Tuesday, 2 October 2012

Guest post by Arthur Doohan: The EU's FTT - a good idea badly done

Arthur Doohan: Tax policy in this jurisdiction is a mess and has been so for a long time. This mess has been a significant contributor to the State’s fiscal deficit through the use of ‘pro-cyclical’ transaction taxes and through tax-breaks that exacerbated pre-existing construction dependencies and excesses in the domestic economy.

I welcome TASC’s effort to debate and suggest much needed development in this crucial aspect of fiscal reform, especially in light of the regressive aspects of the last budget.

However, I am very sad to see another transaction tax being proposed and in a manner at odds with the quality of the rest of the analysis. I refer here to the Financial Transaction Tax (FTT) which has the superficial qualities of a betting tax in that it seeks to punish a perceived vice while raising lots of money for the Exchequer and, at the same time, making life harder for everyone’s favourite “scapegoat du jour”, the bankers and hedgefunds.

I am not against an FTT in principal. In fact, I support the idea. But I am against badly designed public policy of any type and the FTT as proposed here falls into that impractical category.

The core of the FTT idea is that low transaction costs and excessive liquidity facilitates speculative trading in markets dominated by financial corporations which leads to price gyrations that hurt the ‘real economy’ while generating ‘excess profits’ for the ‘players’ in these markets. An FTT, it is supposed, would ‘calm’ these markets while at the same time raising money that could better be spent by Government on ‘widows and orphans’. Derivatives trading comes in for especial criticism in this regard as a ‘smoke and mirrors’ ‘work of the devil’ excessive extravagance of markets.

The TASC paper supports the draft EU Commission proposal for a transaction tax on bonds and shares at 0.10% and at 0.01% on derivatives. No mention is made of foreign exchange or commodities trading. The report includes a sentence “The proposal (the EU Commission one) was focused on open market activities and movements (i.e. trading) and excluded inter-bank transfers and trades which might occur in the normal course for business.”

After this prescription several reasons are advanced in the report to support the introduction of the FTT. Firstly, to ‘establish real-time monitoring mechanisms for the various flows of financial transactions happening each and every day’. Secondly, to raise lots of filthy lucre for the Exchequer. Thirdly, to stop speculative trading, the bullying of small nations and profiteering that damages the ‘real and useful’ economy.

I should like to point out, before critiquing this proposal, that the root cause of the OECD economies problems was the repeated and consistent overvaluation of property assets (residential and commercial) and, in Ireland’s case, the attendant excess supply of same over the decade after the repeal of the Glass-Steagall Act. What systemic failures there were happened in the areas of securities ratings and poor legal administration; neither of which are remedied by an FTT. I am in favour of massive reform of how we do banking but, again, I would rather we have effective and productive reform than mere public whippings of various “Aunt Sally’s”.

On a first point, the rates suggested, while seemingly trivial, are in fact massive proportions of the current quoted prices. It is not made clear whether these rates are the total or the individual counterparty rates but it is clear that both sides to any trade are to be taxed. Even if it is the total due, where derivatives are quoted in spreads of 4 or 5 basis points (0.01% is a basis point), then a tax rate of 1 basis point is a rate of 20 or 25%. Where bonds are quoted in spreads of less than 25 basis points this is a 40% tax rate. Further, if derivatives are the real ‘bogeyman’, why are they being charged the lesser rate?

There is no explanation of why foreign exchange trading is excluded which is most odd since, despite our obsession with the evolution and fate of the ‘Euro’, the EU is still a multi-currency construct. Nor is there a rationale given for the exclusion of commodities which means that fuel oils and foods are not covered yet these are indeed major components of the ‘real’ economy.

Excluding trades ‘which occur in the normal course of business’ is meaningless and would provide a get-out clause for all and any trades since these are all transacted out using the same processes and settlements.

A further major omission is that there is no mechanism suggested where transactions by non-financial corporations for practical hedging purposes of the financial risks of the ‘real economy’ can be excluded from the tax net. So the FTT as proposed will fall equally heavily on those with genuine need but less financial expertise.

The suggestion that the authorities are not aware of market prices and flows is fatuous in the extreme. The Central Bank is a Bank and has its own dealing room and it participates daily in a small but distinct manner in the principal markets. In addition, there is a large and comprehensive reporting mechanism for most forms of transactions. Lastly, the ‘need for real-time monitoring’ argument is further revealed as nonsense in light of the fact that ALL derivatives settle at some significant date point after they are entered into so the need for 'realtime' data is superfluous.

With respect to the notion that the yield would be significant several points arise. This forecast makes the same error that the DoF was excoriated for over its dreadful VAT return forecast of the last budget. It is undeniable that anyone one who accepts the existence of 'elasticities' must accept that there will be a reduction in trading volume, especially as suppression of volatility is a prime aim of the tax. There is no assessment of the likely volume impact provided here or referenced. It is also suggested that the FTT tax would come out of profits and not be passed on to consumers. I am not aware of a single instance where tax burdens are not passed on to consumers and no mechanism is suggested that could ensure this result.

In the case of profiteering and speculating at the expense of small nations, it is in the nature of human beings to describe profitable trades as ‘investments arising from one’s own insight and inspiration’ and to attribute loss making trades to the ‘speculative actions of others’. Every transaction requires a buyer and a seller and as such implies someone who believes an argument/opinion and one who disagrees. Shorting of bonds or shares is not a unilateral action. Further, where 'short selling' has been banned it normally creates more sellers unsettled by the change in rules and the whiff of panic and, consequently, usually worsens the situation.

