Everything I learned about the Tobin Tax, I learned in Stockholm

European regulators need look no further than Sweden as they consider the impact of a financial transaction tax on the economy and market liquidity.
By None

This financial transaction tax business… It rings a faint bell.

I’m not surprised. One wonders what the Swedes think of the European Commission’s proposal to implement a Europe-wide financial transaction tax (FTT) on every trade of a financial instrument. After all, they’ve already attempted a so-called ‘Tobin Tax’. Back in 1984, Sweden imposed a 1% round trip tax on equity transactions, increasing the tax to 2% two years later. Five years later, a tax of 0.002% was levied on fixed-income instruments with a maturity of 90 days or less and 0.003% on five-year-plus bonds.

Well it’s handy that we already have a European example of how the tax works. So, what happened?

In 1993, Steven Umlauf a Massachusetts Institute of Technology Phd, now head of analytics at AIG Global Investment, compared the performance of the Swedish stock market in zero, one per cent and 2% conditions, concluding the imposition and increase of the transaction tax increased share price volatility. Even the relatively small 0.003% FTT on five-year bonds saw trading volumes drop 85% in the first week alone.

Umlauf also noted a huge market migration from the Swedish exchanges to the London stock market as a result of the tax. A London think tank, the Adam Smith Institute, reckons by 1990, 60% of the trading volume for the top eleven most traded Swedish stocks had moved to London.

As for the potential to increase Stockholm’s coffers – which Brussels intends to achieve with its pan-European Tobin Tax – the Swedish levy raised only one thirtieth of the proceeds predicted by its proponents and was scrapped after eight years.

Oh dear. Has anyone alerted Brussels?

The Swedish experience has indeed been mentioned by a few people, including some strong words from the head of one large industry body who highlighted the Swedes’ taxing troubles and branded the idea of an FTT “complete nonsense”.

The Investment Management Association, a UK-based trade body, wants clarification on the objectives for the tax. It is worried European pension funds could be hit twice by a transaction tax – when a fund manager arranges a transaction on behalf of the fund and when the fund acquires or sells that asset. It believes UCITS investors could be hit three times, as they may also be taxed when they buy units in a fund.

The IMA has reminded the Commission that in the UK, stamp duty has been a major factor in funds being domiciled outside the UK. It warns that any tax on financial transactions is highly likely to create distortions between Europe and other key financial centres, which can only result in a loss of business for the EU.

So what are we saying? Brussels wants to punish the financial industry even to the detriment of the wider economy?

We wouldn’t say that. But the Commission just might. According to the EC, there’s a very good reason for the tax: “to limit socially undesirable transactions” and to “limit negative externalities of financial transactions”, said a policy document put out last year by the Commission’s directorate-general for internal policies. It argued some financial transactions were indeed “likely to do more harm than good, especially when they contribute to the systemic risk of the financial system”.

Faced with greatly increased debt levels, governments were keen to raise additional revenues, if possible from the financial sector, which had contributed to the current global economic and financial crisis, the paper said. The political idea was to make those who caused the crisis foot more of the bill.

But the same document recognised that the most obvious and direct argument against transaction taxes was that they increase the cost of funding for the real economy. To that argument, the policy document simply insisted that any financial transaction tax should be “very small”, so that “the burden would be proportionately smaller”.

In this vein, the EC has proposed its FTT on the exchange of shares and bonds at a rate of 0.1% and derivative contracts at a rate of 0.01%, well below the level imposed on equities in Sweden but higher than the 0.003% on 5-year bonds which plunged volumes 85% in a week.

In other words, limiting an already flagging economy can be justified, as long as you only limit it a little.

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