Viewpoint | Robert Boardman
Should we be afraid of Goethe’s Apprentice?
As the European Union moves towards the implementation of a Financial Transaction Tax on 1st January 2014, Rob Boardman of ITG reviews the causes and consequences of this great experiment in taxation policy.
In Goethe’s poem The Sorcerer’s Apprentice the well-meaning trainee attempts to invoke powerful magic learned from his master to do his housework, but soon realises that he cannot control the forces he has unleashed. In 2011 the European Commission President, José Manuel Barroso proposed a new experiment to invoke the magic of revenue-raising through a Financial Transaction Tax (FTT), based on a model proposed by the Nobel Prize winning economist James Tobin. Yet other economists and market participants fear the FTT will cause unintended negative consequences. Perhaps European policy makers, rather like Goethe’s apprentice, have not fully anticipated the destructive power of Tobin’s magic. But should we be fearful of the European FTT?
Certainly the experience of Sweden, which adopted a FTT in the mid-1980s, is not encouraging. After introducing a tax on trading in Swedish stocks, bonds and derivatives, transaction volumes fell, and trading moved offshore. Predictably, taxation revenues were much lower than anticipated, liquidity in stocks and (especially) bonds dropped alarmingly, and the futures market was all but eliminated. Eventually the Swedish government admitted defeat and by 1992 had abandoned the tax completely. So why has the idea resurfaced now?
Since the financial crisis started in 2007, the media and politicians have accused banks of creating markets which made credit (particularly sub-prime mortgages) too easily available because
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risk could be transferred (e.g. via credit derivatives) without accountability. The fact that some banks had to be rescued with public money made them doubly targeted. Of course regulators and credit- rating agencies had their part to play in the crisis, but policy makers are now focused on reducing “speculative” trading in financial instruments. Another factor exposed by the financial crisis was the large budget deficits built up by many European governments. So the FTT kills two birds with one stone: raise money to plug the public finances by imposing a tax which throttles financial market trading. Simple in theory, but will the new European FTT suffer the same fate as Sweden’s? European policy makers have tried to learn the
lessons from the Swedish experience. The process approved at the 22nd January ECOFIN meeting, and revised proposals published on 14th February, although not near to being definitive, crucially are structured to tax “resident” traders irrespective of where the transaction occurs. Furthermore the FTT contains exemptions on transactions involving central banks. These measures are designed to ensure trade cannot simply move offshore and that central bank financing operations avoid the difficulties encountered by the Swedish government. So if anti-avoidance measures work, how much money could the tax raise? Well that depends on the tax rate imposed and how much transaction turnover falls. Assuming a 10 basis point tax on purchases and sales of shares and bonds, and one basis point tax on derivatives, the official European
Best Execution | Spring 2013
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