Towards a Financial Transactions Tax? - European Union Committee Contents


CHAPTER 2: Assessing the commission's objectives

9.  The European Commission proposal for a Council Directive on a Common System of Financial Transaction Tax was published on 28 September 2011. The Commission set out five broad objectives behind the tax:

(a)  To avoid fragmentation in the internal market for financial services, bearing in mind the increasing number of unco-ordinated national tax measures being put in place;

(b)  To ensure that financial institutions make a fair contribution to covering the costs of the recent crisis and to ensure a level playing field with other sectors from a taxation point of view;

(c)  To create appropriate disincentives for transactions that do not enhance the efficiency of financial markets, thereby complementing regulatory measures aimed at avoiding future crises;

(d)  To create a new revenue stream with the objective of gradually displacing national contributions to the EU budget, resulting in a lesser burden on national treasuries;

(e)  To contribute to the ongoing international debate on financial sector taxation and in particular to the development of an FTT at global level.[12]

10.  Commissioner Šemeta told us that "modern tax policy allows taxation to serve several objectives at the same time", and he did not see any contradiction between them. On the contrary, the Commission saw them as mutually reinforcing.[13] We now consider whether these are reasonable objectives to pursue, and whether an FTT is an effective way to do so.

a) To avoid fragmentation in the internal market

11.  The Commission's first priority is "to avoid fragmentation in the internal market for financial services, bearing in mind the increasing number of unco-ordinated national tax measures being put in place."[14] Whilst this priority was listed first in the Commission's Explanatory Memorandum, it has been given less prominence than any of the other objectives. The Commission's written evidence to the Committee barely refers to it, and Commissioner Šemeta made clear that it was not the primary focus for the Commission.[15]

12.  Tellingly, few of our witnesses commented specifically on this aim. John Vella, Clemens Fuest and Tim Schmidt-Eisenlohr from the Oxford University Centre for Business Taxation argued that, though it is right to point out that Member States are introducing unco-ordinated national financial sector taxes (for instance bank levies), these are not transaction taxes, and an EU-wide FTT would not address the lack of co-ordination on these levies.[16] The International Swaps and Derivatives Association (ISDA) cited the Chancellor of the Exchequer's argument that the EU's energies would be better spent harmonising bank levies.[17]

13.  The British Bankers' Association (BBA) considered that a blend of national measures is a reasonable price to pay to maintain competitive tax systems and fiscal sovereignty. They argued that national measures that threaten the free movement of goods, services, persons or capital within the single market can already be challenged under the EU Treaty, and they had not seen any evidence that the levies introduced in a number of Member States have caused any fragmentation in the European financial services market.[18]

14.  The Government noted that the Commission cites article 113 of the Treaty on the Functioning of the European Union (TFEU) as the legal basis of the proposal, which is to ensure the functioning of the single market. However, the Government argued that it is unclear why the Commission feels that an EU FTT would deliver on its stated objectives better than domestic taxes.[19]

15.  Whilst an attempt to avoid fragmentation in the internal market for financial services may be a commendable aim, it is not at all clear how the Commission's proposal for a new tax would help achieve this.

b) To ensure financial institutions make a fair contribution

16.  The Commission's second objective is "to ensure that financial institutions make a fair contribution to covering the costs of the recent crisis and to ensure a level playing field with other sectors from a taxation point of view". This was in light of the fact that "the financial sector has played a major role in causing the economic crisis whilst governments and European citizens at large have borne the cost."[20]

17.  Commissioner Šemeta told us that it was the Commission's 'key priority' to ensure a "fair and substantial" contribution from the financial sector to the costs of the crisis.[21] He argued that, given that the total costs of the bailout have been estimated at €4.6 trillion across the EU, it is legitimate to expect the financial sector to pay this money back sooner or later.[22] Indeed, the Commission's written evidence asserted that the financial sector has "hugely benefitted from massive rescue operations undertaken by the tax payers in Europe". In its view, "asking the financial sector to contribute to the financing of these rescue operations is simply applying a key principle of effective policy making, i.e. that those who benefit from a policy should also be those that should pay for it, unless there is a political consensus that others should pay." The Commission also argued that the financial sector benefits from preferential treatment since it is exempt from paying VAT for most of its operations.[23]

