Tax me if you can

When any government – local, national or indeed pan-European – comes out and says they think a certain part of their constituency is “under taxed”, you pretty much know what’s coming next.
By None

I’m a little unclear on the exact justification for the European Commission’s proposed financial transaction tax (FTT). Any ideas?

When any government – local, national or indeed pan-European – comes out and says they think a certain part of their constituency is “under taxed”, you pretty much know what’s coming next.

And that’s what the EC said in a policy document put out last year by its directorate-general for internal policies. Discussing the viability of an FTT, the paper observed the financial services sector essentially was not paying its way. Even though the paper did not specify a use for the extra revenue, the support of MEPs and national political leaders has prompted the EC to propose implementation of a Europe-wide Tobin tax at a rate of 0.1% on the exchange of shares and bonds and 0.01% on derivative contracts.

But the FTT isn’t aimed at the whole of the financial services sector, is it? I heard that the point was to curb high-frequency trading and limit activities which bring undue risk to the market?

Apart from raising revenue, curbing ‘risky’ behaviour is one of the express purposes of the tax, but many buy-side organisations fear becoming unintended victims. An FTT’s ability to limit HFT is far from guaranteed: no-longer-profitable strategies can be adjusted to avoid a blanket tax; better to use a combination of better regulation and incentives to change market behaviour. As it stands, value investors who have essentially done nothing wrong in the eyes of the EC could be the ones incurring the costs, while HFT firms remain unscathed.

As representatives of the buy-side, UK trade body the Investment Management Association (IMA) believes far from removing incentives for “speculation”, an FTT would simply be a tax on the savings of ordinary people. The IMA explains that if an FTT were to be imposed on the transactions made in buy-side funds – such as mutual funds and pension schemes – it would be the direct and indirect investors in these funds who would bear the costs. This would include the broad mass of savers and those in occupational pension schemes, who as taxpayers have already contributed to the stabilisation of financial markets and who do not perform the types of trading activities that the EC is claiming an FTT would curb.

The International Monetary Fund, in a paper released in June 2010 titled ‘A fair and substantial contribution by the financial sector’, agreed. “[An FTT’s] real burden may fall largely on final consumers rather than, as often seems to be supposed, earning in the financial sector,” the IMF said.

So, in voting terms, it’s a resounding ‘against’ from the buy-side community?

In principal, some buy-siders are not against a Tobin tax, but they believe it would be irresponsible to implement it in the present economic climate and in the way the EC has proposed. They argue that the banking sector is not robust enough to cope with an FTT and there is no doubt in their minds that it would severely hamper London’s – if not Europe’s – prowess as a leading financial region.

An FTT may damage profitability, but if it makes the world a safer place, it could be a price worth paying. However, taxing financial trading must be global to prevent the possibility of market participants relocating to more conducive jurisdictions. Doubts abound whether Asia – and particularly China – would ever comply with global regulation, let alone the United States. As long as it remains Europe-only, an FTT might cost buy-siders more than just higher transaction fees.

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