Towards a Financial Transactions Tax? - European Union Committee Contents

CHAPTER 5: alternatives to a financial transaction tax

a) A Financial Activities Tax (FAT)

137.  In addition to considering the case for a Financial Transaction Tax, we also asked our witnesses for their view on other potential models of financial sector taxation.

138.  Our witnesses gave particular emphasis to the case for a Financial Activities Tax (FAT). An FAT is essentially a tax on remuneration and profit. The concept has been mooted by the IMF in the context of discussions by the G20,[197] and the European Commission's October 2010 Communication on Taxation in the Financial Sector also considered the case for introducing an FAT, appearing at that stage to favour it over an FTT.[198]

139.  Some of our witnesses were in favour of an FAT. For example, John Vella, Clemens Fuest and Tim Schmidt-Eisenlohr argued that it was preferable to an FTT for three reasons: an FAT would be less easily avoided through relocation; its incidence would be more certain; and it could generate the same amount of revenue at a lower economic cost.[199] According to Peter Sinclair, an FAT represented "the best way of taxing the financial sector". However he added that in the present economic climate, its introduction at anything but a very low rate would be most ill-advised.[200]

140.  Nigel Fleming conceded that an FAT had some benefits in comparison to an FTT, since it could be less easily passed on to end consumers, and it applied to the balance sheets of financial institutions rather than to transactions that they conduct for their customers. He also suggested that the most preferable option would be a tax on banks' short-term funding.[201] Peter Sime, Head of Research, ISDA, agreed that "the FTT would be indiscriminate, whereas with an FAT you are looking more at the bank's specific balance sheet and earnings".[202]

141.  Other witnesses were less enthusiastic about the introduction of an FAT. The BBA argued that an FAT would impede growth and constrain lending. They noted that such a tax would run counter to regulatory efforts to boost the strength of the financial system via increased capital and liquidity, and claimed that it would result in increased costs to consumers because, while it could not be passed on directly like an FTT, it would be factored in to higher pricing models.[203]

142.  Sony Kapoor argued that the FTT, FAT and bank levies all have their advantages, but that bank levies and financial transaction taxes may be complementary to each other. Whilst bank levies fall mostly on regulated financial institutions on the balance sheets of banks, with financial transaction taxes the primary point of incidence would arise in the shadow banking system.[204]

143.  The TUC did not consider FATs and FTTs to be mutually contradictory. However, they preferred to see a tax covering wholesale foreign exchange transactions, securities and derivatives since an FAT would tax all financial institutions' activities, regardless of whether they had a beneficial or detrimental effect on the economy. In their view, FTTs would provide a more effective disincentive to undesirable financial activity, and would raise more resources for global public goods.[205]

144.  Commissioner Šemeta told us that whilst the Commission concluded that both an FTT and FAT were feasible, the tax rate for an FAT would need to be about 10% to match the revenue-raising potential of an FTT. He also argued that an FTT would more effectively target high-frequency trading.[206]

145.  Several witnesses strongly advocated the introduction of a Financial Activities Tax (FAT). Whilst we note that this model may hold certain advantages in comparison to a Financial Transaction Tax, notably making it more difficult for financial institutions to pass on the tax burden, it may also hold drawbacks, for instance in taxing all financial institutions' activities regardless of how beneficial they are. Whilst there may be a case for further exploration of the case for an FAT, in the current economic climate there is a need for caution before introducing any new taxation of the financial sector that might impair economic growth.

b) The UK Stamp Duty model

146.  The UK Stamp Duty is a tax on share transactions in UK incorporated companies.[207] In 1974, the UK introduced a Stamp Duty Reserve Tax (SDRT) of 2%. Its rate was reduced in 1984 to 1% and then again in 1986 to the current level of 0.5%. The Commission's proposal states that it would forbid Member States from maintaining existing national transaction taxes, which would presumably include the UK Stamp Duty.

