Banks / Debates / Economic Theory

The Fantastically terrific tax – in defence of the FTT

There we are: the discussion has finally made it to Merchinomics – and this is good. It is a miracle that there are no loud choruses of voices which plead for the financial transactions tax. The reason for this is clearly that the problems that will persist without it are not well communicated. I will try my best to change this in the following post, that is to argue in favour of the financial transactions tax or FTT.

Over the past thirty years one could experience that financial innovations, particularly new derivative instruments of all kinds, as well as a permanent increase in the ‘speed’ of financial trading have led to an enormous growth in the transaction volumes. At the same time, exchange rates, stock prices, and commodity prices have undergone wide swings. Policies to alleviate these developments, as for example the FTT, were not considered. John Maynard Keynes had proposed such an instrument for the stock market in 1936 and James Tobin for the exchange market in 1978. The growing instability of financial markets seems to necessitate a change. Another chief motive regarding the taxation of financial transactions are the fiscal gains: considering the huge trade volume, revenues would, even with minimal taxation rate, be substantial.

The main arguments against a general FTT as put forward by the IMF and the EC have already been highlighted by my dear proposition side. Yet, I will just summarise them again: an FTT would increase the costs of capital and would reduce market liquidity, thus hampering the price discovery process. Additionally, the implementation of the tax at a non-global level would result in a substantial relocation of trading activities to non-taxed jurisdictions.

These, apparently empirically proven, arguments are derived from theoretical models which are based on a specific set of assumptions that have become “assumptions as usual” over the past decades like market efficiency, rational expectations and utility maximising behaviour. How ever, a careful exploration and evaluation of expectations formation and trading behaviour in practice reveals that these assumptions do not hold. In particular, expectations are formed predominantly only in a directional manner (“Will an asset price go up or down over the coming seconds or minutes?”) and trading decisions are to a large extent based on “technical analysis”, i.e. in many cases exclusively driven by computer algorithms (e. g. high frequency trading).

These practices generate excessive liquidity, i.e. trading activities which produce persistent price movements over the short run. Over the long run, short-term trends accumulate to long-term trends. The sequence of these trends brings about the phenomenon of “long swings” of asset prices. Hence, the overshooting of stock prices, exchange rates and commodity prices is rather the rule than the exception.

It is shown that a general FTT is much better suited for stabilising asset prices and generating tax revenues as compared to the alternative measures favoured by the IMF and the EC, namely, a bank levy and/or a financial activities tax. A FTT would not completely prevent boom and busts of financial asset prices to happen, however, it would most probably alter the process in which they develop and, similarly, even out the asset prices swings.

The numbers, put forward by the proposition, concerning pension funds are frankly wrong. This is simple propaganda of the financial lobby. The concept of the tax is as follows: those who want to hold their assets are not affected by it, whereas those who trade their assets are. For the German Bundestag concrete numbers were calculated: over the period of twenty years ordinary investors would pay around €60. Normal bank charges are fifty to seventy times higher than this.

The Thirty-Millisecond Advantage. Copyright NY Times

The Thirty-Millisecond Advantage. Copyright NY Times

Equally, the relocation of trading would not happen to the extent that is prophesied. A well-designed tax will not allow trading to be moved overseas. The UK, for example, had an FTT on stocks and bonds for over three hundred years, but London remains one of the worlds top financial centres. A law preventing the seller from transferring the asset to the buyer unless the FTT has been paid could do the job. It would actually bring trading back, instead of driving it offshore. In addition, offshore movement is already the case today. But they still (have to) trade on exchanges in FTT countries and thus have to pay the FTT. Moreover, high-frequency traders cannot move far away from the main trading centres. Their computer servers need to be located as close as possible to the servers of the exchanges in order to minimise the time span between the trading signal generation and the execution of the trade. The so called ‘Thirty-Millisecond Advantage’ is evidence of this.

Yet, if the FTT implementation does not have a broad consensus among all important countries in a trading time zone, the centralised approach, as intended by the EU, would lead to substantial shifts in market shares of financial centres. If Germany, for example, introduced an FTT together with some other member countries but the United Kingdom did not, then many transactions would “migrate” from Frankfurt to London.

However, there is way to implement the tax successfully and without other countries, like America, China or Japan intervening: the decentralised approach. Here all orders of actors from an FTT country are subject to the tax, irrespective at which exchanges – domestic or abroad – these orders are carried out. The tax is deducted by the bank or broker which places the respective order at the exchange. A concrete example: If Germany would introduce an FTT, then only all German residents placing orders for transactions on exchanges – at home or abroad – are liable to pay the FTT. At the same time, all transactions stemming from residents of non-FTT countries at German exchanges would not be taxed. In this way, German exchanges would not be discriminated relative to exchanges abroad as long as those who place the order would not move from an FTT country to a non-FTT country.

Money

The decentralised approach takes into account the different political and institutional conditions among the advanced economies. In a pragmatic way, it would enable a group of EU or euro countries to start with the implementation of an FTT. Based on the experiences of the “forerunner countries”, other countries could then follow in implementing a general FTT.

And this implementation has its benefits. New calculations show a hypothetical revenue of around €100 billion for FTT-11 countries, €311 billion for the whole of Europe (crucial here would be Britain’s company) or €653 billion if implemented on a global scale.

The arguments for a general FTT can not be outweighed by those opposing it, only by the wrong execution of the tax. And with respect to this it seems as side proposition does not disagree, whereas  consequently they do with the motion. My suggestion: come over to us! With the revenues from the FTT, we could buy up the whole five-star tourism in hell – and in heaven, too. Here, there is widespread support for the FTT: the Holy See approves of the tax, and if God wants us to do it you should be in favour of it as well.

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