18.  Some witnesses sought to reinforce the Commission's arguments. Sylvie Goulard MEP thought that there was "genuine legitimacy in asking these services to take a fair share of their responsibilities."[24] Stamp Out Poverty claimed that the VAT exemption created a significant tax advantage for the financial sector. They also argued that "large banks' 'too big to fail' status" resulted in an "implicit subsidy", since it enabled them to borrow at lower interest rates on the basis of an implicit understanding that the government will bail out bond holders if a large bank defaults on its debt payments.[25]

19.  Unite cited "an apparent disregard being paid by top level bankers to the outrage felt by taxpayers and the general public following the payment of such high bonuses given that the rest of the economy is facing a tight financial squeeze caused by the banks."[26] Indeed, in the view of Owen Tudor, the TUC's Head of European and International Relations, an added advantage of an FTT was that it would be a popular tax reflecting popular feelings that the financial sector is under-taxed.[27] Commissioner Šemeta cited recent opinion polls which suggested that approximately two-thirds of European citizens, and one-half of the UK population, are in favour of a Financial Transaction Tax, although we question the extent to which the general public can be expected to understand all the implications of such a proposal.[28]

20.  Other witnesses disagreed strongly, several disputing the Commission's contention that the VAT exemption constituted preferential treatment. Nigel Fleming, International Head of Tax, BlackRock, argued that it was "misguided" to regard this as a tax break since the major effect of the VAT exemption is that the financial institutions themselves do not recover the input VAT that they suffer on their costs, and they then do not charge VAT to the consumer of the supply.[29] Mr Fleming also pointed out that bank levies, bank bonus taxes and other taxes apply to the financial sector but not elsewhere.[30]

21.  Some witnesses claimed that the Commission's diagnosis was simplistic. The Association of British Insurers (ABI) argued that the Commission had predicated its arguments on "the false notion that all elements of the financial sector are taxed in equal manner and proportion."[31] Other witnesses pointed out that the effect of the tax would not be limited to those firms or those sectors of the financial sector that had caused the crisis.[32] ISDA cited pension funds, unit trusts, holding companies and leasing companies as examples of groups that bear no responsibility for the financial crisis and which received no taxpayer support.[33]

22.  Other witnesses were concerned that the difficult economic climate made the introduction of an FTT an unwise proposition. Richard Woolhouse, Head of Tax and Fiscal Policy, Confederation of British Industry (CBI), argued that the priority at the present time should be to encourage economic growth rather than promoting a tax that could be extremely damaging not only for the financial sector but also for the broader economy in terms of investment and job creation.[34] The Mayor of London, Boris Johnson, agreed.[35]

23.  The Financial Secretary to the Treasury agreed that the financial sector should pay a fair contribution to the Exchequer, and pointed to the UK bank levy as a way that the banking sector did so. Whilst he acknowledged that financial services are exempt from VAT, he cited a recent estimate that financial services firms incurred £6 billion of irrecoverable VAT. He told us that "we have to be very careful. There are some who use the financial services sector as a scapegoat. It is quite easy to point to big bad speculators as the cause of your country's problems, when actually the problem is more around tackling your fiscal problems and getting the competitiveness and growth agenda right in your country."[36]

24.  The Commission's proposal combines two distinct issues—firstly, whether the financial sector should make a financial contribution to dealing with the effects of the ongoing financial crisis, and secondly, whether the financial sector is under-taxed.

25.  The issue of whether the financial sector is under-taxed is particularly nuanced. The evidence we heard focussed on whether or not the financial sector's exemption from VAT could be regarded as preferential treatment. In our view, whilst the financial sector may derive some advantage from the VAT exemption, it is also clear that financial institutions incur a large amount of irrecoverable VAT. Any case for increasing taxation of the financial sector needs to rest on more solid foundations than this.

