics disagree that the Swedish experience is a true reflection of the advantages EU could reap if it is introduced in the 2012/2019 budget plan. Followers of the Tobin brigade say that once launched on a global platform, it could boost world trade by helping to stabilise exchange rates. Such stabilisation can calm fluctuating rates, which create uncertainty and unnecessary jitters in international markets. This was the mantra that preceded the birth of the euro 12 years go. Ideally, once the FTT is a universal charge it brings a level of transparency and lower volatility in exchange rates, which all agree is always conducive to faster business growth (all things remaining equal). Simply put, if importers and exporters can’t be certain from one day to the next what their money is worth, economic planning – including job creation – goes out the window. Here one can extol the merits of a one size fits all type of tax which, if widely used, can reduce undue fluctuations in the market.

Adherents of the FTT concept laud its mitigating design features with respect to the economic effects with its lower risk of evasion. Taking into account the mitigating measures provided by the design features of the FTT as actually proposed, any negative impact on the GDP level in the long run is expected to be limited to around 0.5 per cent. Studies by the International Monetary Fund and the European Commission acknowledged the feasibility of an FTT. Political support of the FTT is also growing. At the MDG Summit in September 2010, French President Sarkozy and Spanish Prime Minister Zapatero publicly called for an FTT mechanism. Subsequently, when presenting France’s key priorities within the framework of its presidency of the G20, President Sarkozy once again emphasised the need for an FTT to finance development and climate change. In March 2011, the German and Austrian Chancellors announced their intention of asking the group of countries that use the euro currency to embrace the tax. In various national parliaments, most notably in the US and Canada, elected representatives have taken the initiative to introduce draft FTT legislation.

To conclude, those countries with a thriving financial services industry such as Britain, The Netherlands, Ireland and Malta are vocal in their vehement opposition to the concept. It may be some comfort to its detractors that a EU-wide FTT is unlikely to be legalised given the opposition by Britain, home to three quarters of the financial services in the EU. It will not be the first time that Britain uses its veto and block the rebirth of Tobin tax. Perhaps such a veto will vindicate the bad experience that Sweden suffered when it experimented with the concept almost 30 years ago.

Mr Mangion is a partner in PKF

an audit and business advisory firm

[email protected]

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