Three and a half years post-Lehman the world is still struggling to deal with the realisation that nothing in life is free, least not when it comes to credit. However, the European Commission’s proposal to introduce an EU-wide financial transaction tax (FTT)1 to remedy the ills of the past suggests that its supporters have either fundamentally misunderstood the causes of the crisis or that they are simply desperate to show that they have done something in response to it. Whichever it is, the result is basically a case of robbing Peter to pay Paul, or more accurately, robbing Paul to pay Paul.
In times of financial turmoil, it is never long before the concept of a Tobin Tax or some variation on the theme crops up. Tobin’s original currency transaction proposal, now 40 years old, sought to stabilise foreign currency markets by introducing a tax to discourage short-term speculation by investors. Variations have been attempted or proposed in many forms, most notably in recent years for charitable purposes, which it should be noted the Commission’s proposal is not intended for, but the conclusion more often than not is that such a tax would need to be applied across all markets to work. The Commission’s proposed FTT seeks to rein in short-term speculation in financial instruments targeting the perceived inefficiencies of high frequency trading, while creating a level platform across the EU and, of course, to raise some much needed cash to ensure financial institutions make a “fair contribution” to the costs of covering the crisis – the argument being that EU taxpayers have largely picked up the bill to date.
The “small tax,” as it was described by Manfred Bergman,2 director of indirect taxation and tax administration at the Commission, would see a 0.1 percent levy on equities and bonds with a 0.01 percent levy on derivatives, both of which would be imposed on the buyer and the seller, with an expectation of annual revenues of up to a not so “small” €60 billion. However, there is mounting evidence to suggest that because of the complicated nature of investment products, end investors will ultimately suffer many multiples of this. The Alternative Investment Management Association’s (AIMA) recent research note suggests a rate of 2.2 percent would be suffered by an investor over the lifetime of a unit trust even before the portfolio is analysed. What appears to be lost in the Commission’s analysis is that EU citizens are both taxpayers and investors (be it directly or indirectly through their pension funds or other investments). Ironically the proposal, which seeks to stop EU taxpayers from dipping into their pockets for the next bail out, is instead effectively asking for the money up front.
If it were simply a case of coming to terms with the fact that life is more expensive in the post-Lehman era (a lesson being taught over and over again by the credit rating agencies), this would be manageable albeit unwelcome news. However, the consequences of the proposed FTT go beyond merely manipulating cash flows to underpin financial markets. Introducing the Commission’s proposal in its current form would damage the fundamentals of price discovery increasing spreads and reducing liquidity. The hope of setting a level playing field across the EU will simply disadvantage its financial services sector compared to the rest of the world if it is not implemented worldwide. As Europe’s financial hub, London and by definition the whole of the UK economy will be hit the hardest by the implementation. Both supporters and detractors alike of the UK’s dependence on the financial sector will agree that now is not the time to inhibit the UK’s growth.
Alternatively, if indeed the rates of 0.1/ 0.01 percent fail to meet their objective of curtailing current levels of investment activity across Europe and the levy does little to dampen financial systems, then the next step may well be that, if these figures do not work, then maybe 0.2/0.02 percent would, or maybe 0.3/0.03 percent. Taxes that are predominantly designed to influence behaviour have a way of creeping up as tax payers become increasingly resistant to them. Duties on fuel, tobacco, alcohol and air travel all have a tendency to go in the same direction (i.e., up). The truth of the matter is that once a revenue stream has been established it is a resource to be tapped by authorities.
Furthermore, as with any new type of taxation, implementation and monitoring compliance pose a costly challenge. It raises questions over how and by whom such a cross-border tax would be monitored. The ability, or lack thereof, of Member States to tackle VAT fraud across the EU will be sounding alarm bells in certain circles with some estimates putting current levels of carousel fraud beyond that of the revenue expected to be raised by the FTT. The only real solution to such a problem is to wield a penalty regime so severe a deterrent that the authorities can rely on taking a risk-based approach to any regulation, pushing the problem of compliance back onto the taxpayer. The outsourcing of cross-border tax compliance risk is a concept that the financial services industry is soon to witness first hand with the rolling out of the U.S. Foreign Account Tax Compliance Act (FATCA).3 The true sign that legislation is a game-changer is that service providers start developing their own in-house teams in order to support client demand – today’s FATCA team may well be tomorrow’s FTT team if it gets the green light.
So, why, when the FTT fails to address its own objectives, damages financial markets, and potentially costs more to administer than it recoups in revenues, is it even on the agenda? The cynical although increasingly popular view is that introducing the FTT is a useful sound bite in the war against past excesses of the financial system and serves as a valuable pawn in a larger European political chess game. The driving force behind the FTT is French president Nicholas Sarkozy, a man with a point to prove with elections this spring. His five-year term ran in parallel to the financial crisis, the cost of which appears to be increasing on a daily basis for the French as Eurozone bailouts continue to weigh heavily on French and German shoulders. Despite hosting both the G-8 and G-20 last year, no substantial steps forward were made in terms of tackling the crisis or indeed how to prevent it happening again. The significance of the recent downgrading of France’s credit rating is probably more symbolic than anything else, but Sarkozy’s response was swift and to the point with the announcement of a local French FTT from August 2012 despite concerns even being raised within the Autorité des Marchés Financiers, France’s own financial regulatory body.
At EU level it has been made quite apparent that the FTT could be introduced to a subset of States if it fails to get the backing of all 27 Member States. The UK’s opposition to the FTT will not leave David Cameron at odds with all the other 26 members on this occasion as Sweden, Malta and Cyprus have all issued reasoned opinions against the proposal. Cyprus takes the rotating six-month EU presidency for the second half of 2012, and current incumbents Denmark have expressed no great desire to push anything through on the FTT. However 2013/14 sees the rotation pass to Ireland, Lithuania, Greece, and Italy. With Lithuania targeting Eurozone entry in 2014, and the other three all having good reason not to bite the hand that feeds them, could mean the FTT starts getting far more traction next year. Even those Member States currently opposed to the FTT may change their view over the coming years if it becomes a point for political horse-trading in the Eurozone.
So, for now, the message in the UK is clear – keep calm and carry on. David Cameron is strictly opposed to implementing a partial FTT without the rest of the world acting in unison to implement such a tax, something that he can be quite confident in saying in the knowledge that action on such a scale would be unprecedented. The UK Government’s view has been widely applauded on all fronts, representing a staunch opposition to a misplaced policy that not only defies logic but represents an attack on the UK economy as a whole. Ironically, if opted out of, the proposal may even be a net positive for London if, as Boris Johnson, Mayor of London, recently quipped, it gives rise to an influx of finance professionals arriving on the Eurostar train from the channel tunnel. Perhaps the UK should be looking to sell off the Olympic village to French bankers in August after their FTT comes into force?
Michael joined Kinetic Partners in August 2010 as a director in the tax department after qualifying with the firm in 2007. He manages a portfolio of asset management clients providing tax advice around tax efficient structuring and restructuring, compliance and transfer pricing. Prior to Kinetic Partners, he was UK tax advisor at Man Group Plc focusing on group tax rate forecasting and reporting, tax compliance, and tax risk management. Telephone: +44 (0) 20 7862 0888; E-mail: Michael.email@example.com.
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