Three Strikes of the New Financial Regulation – Part 1: The Financial Transactions Tax

by Dr Constantin Gurdgiev, Adjunct Assistant Professor of Finance with Trinity College, Dublin

For the global financial sector analysts, there are three persistent regulatory themes that are wedging sleepless nights into 18 hours-long work days: the looming threat of the Financial Transactions Tax, the ongoing pressure of the evolving European Banking Union and the spectre of the risk weighting regulations that are currently being worked out by the Basel Committee on Banking Supervision and are currently known under the ominously sounding monicker of ‘Basel IV’.

The first two are the stuff of worry. The latter one is of fear.

In the series of posts, I will examine each one of these proposals from the point of view of banking sector performance outlook, macroeconomic risks and efficiency.

Financial Transaction Tax (FTT)1 is the European proposal to levy a transaction fee (0.01% on transactions in bonds and 0.1% on transactions in equity) levied on financial services providers activities in the open financial markets. FTT is currently set to come into power in 2016.

The political case in support for this tax is made on the basis of very simplistic and populist arguments: the FTT is presented as the means for

  • Increasing tax revenues (redistributive proposition),
  • Punishing the financial institutions for causing the recent crisis (achieving social justice ex post banks bailouts), and
  • Curbing the power of the markets to inflate and deflate asset bubbles (market efficiency argument).

June 2011 Eurobarometer survey found that 61% of Europeans (63% within the euro area) were in favour of a financial transaction tax.2 However, since then, public support for the FTT has been gradually eroding. In Spring 2014 survey only 45% of Europeans supported the idea, with euro area support declining to 52%.3 No politician can ignore an idea, however naive, if it has broad support in the electoral base.

The economics and finance of the FTT are, however, different from politics. In fact, much of the academic and empirical evidence on FTT suggests that the proposed European measure will not deliver on either one of the cited objectives.

FTT Revenue Fudge

In its impact assessment of the FTT, the European Commission estimated that “the annual revenues raised should be in the order of magnitude of at least 0.3% to 0.5% of the GDP of the EU (FTT jurisdiction)”.4 This is a far cry from the claim made in 2011 assessment by the Commission. Back in 2011, the Commission justified the rationale for introducing the FTT by stating that: “The revenue estimates for an FTT at a tax rate of e.g. 0.01% [a much lower rate than the one imposed by the EU11 states in the end] are between EUR 16.4 billion …and EUR 43.4 billion billion… (0.13% to 0.35% of GDP) when all sources are accounted for and the value of the asset underlying the transaction was taken as the taxable amount. If the rate is increased to 0.1%, total estimated revenues are between EUR 73.3 billion …and EUR 433.9 billion … (0.60% to 3.54% GDP).”5

In other words, within just two years since introduction of the tax proposals and two years before tax adoption, the potential revenue estimates for the measure has fallen from the mid-point forecasts of EUR 29.9 billion to EUR 253.6 billion to the mid-point forecast of ca EUR 28 billion. With Germany and France gaining most of this revenue, there is virtually no point of talking about revenue generation from FTT being a significant rationale for its imposition for other signatory states.

The above estimates are based on rather generous assumptions relating to the economics of FTT and, thus, tend to probably overstate the revenue potential of FTT. According to analysis from Deutsche Borse Group: “The revenue estimate by the European Commission – having already been reduced from the original EUR 57 billion annually to EUR 30 to 35 billion to reflect the participation of only 11 of the 27 member states – is still overstated. The same goes for the estimate of EUR 10-20 billion arrived at by the German Institute for Economic Research (Deutsches Institut für Wirtschaftsforschung, “DIW”) for Germany on behalf of the Bundestag SPD group.”6

In short, the revenue raising capacity of FTT is hardly worth considering as a rationale for the new tax introduction. As next week’s post will show, the same conclusion can be arrived at with respect to the other two key arguments in support of the tax. Stay tuned.

References
1. See here for detailed European Union proposals.

2. More on the politics of the FTT at the time of the proposal development here

3. The latest results are available eb/eb81/eb81_cri_en.pdf">here

4. See here

5. See here

6. Deutsche Borse Group (2013) Financial Transaction Tax: A Discussion Paper on Fiscal and Economic Implications”, June 2013.

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