26.  Furthermore, whilst we acknowledge the strength of public anger against the financial sector, and the widespread view that a form of taxation should be introduced to ensure that those who contributed to the current crisis should contribute to its costs, it is important to recognise that not all elements of the financial sector bear equal (or even any) responsibility for the crisis. Caution should therefore be observed before introducing any proposal that would have a blanket effect on all elements of the financial sector. Therefore, whilst there may be a case for increased taxation of at least some parts of the financial sector, it does not follow that the Commission's Financial Transaction Tax proposal is the most appropriate means by which to achieve this. Much depends upon the specific details of the Commission's proposals, which we examine in Chapter 3.

c) To create disincentives for transactions that do not enhance the efficiency of financial markets

27.  The Commission's third objective is "to create appropriate disincentives for transactions that do not enhance the efficiency of financial markets thereby complementing regulatory measures aimed at avoiding future crises". The Commission stated that the market segments expected to be affected most will be automated high-frequency trading and highly-leveraged transactions (see Box 2 below).[37]

BOX 2

High-Frequency Trading[38]

High-frequency trading (HFT) has been defined as the use of computers to implement various highly active trading strategies to trade at exchanges where automated electronic systems arrange trades. Electronic dealers post standing limit orders to buy or sell securities or contracts and wait for others to trade with them. After they trade, they generally try immediately to trade on the other side of the market to divest themselves of their positions. They hope to profit by buying low and quickly selling high. When this happens, they often profit. But if they believe that the market will move against them, they may be unwilling to wait to trade. Instead, they will actively trade out of their positions by submitting market orders or marketable limit orders. In these cases, they often lose. Traders frequently adjust their orders to respond to changing market conditions. These adjustments may occur several times a second. High-frequency traders use extremely fast computer systems to implement their trading strategies. The time between when an event takes place on an exchange and when a trader is able to respond to that event is often less than one millisecond. During this period, electronic systems will disseminate information about the event. The high-frequency trader's computer will analyse the information, choose a response and submit instructions to the exchange. The electronic systems will route those instructions to the exchange.

28.  Commissioner Šemeta told us that there had been significant growth in this phenomenon, and warned of the risks associated with it. Whilst he denied regarding high-frequency trading as immoral per se, he argued that the growth in this segment of the market meant that, as well as regulatory measures, complementary measures such as taxation need to be used.[39]

29.  Some witnesses stressed the need to target such activity, described by Unite as "casino" banking. They pointed out that Lord Turner of Ecchinswell, Chairman of the Financial Services Authority, had described such activity as "socially useless".[40] Stamp Out Poverty told us that 72% of trades on the New York Stock Exchange are now conducted using algorithms, asserting that "these computer programs drive trading without human involvement, and the interaction between different algorithms can significantly reduce stability in markets." They pointed to the May 2010 'flash crash' in the USA, when the Dow Jones Industrial Average plunged by 600 points in 5 minutes, when high-frequency trading was implicated in the subsequent investigation.[41]

30.  Duncan Weldon, Senior Policy Officer, TUC, told us that there is a legitimate need for interest rate swaps and forward exchange rate contracts, which are useful for real corporations in the real economy. His concern was that "the volume of these contracts far outweighs their use in the real economy."[42] Likewise, Owen Tudor cited the dangers of "vast amounts of money simply going around and around in a spiral that is not being used productively."[43]

31.  Sony Kapoor, Managing Director, Re-Define, argued that high-frequency trading provides "what is essentially spurious liquidity. True liquidity in a financial market actually comes from a diversity of opinion: somebody should want to buy when I want to sell, and somebody should want to sell when I want to buy." With high-frequency trading, "even a small transaction will trigger changes and further transactions, which in turn would trigger even further transactions and cause different exchanges for different high-frequency traders."[44]

32.  Richard Gower, Senior Policy Advisor, Oxfam, cited the view of economist Paul Krugman that an FTT would help cure banks' addiction to short-term finance.[45] He told us that the emerging evidence showed that the frequency of market abnormalities and contagion across markets had increased as a result of such trading.[46] John Vella, Clemens Fuest and Tim Schmidt-Eisenlohr disputed this, citing the Commission's own admission that the empirical economic literature is still rather inconclusive on the effects of such trading on volatility or price deviations.[47] Nigel Fleming told us that much high frequency trading would in fact decrease risk or volatility.[48]

