The European Commission is putting its weight behind a Financial Activities Tax at EU level, saying it could bring cash-strapped governments up to €25 billion in revenue from the banking sector in the wake of the global financial crisis.

A tax on financial activities relates to the total sum of profits and remunerations of financial institutions. It would therefore tax corporations, rather than the individual actors involved in a financial transaction.

By contrast, a tax on financial transactions would hit all kinds of capital movement, including equity, bonds and derivatives.

The tax, also referred to as a ‘Tobin Tax’ in honour of James Tobin, who won the Nobel Prize in 1981 for his work on financial markets, was initially aimed at limiting short-term currency speculation.

The Group of 20 most industrialised nations in the world has so far shown much more interest in a FAT than in FTT. The first discussions at EU level on the two options were carried out at the Ecofin Council at the beginning of September on the basis of a European Commission informal document.

The Commission paper endorsing the FAT, to be issued later, is non-binding but could be followed up by formal legislative proposals at a later stage if backed by EU member states at a summit on 28-29 October.

The Commission’s endorsement of an FAT signals the EU executive’s preference for a tax applicable on financial institutions such as banks and insurance companies rather than capital flows.

EU Tax Commissioner Algirdas Šemeta, who is due to announce the measure today, says the tax should be applied at European level, regardless of its possible adoption worldwide.

In contrast, a Financial Transactions Tax (FTT), which is strongly backed by Germany and the European Socialists, would apply to all capital movements but would have been impossible without an agreement at global level, an option which appears highly unlikely.

“At EU level, the Commission recommends that a Financial Activities Tax (FAT) would be the preferable option,” reads the Commission paper, issued this week.

According to the EU executive, the alternative FTT would present “considerable risks, particularly of relocation, in its unilateral introduction”. Meanwhile, “risks are considerably lower with the FAT, because profits and wages are less mobile than trading,” it argues.

The FAT is also deemed more suited to the objective of targeting the financial sector since the tax would apply to corporations instead of all international financial transfers, as would be the case with an FTT.

Brussels estimates that revenues from the application of a FAT at EU level could reach up to €25 billion annually if the tax rate is five per cent. How this money would be used will be subject to further debate should the proposal be approved.

The Commission paper is expected to be debated by the finance ministers of the 27 EU countries at a 19 October meeting in Luxembourg.

EU leaders could then endorse the idea at a Brussels summit on 28-29 October, ahead of the G20 summit in Seoul in mid-November.

EU officials insist that Brussels does not want to give up on an FTT and will continue to push for its introduction at global level.

But the decision has potentially dealt a fatal blow to this option, which enjoys strong backing from the European Socialists. Indeed, G20 leaders have shown little support for the FTT and linking its introduction in Europe to a global consensus could put the final nail in its coffin.

According to Commission estimates, the FTT could generate revenues of up to €60 billion annually if applied worldwide with a 0.1 per cent rate. If the tax were also applied to derivatives, revenue would amount to around €600 billion per year.

The Commission’s arguments for backing a tax on the financial sector are well-known. Brussels considers the sector as a “major cause” of the global financial crisis and notes that it received “substantial government support over the past few years”.

“It should therefore properly contribute to the cost of re-building Europe’s economies and bolstering public finances,” reads the Commission paper.

Moreover, the financial sector is currently exempted from value added tax. Applying some form of taxation would therefore “ensure that this sector is not under-taxed compared to others,” the Commission argues.

The proposal comes as the EU is also considering a bank levy to fund future possible bailouts in the banking sector.