I’M IN FAVOUR of a Financial Transaction Tax (FTT), but only of one that works properly. Apparently, I need to say that first before the witch-hunters and banker-burners set out for me.
The first thing to say is that the root cause of the West’s economic problems was the repeated and consistent overvaluation for a whole decade of property assets (residential and commercial) and, in Ireland’s case, the attendant excess supply of same . What systemic failures there were happened in the areas of securities ratings and poor legal administration; neither of which would be prevented by or are remedied by an FTT.
Further, the ‘volatility’ that many complain of was a symptom of the ‘bust’ not the ‘boom’. Lastly, the FTT is just another transaction tax – yet despite the damage we have seen them do in our property markets, it is being proposed by Brussels and by many commentators here.
The core of the FTT idea is that low transaction costs and excessive liquidity facilitate speculative trading in markets dominated by financial corporations, which leads to price gyrations that hurt the ‘real economy’ while generating excess profits for the players in these markets. So the Financial Transaction Tax seeks to punish a perceived vice while raising lots of money for the Exchequer and, at the same time, making life harder for everyone’s favourite scapegoat du jour, the bankers and hedge funds.
An FTT, it is supposed, would ‘calm’ these markets while at the same time raising money that could better be spent by Government on widows and orphans. Derivatives trading comes in for especial criticism in this regard as a smoke-and-mirrors work-of-the-devil extravagance of markets.
The draft EU Commission proposal is for a transaction tax on bonds and shares at 0.10 per cent, and at 0.01 per cent on derivatives. No mention is made of foreign exchange or commodities trading. The report includes a sentence: “The proposal was focused on open market activities and movements (ie trading) and excluded inter-bank transfers and trades which might occur in the normal course for business.”
On a first point, the rates suggested, while seemingly trivial, are in fact large fractions of the quoted prices. Derivatives are quoted in spreads of 4 or 5 basis points (0.01 per cent is a basis point), so a tax rate of 1 basis point is a rate of 20 or 25 per cent. Bonds are quoted in spreads of less than 25 basis points so a this is a 40 per cent tax rate. Further, if derivatives are the real ‘bogeyman’, why are they being charged the lesser rate?
With respect to the notion that the yield would be significant, several points arise. A tax this heavy would distort trading levels and I’m not sure that has been accounted for. Further, there is no assessment of how much trading is done here and what share of the millions would come to the Irish Exchequer. Lastly, since the banks hedge their ‘on-balance’ sheet risk with these ‘off-balance’ sheet trades, we have no idea if this will drive ‘volatility’ back into the more expensive ‘real’ markets.
There is no explanation of why foreign exchange trading is excluded, which is most odd since, despite our obsession with the evolution and fate of the euro, the EU is still a multi-currency construct. Nor is there a rationale given for the exclusion of commodities which means that fuel oils and foods are not covered yet these are indeed major components of the ‘real’ economy.
It is also proposed to exclude trades ‘which occur in the normal course of business’. This is meaningless and would provide a get-out clause for all and any trades, since these are all transacted out using the same processes and settlements.
A further major omission is that there is no mechanism suggested where transactions by non-financial corporations for genuine hedging purposes of the financial risks of the ‘real economy’ can be excluded from the tax net. So the FTT as proposed will fall equally heavily on those with genuine need but less financial expertise.
In the case of profiteering and speculating at the expense of small nations, it is in the nature of human beings to describe profitable trades as ‘investments arising from one’s own insight and inspiration’ and to attribute loss making trades to the ‘speculative actions of others’. Every transaction requires a buyer and a seller and as such implies someone who believes an argument/opinion and one who disagrees. Shorting of bonds or shares is not a unilateral action. Further, where ‘short selling’ has been banned it normally creates more sellers unsettled by the change in rules and the whiff of panic and, consequently, usually worsens the situation.
In capital owning democracies, people are entitled to decide whether they believe a government’s policies are credible/effective and to vote with their assets if they disagree. Manipulating market rules to suit Government preferences is a form of censorship, and suffers from all of the hypocrisy and ineffectiveness that goes with censorship.
Finally, it seems the banks aren’t getting into too much of a lather about it because it will cost them practically nothing to circumvent the tax. In exactly the same way as every trade executed on Wall Street is booked through entities in the Grand Cayman Islands, every trade in Dublin, London, Paris and Berlin will be routed through entities in Gibralter, Jersey or Malta the day after the legislation is passed and, consequently, hardly any ‘transaction tax’ will be collected. And this will happen without moving a single trader or company.
The EU proposes to tax on the basis of residence but if the US authorities have not managed to shut down the Cayman loophole, I do not see how the EU with its vastly more complex legal hinterland will be able to do the equivalent.
In sum, this FTT proposal is long on wishful thinking, short on concrete details, internally inconsistent and absent a working knowledge of the operation of the market and its systems. Proponents of it need to ‘up their game’ somewhat in order to have it gain serious consideration.
Arthur Doohan is a banker by experience and a web consultant by choice. He writes at doohan.org. A version of this post first appeared on the Progressive Economy blog.
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