33.  Some witnesses defended the role of high-frequency trading and of derivative markets more broadly. Joanna Cound, Managing Director, BlackRock, told us that high-frequency trading is generally beneficial from the point of view of their investors. She told us that it reduced bid offer spreads, which in turn helped investment performance.[49] The CBI argued that the use of derivatives sensibly to manage risk is essential for the majority of types of business, allowing firms to manage risks, invest over the longer term, export to customers outside the UK and manage the price of their raw materials.[50]

34.  Several witnesses argued that a tax would in any case be too blunt an instrument to have any beneficial effect. The Institute of Economic Affairs (IEA) argued that it would have had no effect upon either the 2007-8 financial crash or the continuing euro area crisis, since the markets that would have been affected by an FTT were the foreign exchange (FX), futures, options and stock markets, including high-frequency trading. In contrast, Mortgage Backed Securities (MBS), Collateralised Debt Obligations (CDO), Credit Default Swaps (CDS) and the leverage of the banks themselves, which did cause the problems in 2007/8, would not have been affected.[51] The CBI pointed out that whilst the FTT is supposedly aimed at reducing the number of 'risky' practices, in reality it does not discriminate since all transactions would be affected, "from risk management products to long term pension investments."[52]

35.  Joanna Cound argued that any concerns arising from high-frequency trading should be dealt with through regulation, citing the Commission's current Markets in Financial Instruments Directive (MiFID) and Market Abuse Regulation (MAR) proposals.[53] The CBI agreed that "as a matter of principle, undesirable market behaviour should be dealt with through regulation."[54] John Vella also thought that "targeted regulation" was the preferable approach.[55]

36.  The Financial Secretary to the Treasury told us that "the initial evidence suggests that high-frequency trading does not have an adverse impact on volatility but does improve liquidity and efficiency in markets." In his view, financial market instability and the financial crisis "was not really about the volume of transactions; it was about the structure of banking in the UK and the rest of the world, and the inadequate regulation and supervision of that banking model." He was not convinced that reducing the volume of transactions would make that system any more stable. In his view, "those who propose an FTT as a means of delivering financial stability need to provide some more evidence for their views."[56]

37.  We heard divergent views as to whether high-frequency trading and other related transactions, regarded by the Commission as inefficient, should be discouraged. We note the equally divergent evidence as to the impact of such transactions on market volatility. In our view, it is not yet clear whether and to what degree such activity has a detrimental effect on the national, EU and global economy.

38.  Yet even if the case is made that such transactions should be discouraged, it is far from clear that a Financial Transaction Tax is the best way to achieve this. We note the concerns of several witnesses that such a tax would be too blunt an instrument to tackle the issue effectively, since it would impinge upon other transactions and parts of the financial sector that are not seen to be problematic. Again, much depends upon the specific details of the Commission's proposal, which we explore in detail in Chapter 3.

39.  We note that the Commission itself has brought forward proposals to improve regulation of these markets, for instance through the current Markets in Financial Instruments Directive (MiFID) and the Market Abuse Regulation (MAR) proposals. Whatever the merits or otherwise of these specific proposals, it is our view that focussed regulation is likely to be a more effective means by which to tackle undesirable market behaviour arising from the use of such transactions.

d) To create a new revenue stream

40.  The Commission's fourth objective is to create "a new revenue stream with the objective to gradually displace national contributions to the EU budget, leaving a lesser burden on national treasuries".[57] Commissioner Šemeta told us that, alongside the desire to secure a financial contribution from the financial sector, this was one of the Commission's main priorities.[58] In light of our current inquiry on the Multiannual Financial Framework 2014-2020, we stated in our Call for Evidence that this inquiry would not consider the debate as to whether an FTT could form a possible revenue stream for the EU budget. Notwithstanding this, we note that a number of witnesses expressed concerns about the Commission's objective.

