The German finance minister Wolfgang Schäuble has said that a financial transaction tax (FTT) - or Tobin tax as it is commonly called - is necessary to show the public that the financial sector was being held to account for its reckless behaviour.
The French government has pre-empted European moves to introduce an FTT, doubtless in a bid to aid President Sarkozy’s chances in the forthcoming presidential elections.
For its part, the UK government has said it is in favour of an FTT at a global level but against Europe-only introduction, given the disproportionate effect it would have on the country’s financial sector.
A blanket, small-scale tax on financial transactions to discourage speculative behaviour is attractive. It has the benefit of being easy to understand and to implement, and it could allow society to claw back the cost of bank bailouts. “What’s not to like about it?” Undoubtedly, there is widespread public dissatisfaction at the effects of the financial crisis on the wider economy, employment and prosperity. And the reckless financial behaviour that underlies the crisis should be discouraged.
But the European Commission proposal of September 2011 would levy 10 basis points on debt and equity transactions and one basis point on those involving derivatives. De Nederlandsche Bank (DNB), the Dutch central bank, has calculated the net annual cost for pension funds alone to be some €1.7bn.
Indeed, given that a European FTT would affect all market participants, it does not discriminate between beneficial investment behaviour such as trading shares and bonds for long-term investment goals or hedging risks with derivatives. As the DNB points out, an FTT might actually increase risk by discouraging pension funds from hedging transactions.
A position paper published in February by the European Federation for Retirement Provision (EFRP) also claims that an FTT could increase market volatility by decreasing liquidity. Further, according to the EFRP, an FTT could encourage the use of less regulated domiciles outside the area covered by the tax and could encourage tax avoidance.
As EFRP sees it, an FTT would lower returns, and make for less efficient investment strategies. The position paper notes: “Pension funds and IORPs would be taxed to recover the costs of a financial crisis which they are not responsible for. On the contrary, pension funds and IORPs have been suffering the effects of the crisis and they are contributing to alleviate it by providing long-term investments and market liquidity”.
The position paper also points out that the costs are bound, in many cases, to be borne by occupational pension fund members themselves, in the form of increased contributions or lower benefits over time. “It seems ironic that many member states strongly encourage their citizens to provide for their retirement, not least with tax incentives, in order to alleviate the strain on state pension systems, and yet entertain the idea of a tax that will counteract these efforts,” the EFRP paper continues.
In 1998, the UK’s removal of the dividend tax credit from pension funds had a corrosive long-term effect on pension funds and on wider occupational pension provision. Those who wish to regulate financial markets should be aware of the potential unintended consequences of their actions.
For these reasons, the concept of a universal FTT is a flawed one. Not-for-profit long-term investors beneficial to society and the wider economy - such as pension funds - should be exempt from an FTT proposal whose aim is to exact society’s due from those who helped cause the financial crisis. If this cannot be achieved, the proposal should be abandoned.
This story first appeared in the March issue of IPE magazine.