In May 2011 the European Commission published the responses to a consultation paper (PDF) issued in February which asked the European Community to provide its views on the following:
- whether a new tax on the financial sector should be introduced;
- if so, what impact the tax would have; and
- how it should be designed and implemented?
In its paper, the Commission proposed two (potentially complementary) options:
1. A Global Financial Transactions Tax (the “FTT”) to be imposed on all financial services transactions (including on exchange and over-the-counter (OTC) transactions), based on transaction value; and
2. An EU Financial Activities Tax (the “FAT”) on the profits and remuneration of those in the financial sector, aimed primarily at preventing excessive risk taking and remuneration by firms.
The FTT has also been described as the ‘Tobin Tax’, after economist James Tobin who initially coined the concept of a transaction tax in the 1970’s while, as you can imagine, the ‘FAT’ acronym has been gleefully adopted by the UK press, with no need for further explanation.
The reasons stated for the Commission’s proposals include:
- the level of financial support received by the financial sector during and after the economic crisis;
- the possible ‘under-taxation’ of the financial sector as a whole (largely as a result of the existence of certain exemptions, including the exemption from VAT of financial services);
- the need to reduce undesirable behaviour, such as excessive risk taking, using fiscal means (in conjunction with regulation); and
- the need for fiscal consolidation and harmonisation within the EU to deal with, for example, certain Member States imposing their own additional taxes on the financial sector (which, it is worried, will lead to distortions of competition and double or non-taxation).
The responses are now in, and it is clear the consultation has generated considerable interest – not surprising considering the potential impact on most financial industry firms and the strength of feeling of the general public on the issue. Over 200 responses were received from market participants (including 10 fund/asset management firms), investors, consulting firms, national authorities, academics, NGOs and individuals, the views of whom were unsurprisingly polarised.
In common were respondent’s views that a patchwork approach by Member States to financial sector taxation is unhelpful and that improper risk management, improper incentive schemes, de-regulation and lax supervision were most to blame for the financial crisis.
Other than that, we can see the following battle lines being drawn:
1. Financial organisations and their consultancies are strongly opposed to any kind of additional taxation on the financial sector. The main thrust of those on this side of the fence is that;
- the imposition of an EU level financial sector tax would damage the competitiveness of the EU as a financial centre, which would, in turn, result in the relocation of financial activity and job losses. Reference to the FTT imposed by Sweden in the 1980’s which resulted in an exodus of financial trading from the country is referenced in an appropriately dramatic fashion. ISDA describes (by way of example) a financial institution being able to write derivatives (if these were caught by an EU level FTT) more cheaply from branches outside of the EU and, as such, being incentivised to re-locate these operations, rather than passing the cost on to the customer or bearing them itself;
- the financial sector is not under-taxed, either as a result of being exempt from VAT or from anything else. If it were, the current proposals by the Commission to reform the VAT system would better meet the Commission’s objectives than the FTT or FAT;
- neither the FTT nor the FAT will have a positive effect on market volatility and may even increase it;
- further study should be conducted into the effect of the proposals in conjunction with all other taxes, levies and regulations currently in force or under consideration in relation to the sector; and
- the FTT should only be implemented on a truly global level (ideally, wider than the G20) and at extremely low rates (less than 0.01%) which target particularly high volume trading, if at all.
2. Investment management firms and their associations sit as a sub-group within the above camp, arguing in particular that;
- investment managers and their funds do not pose systemic risk, did not receive public sector funding, have a different business model to investment banks (in particular, the level of risk taken is mandated by investors, rather than the manager) and, as such, should be carved out of the FAT. Alternatively, if the Commission is worried that the proprietary trading activities of banks would migrate into the funds sector, the industry argues that at least funds meeting “widely held” or similar criteria and exchange traded funds, should be specifically excluded from new taxes;
- the FTT and FAT could damage investors (including, pensioners and long term savers) who would ultimately bear the cost of the taxes. Clearly, it is anticipated that the cost of the FAT will be added to the asset management fee if levied on the manager, or will result in a direct reduction in investor return if levied on the fund;
- the FTT could distort the proper operation of the asset management industry by encouraging managers to retain assets to reduce costs contrary to good asset management principles;
- investment managers pay the full range of taxes to which other bodies corporate are subject and, as such, are not under-taxed. The fact that the majority of investment funds are based on non-taxed locations continues to be justified by the need to maintain a neutral position between investing in an asset directly and investing through a collective vehicle; and
- the impact of any additional tax would be greater for small and medium enterprises (“SMEs”) , as they will have less sophisticated techniques for accessing financing sources outside of the EU.
3. At the other end of the scale, Citizens, Trade Unions, NGOs and Local Authorities are broadly (and passionately in some cases) in favour of the FTT being levied at a European level, but neutral (many chose not to respond to the FAT option) or opposed to the FAT. The gist of the arguments in favour of the FTT include the following;
- the financial sector operates on a disproportionate scale to the needs of society, with profits being re-invested to create bubbles, resulting in the general public being driven into ever higher levels of debt;
- public intervention to rescue the wayward financial sector has created a strain on public finances which translates into cuts in public jobs, pay reductions and the deterioration of public services in most EU Member States. The recovery of the financial sector without recompense to the public purse would represent the socialisation of losses and the privatisation of profits – a poor basis for a sustainable economy.
- if Member States only focus on expenditure cuts, the risk of a debt spiral in Europe increases. Fiscal harmonisation should focus also on raising revenue;
- the financial sector is currently under-taxed as a result of balance sheet re-structuring, group taxation options, the abolition (in many Member States) of tax on securities transactions (by contrast to tax on transactions in goods and services), the VAT exemption and capital gains and income tax incentives offered to the sector by many Member States;
- the majority of investors/consumers in the financial sector are institutions or high net worth individuals, who can and (presumably, taking the argument to the next logical level) should, bear the cost of the FTT if it is passed on. The cost to pension funds and insurance firms (who turn their portfolios irregularly) of a less than 0.01% transaction tax would be ‘tiny’ and worth the benefit to society of the revenue generated from taxes on speculative trading;
- the IMF has stated that stamp duty type taxes on transactions in securities have not resulted in financial activity being relocated from the UK, Hong Kong or Singapore; these are contrasted with the Swedish FTT which, by comparison, is described as poorly designed;
- the re-allocation of capital to the ‘real economy’ would boost demand for the services of SMEs; and
- the EU should take the lead in implementing what it believes should be implemented globally.
So what’s next?
Which side of the line the Commission will come out on is unclear. While the arguments against any kind of additional tax are technically convincing, the arguments for the tax represent the wider (more political) call for the reigning-in of the financial sector and the re-distribution of profits to those people (and possibly Member States themselves!) at the poorer end of the chain.
What is certain is that the European Commission has included an EU-wide financial transactions tax in its budget proposal for 2014-2020 (published on 29 June) and a legislative proposal of some sort is expected in Autumn this year.
From a UK perspective, the Government has expressed opposition to a European FTT in a recent meeting of the ECOFIN, but has been less clear on its position on a global FTT, should one be proposed at the G20. In contrast, both France and Germany support the FTT, with some smaller Member States prepared to accept the FTT in varying forms. We seem set for some mighty debates ahead…!