41.  John Vella, Clemens Fuest and Tim Schmidt-Eisenlohr argued that it is not clear why the EU should be funded by the financial sector to a larger extent than by other sectors of the economy.[59] Likewise ISDA argued that it would be imprudent for the EU's budget to become dependent upon one sector of the economy.[60]

42.  We also note that those who supported an FTT tended to stress alternative uses of revenue. Arlene McCarthy MEP, the TUC and Unite advocated the potential use of the revenues to address such challenges as development and climate change, poverty at home and abroad, and public sector deficits.[61] Stamp Out Poverty argued that the majority of revenue should be used to protect public services, meet international aid commitments and promote climate change initiatives, rather than financing the deficits of EU Member States. In their view, "one set of banks should not be taxed in order to bail out another set of banks."[62] Duncan Weldon was conscious that "the European Commission may not be entirely in agreement with us about exactly what should be done with the money that is spent. In fact, I am not entirely certain the European Commission is in tune with anybody about how the money should be spent".[63] David Hillman, Director, Stamp Out Poverty, pointed out that even the most vociferous national proponents of a tax, Germany and France, rejected the Commission's proposal to use an FTT as an own resource for the EU budget.[64]

43.  The Financial Secretary to the Treasury told us that the Government had made clear in their negotiating position on the budget that they are opposed to an increase in the EU's own resources, and that they therefore opposed using FTT to fund the EU budget.[65] Noting the other proposals for use of revenue that had been put forward, he stressed the Government's view that, in general, hypothecation of revenues limits the scope of government to demonstrate flexibility in using the public finances to support priorities and economic needs at any given time.[66]

44.  The question of the EU budget, and whether an FTT could form a potential revenue stream for it, lies outside the scope of this inquiry. Notwithstanding this, we note the concern with which this objective was viewed by several of our witnesses, including, notably, those who advocated the introduction of an FTT, many of whom have stressed that revenues should be used to tackle such issues as global poverty and climate change. The use to which any revenues from an FTT would be put is evidently a matter of contention amongst its supporters. That the Commission has so far failed to secure support for its objective of using an FTT as a revenue stream for the EU budget suggests that such an objective is unlikely to be met.

e) To pave the way for a global FTT

45.  The Commission's final objective is to make a contribution to "the ongoing international debate on financial sector taxation and in particular to the development of a FTT at global level. In order to best minimise risks, a co-ordinated approach at international level is the best option. The present proposal demonstrates how an effective FTT can be designed and implemented, generating significant revenue. This should pave the way towards a co-ordinated approach with the most relevant international partners."[67]

46.  We explore the questions of the geographical scope of the tax and the threat of relocation in more detail in Chapter 3. Therefore at this point we only consider the likelihood that an EU tax would pave the way for a global FTT.

47.  Commissioner Šemeta pointed to policy issues such as climate change, where the EU had set an example that others later followed. He argued that "somebody has to start in order to reach a global agreement, and I believe that, with the design of the tax which we propose, we can do it."[68] Some witnesses defended the Commission's position. Arlene McCarthy MEP argued that an EU tax would be "a powerful demonstration of the potential of an FTT, and could advance the cause of global agreement".[69]

48.  However, the majority of witnesses who commented felt that this was unrealistic. The Financial Secretary to the Treasury cast doubt on a consensus emerging.[70] John Vella, Clemens Fuest and Tim Schmidt-Eisenlohr asserted that the USA, Australia and Canada had already declared their lack of interest in adopting an FTT, and that, far from encouraging a global tax, the unilateral adoption of an FTT by the EU could act as an incentive for other states not to follow suit and thus to attract financial transactions from the EU.[71] Lloyds perceived "little or no enthusiasm on the part of policymakers outside the EU for the imposition of an FTT".[72] Richard Woolhouse thought that "the chances of this being implemented globally are zero."[73] Commissioner Šemeta conceded that the USA were "rather sceptical" about the idea.[74]

49.  Seeking to set a pioneering precedent in the development of a new policy is often to be commended. Yet given the palpable lack of appetite for the introduction of a tax amongst other nations, most notably the USA, the Commission's argument that an EU-wide FTT will pave the way for the introduction of a global tax appears to us to be wholly unrealistic.

