The European Commission is determined to press ahead with the proposed financial transactions tax (FTT) in spite of all the evidence that it would be a disaster. The measure is driven by politics rather than economic logic. Fortunately the US Secretary of the Treasury, Jacob Lew, has been given the task of adding his voice to those trying to make the Commission see sense. In this effort, Secretary Lew needs all the help he can get.
The US financial community must take this EU initiative very seriously, particularly as the Commissioner clearly intends that the proposal affect any financial institutions, wherever based, if at least one of the parties is a financial institution established within a member state that participates in the FTT. The scheme imposes joint and several liabilities on all the parties to the transaction—a far-reaching obligation.
Description of the Tax
James Tobin proposed a financial transactions tax in 1972 on currency transactions to check short-term movements. Years later, he reinvented it as what became the basis for the Commission's "Tobin Tax: proposals to impose a tax of not less than 0.1 percent of the consideration or market price (whichever is higher), or 0.01 percent (on the principal value of the asset) on derivatives. These sound modest, but they would be applied on all transactions, including those between financial intermediaries, and are therefore much more serious than a single tax on actual change of ownership. Furthermore, EU member states would be permitted to impose higher rates of tax.
Proponents of the tax argue that financial institutions are undertaxed, that they should be punished for the losses they impose on the rest of the community, and that an FTT would bring in substantial revenue, which could be applied to "good causes: (there are many claimants). They also want to "create appropriate disincentives for transactions which do not enhance the efficiency of the financial markets, and curb speculative activities.: That problem would be better approached by regulation; moreover, in their calculation, the proponents ignore that success in changing behavior must reduce the take of the tax. The defects of these arguments are widely discussed, including in the two documents referred to in the notes.
The original 2011 proposal for an FTT at the EU level was rejected 1 but later agreed to by 11 of the 28 member states under the Enhanced Cooperation Procedure (ECP). One might have thought that the resurrected FTT would just affect the 11, but the Commission is still determined to ensure that European nonsignatories are included and indeed that financial centers as far away as New York and Singapore should be required to collect (but not necessarily retain the revenues from) the tax on any transactions involving parties in, or securities issued by, the participating EU countries. The Commissioner has said that, "to put it simply one would have to abandon their entire EU client base to escape the tax."
A second pamphlet2 was upstaged by an EU "leak" that the Commission was reconsidering the tax, but a check with the EU press department proved the leak to be untrue.
Why Should the United States Worry?
There are several specific problems from the United States and indeed the international point of view:
- The European Union may well push ahead with introducing the tax only to abolish it when the FTT is seen to be damaging financial markets or when serious legal challenges have run their course. Most of these challenges would be decided by the European Court of Justice (ECJ), a body not noted for its speed. Financial firms will already have incurred the substantial costs of setting up compliance procedures.
- A cascade tax collected multiple times on successive transactions in the same security is far more damaging than a tax on the ultimate sale of security by the beneficial owner (e.g., a pension fund). The FTT would attack the vast number of intermediate transactions that take place in modern financial markets. Speculative transactions would not cease but be driven away to jurisdictions where EU laws could not be enforced and by institutions taking care to have no presence in the European Union.
- The Commission has been deliberately vague about how the incidence of the tax will fall. It appears that it will be collected by the country of residence of the institution undertaking the transaction, but the revenue would have to be paid over to the country of origin of the security (we hope less a fee to cover collection costs).
- A major consideration is that the cost of paying the tax and accounting for it will be borne either out of taxable profits of the collecting institution or passed on to its counterparty, which may be a different country. There would thus be a substantial reduction in the yield of corporation tax (and personal tax on bonuses) in that country, and the United States would be a particular sufferer. Where the FTT is borne by individual investors, charities, pension funds, and mutual funds, there would be no offset through reduced income tax revenues. Are these investors, charities, and pension and mutual funds the intended victims of the FTT?
When the 11 participants signed up, and when the deal was approved by the European Parliament in December 2012, no one had any idea what they were agreeing to. Indeed, the Commission announced that the details would only be published "in due course.: But when the details were leaked in February 2013, it turned out that the new FTT was a rehash of the old proposal—with exactly the same estimated revenue! The ECP rules provide that measures should "respect the competences rights and obligations of those Member States which do not participate in it.: This proposal doesn't. The EU rules also require unanimity to force changes in tax rules on members. The Commission is arguing (before the ECJ) that the FTT is not a tax.
A so-called "non-paper" dated April 16, 2013, was submitted to the Commission by some of the signatories seeking clarification. When it was leaked, the Commission commented that it was "not embarrassed: by this leak and that "it would be discussed at a meeting on 22 May.: The report of that meeting, also leaked, showed the EU determination to go ahead, even suggesting new ways in which its objectives could be achieved.
Confronted with this determination, the Treasury Secretary faces a major challenge to prevent the FTT from damaging US financial markets and embroiling the United States in protracted tax disputes with the European Union.
John Chown is an international tax adviser based in the United Kingdom and cofounder of the Institute for Fiscal Studies. Gary Clyde Hufbauer is the Reginald Jones Senior Fellow at the Peterson Institute for International Economics.
1. "Time to Bin the Tobin Tax,: John Chown, Pointmaker, London: Centre for Policy Studies, April 2012.
2. "The Tobin Tax Rears its Ugly Head, Again," John Chown, Pointmaker, London: Centre for Policy Studies, May 2013.