147.  The UK Stamp Duty was widely discussed during the course of the inquiry. Several witnesses (including the Financial Secretary to the Treasury) argued that the UK's Stamp Duty was not a useful comparison in seeking to determine the probable effects of an FTT on the EU market.[208] Witnesses also stressed the superiority of the Stamp Duty model over the FTT proposal. The BBA told us that the Stamp Duty is levied on market participants, but not on financial intermediaries, regardless of where the buyer and seller are located, at a rate of 0.5% of the value of purchases of UK listed companies. By contrast, the FTT has a broader scope[209] and is levied on all intermediaries except the central counterparty, resulting in a cascade effect, making the effective rate of the FTT much higher than the headline rate of 0.1%. Because the Stamp Duty applies to UK shares regardless of where the buyer and seller are located, there is no incentive for the financial sector to move elsewhere. The proposed FTT, however, applies wherever a party is located in the EU, thereby encouraging relocation.[210]

148.  Peter Sime told us that the UK Stamp Duty was "something people are happy to live with", and as it applies to everything listed in the UK, there was a "known population of which you capture 100%, and where the players are and where the trade takes place is irrelevant."[211]

149.  During the course of the inquiry, there was considerable discussion as to whether the UK Stamp Duty could be a model for an EU tax on the financial sector. This question became particularly topical in January 2012 when President Sarkozy announced his intention to introduce a French tax on the trading of shares, a proposal which closely resembled the UK Stamp Duty model, but which would be set at a lower rate of 0.1%. There were suggestions that other Member States were sympathetic to such a model. Philipp Rösler, German Economy Minister, was reported to have said that "if the British aren't willing to get closer to the European model of a financial transaction tax, it would make sense to talk with the British and other European states about the British model."[212] The German Finance Minister, Wolfgang Schäuble, was also reported to have mooted the possibility of a stamp duty that would include derivatives, after it became clear from a meeting of EU finance ministers in March 2012 that consensus around the Commission's proposal remained a long way off. The Danish Finance Minister, Margrethe Vestager, said that officials would now draw up "alternatives" to the Commission's original proposal.[213]

150.  Several witnesses argued that the UK Stamp Duty structure could indeed provide a good framework on which to develop an effective tax. David Hillman argued that the Stamp Duty was a good example of a financial transaction tax since anyone trading on the London Stock Exchange, regardless of where they are in the world geographically, has to pay the tax. Richard Gower added that "for those interested in buying a share for the long-term benefits ... the impact of quite a high-rate FTT on that sort of investment is not particularly large. The London Stock Exchange is one of the most successful exchanges in the world at attracting new listings despite the fact that there is a 0.5% ... FTT applied that raises £3 billion a year for the Exchequer."[214]

151.  Sony Kapoor argued that the UK Stamp Duty was a "much fairer model" than the proposed FTT. He argued that it was "less politically controversial" since each country would tax something that belongs to it or at least originated in it and is related to the real economy within that country. He also argued that the UK Stamp Duty created a "first mover advantage".[215] He argued that 60% or more of UK Stamp Duty revenue comes from non-UK tax payers. In Mr Kapoor's view, HM Treasury were opposed to other countries implementing this because the UK would lose its relative advantage. By contrast, the Commission's residence-based principle led to a first mover disadvantage.[216]

152.  At the same time, some witnesses brought to our attention the unintended consequences that had followed the introduction of the Stamp Duty in the UK. BlackRock told us that it had resulted in "a shift from cash equity investment to investing in equity derivatives which are not subject to the stamp duty. It also causes a performance drag, especially for lower velocity, derivatives-adverse investors ... Contracts for Difference (CFD)[217] investors obtain the economic rights, but not the legal privileges that come from direct ownership of shares themselves, nor do such investors have a say in corporate governance". In their view, Stamp Duty inflates bank's balance sheets, levers the system, hides the true ownership of companies thus diminishing shareholder engagement, obliges investors to favour derivatives over shares, and gives banks revenues based on the market makers exemption.[218] They argued that, were an FTT to similarly exempt market makers, this would point an FTT away from the very institutions that the European Union is actually seeking to target and thus fail the European Union's own test of making those responsible pay.[219]

153.  Furthermore, IMA observed that a great deal of inter-bank trading of equities does not, in fact, result in any SDRT being paid because of a combination of the market maker exemption and the use of SDRT exempt derivatives (in particular, Contracts for Differences) in such trades. They concluded that, as of 2005, more than 70% of the total UK stock market volume remained exempt from SDRT. In their view, "SDRT is manifestly not a tax on financial traders or a tax on speculation."[220]