Overall conclusion

50.  The Commission has set out a number of objectives behind its proposal for a Financial Transaction Tax. Yet we are not convinced that the proposed model would meet any of them. It is difficult to see how the Commission proposal can pave the way for a global tax, whilst the case for using an FTT as a new revenue stream for the EU budget is contentious to say the least. Whilst there is a stronger case for asking the financial sector to make a contribution to the costs of the financial crisis, and for seeking to deter certain transactions, in neither case is the Commission's position compelling. Furthermore, whilst we acknowledge the strength of public anger against the financial sector, and the widespread view that those who contributed to the current financial crisis should contribute to its costs, we fear that a Financial Transaction Tax is the wrong way to seek to meet such demands. In our view, the case for introducing a new tax needs to be based on an assessment of its efficiency, simplicity, the ease with which it can be collected and whether it is open to abuse. Much depends on how well the FTT might be designed. In the next chapter we consider the Commission's proposal in detail.


12   Ibid. Back

13   Q 122. Back

14   COM (2011) 594 FINAL, op cit. Back

15   Q 122 and European Commission Directorate-General Taxation and Customs Union. Back

16   Oxford University Centre for Business Taxation. See also Association for Financial Markets in Europe (AFME), and Association of British Insurers (ABI). Back

17   International Swaps and Derivatives Association (ISDA). Back

18   British Bankers' Association (BBA). Back

19   HM Treasury, Explanatory Memorandum on European Legislation: Proposal for a Council Directive on a common system of Financial Transaction Tax and amending Directive 2008/7/EC, EM 14942/11, paras 17, 32-35. Back

20   COM (2011) 594 FINAL, op cit. Back

21   Q 122. Back

22   Q 123. Back

23   European Commission Directorate-General Taxation and Customs Union. Back

24   Sylvie Goulard MEP, European Parliament. Back

25   Stamp Out Poverty. Back

26   Unite the Union. Back

27   Q 2. Back

28   Q 128. Back

29   Q 59. See also, for example, Investment Management Association (IMA) and ABI. Back

30   Ibid. See also AVIVA plc.  Back

31   ABI. Back

32   See for example Confederation of British Industry (CBI) and Lloyds. See paras 27-39 below.  Back

33   ISDA. Back

34   Q 1. Back

35   Mayor of London.  Back

36   QQ 105, 107, 112. Back

37   COM (2011) 594 FINAL, op cit and European Commission Directorate-General Taxation and Customs Union. Back

38   With thanks to http://lexicon.ft.com/Term?term=high_frequency-traders.  Back

39   Q 130. Back

40   Unite the Union. Back

41   Stamp Out Poverty. Back

42   Q 16. Back

43   Q 23. Back

44   Q 94. Back

45   Q 29. Back

46   Q 40. Back

47   Oxford University Centre for Business Taxation. Back

48   Q 64. Back

49   Q 63. Back

50   CBI. Back

51   IEA. Back

52   CBI. Back

53   Q 63. Back

54   CBI. Back

55   Q 37. Back

56   QQ 110, 117. Back

57   COM (2011) 594 FINAL, op cit. Back

58   Q 122. Back

59   Oxford University Centre for Business Taxation. Back

60   ISDA. Back

61   Arlene McCarthy MEP, TUC, Unite the Union.  Back

62   Stamp Out Poverty. Back

63   Q 21. Back

64   Q 30. Back

65   Q 104. Back

66   Mark Hoban MP, Financial Secretary to the Treasury, supplementary written evidence.  Back

67   COM (2011) 594 FINAL, op cit. Back

68   Q 133. Back

69   Arlene McCarthy MEP. Back

70   QQ 98, 103. Back

71   Oxford University Centre for Business Taxation. Back

72   Lloyds. Back

73   Q 9. Back

74   Q 134. Back


 
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