Europe Should Embrace a Financial Transaction Tax
Financial Times, 5/29/13
By Avinash Persaud
Published on 5/28/13
Opponents’ arguments are inconsistent and lack proportion, says Avinash Persaud
The banking industry has launched a concerted and broad attack against the plans of 11 European countries to impose a financial transaction tax. Bankers are complaining that the tax will kill growth, rob pensioners, make the European debt crisis worse, impoverish small farmers and more.
On examination, the arguments by opponents of the FTT have three defining features. First, they are inconsistent. We are told that the tax will be so completely avoided that no one will pay it. Then we are told that the tax will bring economic and financial ruin. It is hard to have it both ways.
Second, the arguments lack a sense of proportion. The actual levy rates proposed by the European Commission are small: 0.1 per cent on stocks and bonds, and 0.01 per cent for derivatives. The impact of a tax of these levels would be no more pernicious than if the spread between the buying and selling prices given by market makers for many stocks returned to where they were about a decade ago.
The FTT would be only one of several costs for investors who decide to buy or sell a security. When all the transaction costs are added up – administration, management, research, broker and banker commissions, clearing and settlement fees – they amount to nearly 1 per cent of assets per year for liquid assets and significantly more for illiquid assets.
On average, long-term equity funds turn over their portfolios only once every two to three years so the cost of the tax on an average share transaction would be spread over two or more years. These funds also participate in initial public offerings and cash markets that will be exempt. I estimate that the FTT will comprise no more than 5 per cent of annual transaction costs for long-term equity holders. Why is nobody complaining about the ruinous effects of the other 95 per cent?
Critics of the FTT also argue that the same stock is traded several times by brokers before there is an end buyer – but those buying the stock on behalf of others will also be exempt from the tax.
Third, the analogies used by opponents of the FTT are irrelevant. For example, they often tell the story of how Sweden’s experiment with such a tax in the 1980s was avoided. But they ignore the approximately $38bn raised in 40 countries today with FTTs – which, like the proposed European version, are difficult to avoid. In the case of Britain’s stamp duty on shares, 40 per cent of revenues come from non-British residents concerned that without paying the tax they would not have legal title to the shares. Seven of the 20 largest stock exchanges in the world are in countries with transaction taxes on equities.
Financial trading is undertaxed relative to the rest of the economy, in large part because the industry is exempt from value-added tax. Along with the profits banks derive from trading, this encourages excessive trading. It not only creates needless costs to pensioners and savers, it also undermines financial stability. This can be seen in the unnecessary activities of high-frequency traders. These are biased towards contrarian trades – they buy when others sell – and so they provide liquidity, but at a time when liquidity is plentiful. In times of market disruption, they try to get ahead of the trend, draining liquidity when it is needed most, such as before the “flash crash” of May 2010.
Further, when the financial system is working smoothly, few worry about the huge number of offsetting trades (for example, via derivatives) that are built on top of small exposures. But when the music stops and counterparties can no longer be trusted, it is these gross exposures that bring down the banks. In a number of different ways, this small tax on churning would limit some of these activities and help to refocus the financial system on to its purpose of the safe financing of real economic activity. Believers in the true purpose of finance – the funding of genuine economic activity – should embrace the FTT.
The writer is a former senior executive at JPMorgan and UBS, and is an executive fellow at London Business School