154.  The Financial Secretary to the Treasury told us that "Stamp duty in the UK is a modest transaction tax. It is very carefully defined. Its collection points are very clear. My understanding is that the model suggested by President Sarkozy is something along those lines. One of the members of the German coalition Government has suggested something similar ... If people choose to adopt a stamp duty tax model, that is their prerogative, and I would not stand in the way of member states who wished to do so."[221]

155.  We note the growing interest amongst other Member States in adopting a model of financial sector taxation similar to the UK Stamp Duty. The Commission continues to stress the case, as it sees it, for an FTT, yet given the manifest weakness of the Commission's FTT proposal and the tentative moves being made in other Member States, led by President Sarkozy, it appears that a tax on the Stamp Duty model is more likely to be introduced. If it is accepted that a robust case for the introduction of a new tax on the financial sector can be made, then this proposal may bear further exploration. Yet whether the support for such a measure spreads beyond France to other Member States, whether there is any prospect of an EU-wide basis for such a tax, what the base and rate of the tax would be, and what the potential impact of such developments would be on the UK and its own Stamp Duty regime, remain uncertain. In this context we strongly urge the Government to continue their dialogue with EU partners and other Member States as they seek to determine whether the UK Stamp Duty model would be a more appropriate basis for taxation of the financial sector at the EU level.

197   Q 31. Back

198   COM (2010) 549 FINAL, op. cit. Back

199   Q 31 and Oxford University Centre for Business Taxation. Back

200   Peter Sinclair. Back

201   Q 68. Back

202   Q 69. Back

203   BBA. Back

204   Q 87. Back

205   TUC. Back

206   Q 124. Back

207   See 'Stamp Duty on Share Transactions: is there a case for change?', by Mike Hawkins and Julian McCrae, Institute for Fiscal Studies, Back

208   Q 119. Back

209   The BBA state that "FTT applies to financial transactions, which includes the purchase and sale of a financial instrument ([including] shares, bonds and other securities, options, futures, derivatives, units in unit trusts and other funds/collective investment schemes), repos and stock lending, the conclusion or modification of derivatives, and in the case of group transactions only, 'the transfer of the right to dispose of a financial instrument as owner and any equivalent operation implying the transfer of the risk'." See BBA. Back

210   BBA. See also IMA. Back

211   Q 60. Back

212   See 'France pulls punch on financial tax', by Hugh Carnegy, Financial Times, 30 January 2012 and 'Britain will pay Tobin tax anyway, EU warns', op. cit. Back

213   'EU looks at stamp duty to settle tax impasse', by Alex Barker, Financial Times, 14 March 2012, and 'Ministers consider alternatives to financial tax', by Ian Wishart, European Voice, 15 March 2012.  Back

214   Q 32. Back

215   First mover advantage is defined as "the edge that a company gains by entering a particular market before any competitors. This advantage can be gained in many ways, such as having the first chance at accessing resources (and if a particular resource is scarce, another company might not be able to get enough to have a chance at competing), gaining funding from the most-interested individuals, or by developing new technologies which other companies do not have access to. Although being the first-mover has the potential for many advantages, some disadvantages can arise as well, such as the ability of other companies to study and mimic the products and techniques of the first company." See Back

216   QQ 90-1. Back

217   A Contract for Difference (CFD) is essentially a contract between an investor and an investment bank or a spread-betting firm. At the end of the contract, the parties exchange the difference between the opening and closing prices of a specified financial instrument, including shares or commodities. See Back

218   Under this provision "market makers" (defined by the FSA as an entity that, ordinarily as part of their business, deals as principal in equities, options or derivatives (whether OTC or exchange-traded) a) to fulfil orders received from clients, in response to a client's request to trade or to hedge positions arising out of those dealings; and/or b) in a way that ordinarily has the effect of providing liquidity on a regular basis to the market on both bid and offer sides of the market in comparable size. Trading in circumstances other than genuinely for the provision of liquidity is not exempt) are exempt from certain short selling restrictions. See Back

219   BlackRock. Back

220   IMA. Back

221   Q 119. On the other hand the Mayor of London said "Bienvenue à Londres ... if your own President does not want the jobs, the opportunities and the economic growth that you generate, we do." See 'Boris to French bankers: Bienvenue à Londres', by Nicholas Cecil, London Evening Standard, 31 January 2012. Back

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