A Tobin tax for Europe
The prospects for a Tobin tax seemed never more favorable. The Merkel/Sarkozy proposal to tax financial transactions in Europe raised widespread new hopes to curb financial speculation and, as long requested by tax proponents, at the same time to collect vast sums for the global fight against poverty. The details of the plan are still unknown, but the little information available suggests that these hopes may be disappointed.
In an earlier contribution I listed some general reservations about the tax. In particular, I argued that the success of the tax and the size of revenues will largely depend on the ability to include OTC derivatives, and above all foreign exchange transactions which, given market practices and the current state of reporting, seems not possible. The alternative to tax well-documented exchange-traded transactions and/or bank loans would have the disadvantage not only to result in lower revenues but also more likely to produce market distortions and undesirable side effects on the real economy.
Observers expect that, in analogy to an earlier paper of the European Commission, the current plan will propose a tax on banks of 0.1% on stocks and bonds and 0.01% on derivatives. This could raise between €30bn and (if currencies were included) more than €50bn per year.
The percentage rates may look small but the effects on individual banks are by no means negligible as the following example of the Trefis Team demonstrates:
“We can look at the implication of this tax on Barclays – which had close to $221 billion in bonds and other fixed-income securities in 2010 and just less than $40 billion in equity-based securities including derivatives.
Assuming the entire portfolio is subject to a transaction, the bank essentially pays a transaction tax of $221 million on its fixed-income securities and $4 million on the equity-based securities. This totals $225 million in additional taxes for the sales & trading division. And this number represents the lower-end of the potential payout as banks normally enter in a large number of transactions using their portfolio and each transaction would attract the tax.”
Details of the proposal are expected to emerge this month with a view to implementation in 2013. At that time, new regulation on the reporting of OTC derivatives will likely have come into effect and the availability of information will have improved considerably. However, it is not clear whether the reporting format will suit tax purposes – authorities’ focus here is on information about systemic risk which is a different viewpoint – and whether and to what extent OTC forex derivatives, which account for the largest market segment, will be included.
One crucial question deciding about success or failure of the plan is countries’ participation. Implementation would require the unanimous approval of all 27 EU member states to become law, not only of the 17 eurozone countries. So far, the British, Dutch and Swedish governments signaled to oppose the plan while Austria and some others announced support.
Beside the earlier listed arguments there are three severe objections against a Tobin tax in Europe:
a) Cost. As the Barclays example demonstrates, against a widespread view, the tax will impose a non-negligible burden to market participants which are already weakened by the current crisis and by preparations to meet new national and international regulations looming at the horizon.
The favorite subject of many supporters of the plan is high frequency trades in equities (otherwise a less profitable market segment for the tax collector): The idea to make money charging the activities of „machines trading hundreds or even thousands of times a second” (The Robin Hood Tax) seems irresistible. However, this attitude is not free of inconsistencies: On the one hand, proponents emphasize that a minor tax will suffice to make these trades – which are considered as highly speculative and unwanted – unprofitable and drive them out of the markets. On the other hand they do wild calculations of prospective revenues from taxing just these trades.
Who will suffer most from a Tobin tax? First of all, beside high-frequency traders the tax will affect traditional arbitrageurs who seek to profit from tiniest price discrepancies. They may be driven out of the markets as well, so that financially nothing is won. On the contrary, as far as a useful role of arbitrage in the price discovery process is acknowledged, or market liquidity is regarded as an indispensible advantage, harm will be done.
Beside these groups, it is not “the speculators“ who will suffer. For those market participants traditionally attracted by price and rate volatility – for instance, betting on changes of up to several per cent in currencies as in Tobin’s times, or in EMS times with the bandwidth of 30% – the tax burden will indeed be small compared to expected gains. It will be much less felt by these traders than, for example, by actors who in investing or hedging exposures are calculating with low margins. The Tobin tax is punishing the wrong addressee. Speculation is hardly hindered in this way.
b) Competitiveness. The second objection is that the Tobin tax is unfair. It affects banks’ activities which are documented and under regulators’ influence and spares others. As a consequence it may exacerbate developments supervisors generally regard as undesirable such as the trend for deals to take place outside exchanges or the emergence of more and more shadow banks.
Furthermore, a European Tobin tax is particularly unfair in that it imposes a special burden on banks and markets in the region thereby weakening their international competitiveness. Two reactions are possible: One is trading activities moving to less regulated places outside Europe, the other is an overall reduction of trading volumes. Both would not only limit the success of the plan but also affect the already crippled European economies which so far enjoy the benefits of an advanced financial system at their disposal.
There is a widespread belief that the decline of international competitiveness of the region’s financial centres would affect first of all London and that, given the weight of the finance sector in the British economy, the UK would have to bear an overproportionate share of the resulting cost. (The remark that the Tobin tax is essentially taxing London, which is not in the eurozone, to bailout the eurozone and possibly kill-off a key component of the UK economy shows the lack of enthusiasm in this respect.)
