Doubts cast on Europe-wide financial transaction tax
It’s a seductive idea that just won’t go way: Taxing the massive volumes of financial transactions sloshing around the global economy.
German Chancellor Angela Merkel and French President Nicolas Sarkozy forced the proposal back to the top of the political agenda this week, pitching a Europe-wide tax as a key part of a solution to the continent’s deepening debt crisis.
But will it fly?
Proponents say the tax, which experts estimate could raise as much as €200-billion ($280-billion) a year, would deter speculators, help debt-strapped countries balance their budgets, and pay for the bailouts of Greece, Ireland and Portugal.
And with taxpayers in much of Europe looking for scapegoats, a financial transaction tax would satisfy the growing desire to punish bankers seen as responsible for the crisis.
Not so fast, critics say. Unless all of the world’s major financial centers are in on the scheme, trading activity will simply flee to lower-tax jurisdictions – in North America, Asia or some tiny Pacific Ocean atoll. Even then, traders may simply invent new financial instruments to duck the tax.
And where it is collected, the tax could reduce much-needed liquidity, thereby increasing the kind of volatility policy makers want to avoid, according to numerous academic studies on the subject.
A spokesman for the European Union’s executive body said Wednesday that it will go ahead with a legislative proposal for a financial transaction tax in the fall. And no one doubts the Merkel-Sarkozy proposal has the potential to raise piles of money – if imposed everywhere.
But that’s unlikely to happen, given the lack of consensus, even within the 27-member European Union. Bank of England Governor Mervyn King and European Central Bank president Jean-Claude Trichet are both highly skeptical that a tax on financial dealings would work.
The proposal may be more of a political sideshow than a realistic solution to Europe’s problems, suggested Dan Ciuriak, former deputy chief economist at Foreign Affairs and International Trade Canada, and now a consultant.
“Government must be seen to be dealing with their fiscal problems by taxing the parties that created them,” Mr. Ciuriak explained. “But if it’s theatre, it doesn’t go anywhere. It’s part of the buzz for a while, and then it fails.”
Already, officials in Britain, Sweden and Ireland are expressing doubts the plan would work.
“We can’t have a situation where there is a transaction tax in Dublin and there is no transaction tax in London,” Irish Finance Minister Michael Noonan told Ireland’s state broadcaster Wednesday.
For traders in Europe, the issue is less that the tax is likely to happen – their view is that it’s not – and more, that even floating the idea shows governments don’t understand markets.
The belief is that Mr. Sarkozy is keen on the tax as a way of reducing speculation in financial markets, thereby cutting volatility, but those in markets argue that a tax will reduce trading activity and in fact drive up volatility. They point to the fact that the mere thought of a tax sparked a selloff in some shares as proof that the tax would have the opposite of the intended effect.
There is also a fear that the governments will be distracted by the logistical challenges of instituting a tax, when that time could be better spent dealing with the union’s fiscal issues.
“Europe is in a huge state of flux, the problems are huge, and we’re just tinkering at the edges,” said Rebecca Healey, a London-based senior analyst with TABB Group, a financial markets research firm. “This is sound-bites rather than addressing the elephant in the room.”
Introducing the tax now might also destabilize already weakened European financial institutions. BMO Nesbitt Burns economist Benjamin Reitzes pointed out that European governments would essentially be taxing themselves by taking back some of the bailout cash they spent to rescue bondholders.
The idea of taxing financial transactions has been around since at least the early 1970s when Nobel Prize-winning U.S. economist James Tobin proposed a tax on international currency transactions as a way to discourage speculation.
Both Brazil and Sweden have since tried versions of a financial transaction tax, experiments later abandoned in failure. In Sweden’s case, half the country’s trading activity fled to London, leaving no net tax gain.
U.S. President Barack Obama’s bid to make banks share the burden of cleaning up the mess from the 2008 financial crisis faltered in the U.S. Congress. And efforts to get a nod from the Group of 20 have so far failed.
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