WORLD VIEW:José Manuel Barroso estimates a financial transaction tax would raise €57bn a year in EU, writes PADDY SMYTH
BRIAN LUCEY was taking no prisoners. Trinity's combative professor of economics was laying about him on all sides on Morning Irelandon Thursday, inveighing entertainingly against Brussels's latest, in his view, monstrosity, a tax on financial transactions, proposed the previous day by European Commission president José Manuel Barroso.
The tax would be levied on all transactions on financial instruments between financial institutions when at least one party is located in the EU.
The exchange of shares and bonds would be taxed at 0.1 per cent and derivatives at 0.01 per cent, with the revenues shared between EU coffers and the member states where the tax is levied.
This would, Barroso said, tap into about 85 per cent of all inter-dealer transactions in the EU and raise €57 billion a year. The proposal will be discussed by the European Council of Ministers, and the commission will present it to the G20 summit in November.
The announcement was no surprise. The tax has been well touted, both as a means of making the financial sector contribute to getting out of the mess it helped to create – member states have committed €4.6 trillion to bail it out and it has benefited from low taxes in the form of VAT exemptions worth some €18 billion a year – and a new source of “own resources” for the cash-strapped commission.
Others, notably aid agencies, have been arguing for some years that such a tax would help boost development aid and overcome the effects of donor fatigue.
It is also seen by its proponents, originally John Maynard Keynes and more recently James Tobin, whose name has been attached to it, as an important market-calming measure. By raising the cost of transactions one could throw sand in the wheels of what the latter called “excessively efficient” markets, dampening the vast speculative trading that causes such damaging volatility.
Not so, says Lucey, citing an important 2007 report, by Ireland’s now Central Bank governor Patrick Honohan*, who suggested the tax would be a “damp squib”, “raising much less revenue than expected and . . . generating far-reaching changes in economic behaviour” . These changes, he argues, strongly echoed by Lucey, would not address the causes of the crisis.
In that regard they are certainly right. Reckless lending rather than speculative trading was the guilty party – but, then, the tax’s proponents do not argue that it is a panacea for our current woes, though they would take issue with Honohan’s counter-intuitive finding that a Tobin tax, and consequently reduced trading, would actually increase volatility by reducing the efficiency of the market in setting prices.
It is certain that the tax would have far-reaching effects on the financial markets. First, it would incentivise an extremely mobile activity to relocate, hence the fierce opposition coming from London, and the main argument made against the tax – that it would have to be introduced universally to work and that there is no way the US would wear it.
“The consensus is that anything less than a globally applied, uniform tax would distort the markets and reward dissenting low-tax regimes rather than raising significant revenue,” the British Bankers’ Association argues predictably.
Critics point to the Swedish experience of taxing equity and bond transactions between 1984 and 1991, which caused a sharp decline in trading volumes and a flight of business to London.
But as John Plender argues in the Financial Timesthis week in favour of the tax, "this overlooks the fact that Britain already has a financial transactions tax – stamp duty – in place since 1694". Ireland also already taxes share purchases at 1 per cent – 10 times the level proposed by Barroso.
Economists from the Deutsche Institut für Wirtschaftsforschung, the largest economics research institute in Germany, argue that, to meet the challenge of businesses relocating, the tax could be applied to transactions in a country in which the counter-party has its headquarters, arguing that a bank or an insurance company would not in those circumstances automatically elect to relocate its headquarters to the UK – shades of the argument about EU harmonisation of the corporate tax base.
The tax’s second effect is likely to be a dramatic change in the market for derivatives and in activity among “high-frequency traders”, ultra-fast automated traders whose margins are tiny (and who represent some 40 per cent of the London Stock Exchange volume, according to Credit Suisse).
The commission’s own revenue model assumes a decline or migration of up to 90 per cent of the derivatives market.
Supporters of the tax say that would be no loss – the high-frequency activities are essentially non-productive in terms of the real economy, performing no socially useful function and their sheer scale creates unmanageable volatility.
The claim that they provide market liquidity is illusory, John Plender argues: “While HFTs [high-frequency traders] claim they have brought about a narrowing of spreads and greatly increased liquidity, the liquidity can vanish in an instant, as it did in the notorious ‘flash crash’ of May 2010.”
And their “asymmetric information advantage” distorts the market, he says.
More worryingly the commission’s own model suggests the Tobin tax could cut long-run GDP in Europe by 0.5 per cent to 1.8 per cent.
Credit Suisse claims it would cost the economy €62 billion a year in GDP – more than the €55 billion Barroso says it will raise.
Yet the proposals have wider support and appeal than Lucey’s swipe at the Socialist Workers Party suggests.
Backed by the French and Germans, as well as the commission, the idea has also recently been supported at international level by Bill Gates in a forthcoming report commissioned by the G20, and internally within the IMF.
In truth, however, no matter how morally appealing in terms of tax equity – and it definitely is that – the Tobin tax is almost certainly politically doomed. It will be sunk by vehement British opposition, backed, no doubt, by a Dublin implacably opposed to EU encroachment on “national” tax bases and prerogatives.
* Financial Transactions Tax – Panacea, Threat or Damp Squib?– Patrick Honohan, Sean Yoder: World Bank, 2007