London is the world’s leading centre for foreign exchange trading. In 2010, foreign exchange turnover in the UK reached over $1.8 trillion daily, accounting for 36.7% of the global total. Strong relationships with hedge funds, prime brokerage and the capital markets result in twice as many US dollars being traded on the UK foreign exchange market than in the US itself, and more than twice as many Euros being traded in London than in the whole of the Euro-areas combined. Approximately half of European investment banking activity is conducted through London, with over 80% of Europe’s Hedge fund assets being managed in London.
On the other hand, exactly for these reasons London might even benefit from the tax. The obvious example is a UK “opt out” which might enable the City to win market shares from Frankfurt and Paris. But even in the case of UK participation a scenario is perhaps seemingly far-fetched but conceivable in which London’s historic supremacy and the described advantages might allow it to stay comparably unharmed or even regain its former predominance at the expense of Frankfurt and Paris if there is no longer enough substance to support a multi-centre structure. Market interference may end up in wholly unforeseen results.
The Tobin tax cannot work unilaterally. In order to establish a level playing field and avoid regulatory arbitrage the EU will address the issue at the G20 summit in Cannes in November. However, the chances to reach an agreement are low. An earlier attempt in 2010 was met with reservations by the US, and also Japan which has an interest to promote its own financial institutions and enhance Tokyo’s role as international financial centre may rather bank on the competitive advantage of abstention.
c) Credibility. A third objection is that the tax is introduced in a sense under false pretences. Many people and organisations support the plan hoping that the tax will help substantially to curb speculation and that tax revenues will be used to fight global poverty. As I stressed earlier there has been a shift in targets in recent public debates, and the current proposal is solely directed at financing EU aims. This becomes clear from the following citation from the transcript of President Barroso’s video message on the EU priorities for the autumn:
Ahead of the Cannes summit, we will come forward with a proposal for a European financial transaction tax, and we are committed to explore this further also at G20 level. …
The proceeds from this financial transaction tax would help to fund the EU’s new multiannual financial framework [my emphasis], which is geared towards investing for growth and jobs across our Union. We will make detailed proposals on this over the course of the autumn.
So far, the details of what is meant by this “multiannual financial framework” and its purposes are not known. There had been earlier vague mentionings of “development projects”, but given the precarious EU financial situation in the current crisis it cannot be precluded, or perhaps must even be expected, that the revenues will be used for future crisis management and implicit or explicit bank bailouts. However, financing crisis management is not what countless supporters of the plan hope for. They do not campaign for a tax which will be used to sustain the remainders of a flawed EU project and for a policy directed at reshaping the business conditions for European banks at the expense of citizens in some of the poorest European countries.
Only time can tell whether the plan will succeed in the proclaimed way or whether it will be thwarted by evasive manoeuvres, unforeseen market reactions or the withdrawal of public support. Like the euro and the EMS before, the Tobin tax risks to become a failed European experiment. Unlike the euro it can be taken back easily. This is the good news.
There is a flood of articles and statements on the Tobin tax and related issues. The following few references give an impression of the width of views and arguments and the hopes related to the implementation of the tax.
Adam Baldwin: The Tobin tax: Reason or treason?
A Tobin tax is a proportional tax on all spot conversions from one currency to another. There are now growing calls for a Tobin tax to be introduced into the UK, both to raise revenues and to reduce market volatility. In this policy paper, Adam Baldwin examines the case for the Tobin tax and the associated “Robin Hood Tax” that was inspired by the Tobin tax. Looking at the underlying economics and the international experiences with Tobin taxes, he argues that such a policy would at best be ineffective, and at worst hugely counterproductive and harmful to the UK’s financial sector and wider economy.
What connects hunger in Africa, people dying for want of medicines or health care and fast-paced global capitalism? A small tax on financial transactions.
A new report about computer-driven high frequency trading (HFT), compiled by supporters of the Robin Hood tax campaign, reveals a niche world of millions of transactions each day. The report highlights how HFT threatens a new financial crisis.
The Robin Hood Tax: Financial Crisis 2: The Rise Of The Machines
Rapid increases in high frequency trading (HFT) have created a dangerously unstable web of computer-driven trading that spans global stock markets, putting them at risk of a system-wide ‘flash crash’. Incredibly, as much as 77% of trading in the UK stock exchange is now computer driven with shares bought and sold hundreds of times a second. Many experts believe that HFT is a dangerous threat to market stability. A Robin Hood Tax on financial transactions could stop the machines in their tracks, as well as raising sorely needed finance to fight poverty and climate change at home and abroad. Hong Kong already applies just such a tax, but in the big European economies, regulators are playing catch-up.