In capital owning democracies, people are entitled to decide whether they believe a governments policies are credible/effective and to vote with their assets if they disagree. Manipulating market rules to suit Govt. preferences is a form of censorship and suffers from all of the hypocrisy and ineffectiveness that goes with censorship.

I note also that the report indulges in discussing “the best place to use the additional resources an FTT would generate." This section smacks of counting chickens before they are hatched. More importantly, hypothecation of tax receipts is generally regarded as poor practice for a whole host of reasons .

Lastly, I would like to point out the complete absence of complaint or comment by the banks themselves on this topic.

Partly, of course, it is because they know that any such pleading on their part would likely harden hearts and prejudices against them. The real reason is because it will cost them practically nothing to circumvent the tax. The FTT makes explicit the intention to tax trades in their ‘domicile’. So, in exactly the same way as every trade executed on Wall Street is booked through entities in the Grand Cayman Islands, every trade in Dublin, London, Paris and Berlin will be routed through entities in Gibralter, Jersey or Malta the day after the legislation is passed and, consequently, hardly any ‘transaction tax’ will be collected. And this will happen without moving a single trader or company. The EU proposes to tax on the basis of residence but if the US authorities have not managed to shut down the Cayman loophole, I do not see how the EU with its vastly more complex legal hinterland will be able to do the equvalent.

This FTT proposal is long on wishful thinking, short on concrete details and absent a working knowledge of the operation of the market and its systems. Proponents of it need to "up their game" somewhat in order to have it gain serious consideration.


Robert Sweeney said...

'I would like to point to the complete absence o complaint or comment by the banks'. This is false. Financial institutions have been lobbying vigorously to prevent this from being implemented. http://corporateeurope.org/sites/default/files/publications/Killing_Robin_Hood.pdf
Re: 'in exactly the same way as every trade executed on Wall Street is booked through entities in the Grand Cayman Islands, every trade in Dublin, London, Paris and Berlin will be routed through entities in Gibralter, Jersey or Malta the day after the legislation is passed'. Is there any evidence of this? Ireland taxes equity trades at 1% while the UK does so at 0.5%. Given the rate in Ireland is double the rate in the UK, why has every trade previously booked in the UK been routed through Ireland?

Robert Sweeney said...

Correction: why has every trade previously booked in the UK been NOT routed through Ireland?

Robert Sweeney said...

Correction: why has every trade previously booked in the UK NOT been routed through Ireland?

artied said...

Hi Robert...and thanks for commenting.

The banks have engaged in private lobbying, they have not participated in any public debate.

The banks have stated publicly that there will be business flight should an FTT be introduced (and, no, making declarations is not the same as engaging in debate, in my opinion, anyway). The evidence of what happened in the US, prompted by tax and regulation, is a good parallel, I believe.

Lastly, while I am not an equity market expert it was my understanding that shares have to be traded on the exchange where they are listed. The paucity of new listings and low volumes traded on the ISE might suggest that it is seen as poor place to trade for many reasons including the tax rate.

Robert Sweeney said...

Hi Arthur,
It's difficult to find a single example of a policy impinging on profits which hasn't been objected to with business claims that it would destroy employment, innovation, and so on. Claims of business flight therefore need to be taken with more than a pinch of salt.

I wasn't suggesting that shares can be traded on exchanges in which they are not listed. I was merely pointing out that capital flight - which I believe you were warning against - has not taken place, despite the sizable differential.

Last time I checked, Irish (and UK) stock market capitalisation as a % of GDP was well above, for instance, the German (and EU) average, which removed its equity tax in 1991. (See my article: http://www.irishleftreview.org/2012/07/10/ireland-financial-transactions-tax/). The ISE seems to be doing well, despite its relatively large tax.

artied said...

Hi Robert

I'm not warning against 'capital flight'.

I'm saying that the FTT as envisioned will not bring in lot's of money and it is not likely to prevent the kind of market exaggerations that are the real underlying cause of our economic problems.

Again, stock markets are not the focus of the FTT and the very different norms of company corporate structure of Ireland and Germany do not do much to elucidiate the FTT debate.

Lastly, now that bring that up, would you rather have the German Mittelstand or the Irish Banksters as the dominant force in this economy??

Robert Sweeney said...

Hi Arthur,
I appreciate capital flight is not the core of your argument but your contention "in exactly the same way as every trade executed on Wall Street is booked through entities in the Grand Cayman Islands, every trade in Dublin, London, Paris and Berlin will be routed through entities in Gibralter, Jersey or Malta the day after the legislation is passed and, consequently, hardly any ‘transaction tax’ will be collected." seems to me to be highly questionable. I hate to refer to my linked article again, but as shown, Switzerland, which like Ireland and the regions you mentioned, is an offshore financial centre. It has a tax on equities of 0.15% (I refer to equities because they are the securities which are most widely taxed across countries and so serve as an example). As far as I'm aware, this hasn't resulted all trades in equities executed in Dublin or London being booked in Switzerland. So the idea that the tax will collect little revenue seems speculative, so to say.

Re Germany: I would say its bank-based financial system with its (historically at least) relatively long time horizons regarding investment is preferable to the short-termism associated with the shareholder value based Anglo-Saxon systems of finance. But that's a discussion for another day.