Viable solution or impossible dream?

The case for and against a financial transaction tax

Welcome and Introductions

Jean SaldanhaPolicy and Advocacy Officer

CIDSE

Anni Podimata MEP

Philip Kermode Director of Direct Taxation, Tax Coordination,

Economic analysis and EvaluationDirectorate General for Taxation and Customs Union

(DG TAXUD)

Dr Neil McCulloch Research Fellow

Institute of Development Studies

Financial Transaction Taxes – a Systematic Review

Neil McCulloch

14 June 2011

Overview1. Why do a Systematic Review of Financial

Transaction Taxes?

2. Do FTTs reduce volatility? Theoretical approaches Evidence from similar taxes

3. Are FTTs feasible? Substitution Migration

4. How much money might a FTT raise?

5. What is the incidence of a FTT?

6. Conclusion

1. The Tobin (or Keynes) Tax?

“…an international uniform tax on all spot conversion of one currency into another, proportional to the size of

the transaction.”

“A Proposal for international monetary reform”, James Tobin, 1978.

“The introduction of a substantial government transfer tax on all

transactions might prove the most serviceable reform

available, with a view to mitigating the predominance of

speculation over enterprises in the United States.”

Keynes, J.M. The General Theory of Employment, Interest, and Money. New York, 1936

A fractious debate

“The Robin Hood Tax is justice. The banks can afford it. The systems are in place to collect it. It won't affect ordinary members of the public, their bank accounts or their savings. It's fair, it's timely, and it's possible”

Robin Hood Tax campaign

“…the Tobin tax is a bad idea, since it would greatly increase both the costs and volatility of foreign exchange dealing and throw a huge spanner into the workings of the global financial economic system.”

Prof. Charles Goodhart, LSE

A Systematic Review Protocol

Search protocol FTTs & Volatility,

feasibility, revenue, incidence

Specified electronic and non-electronic sources

Expert panel Authors who have

written on FTTs

Refining the results Almost 500 papers! Inclusion/Exclusion

criteria Topic, rigour, post 1996

Reduces to ~200 papers

Synthesize the results Draft sent for comment Finalise Review

2. Does a Tobin Tax reduce Volatility?Theoretical models balance two opposing effects of a Tobin Tax:

Reduction in volatility by reducing the number of speculators/ “noise” traders relative to “fundamentals” traders

Increase in volatility due to the reduction in the liquidity of the market as a result of the tax

The Effect of a Tobin Tax on Volatility: Simulation Results

AUTHOR(S) RESULTS

Hanke (2006) Increase or decrease depending on market size

Shi and Xu (2009) Increase or decrease depending on the effect on the number of noise traders

Westerhoff (2003) and Westerhoff and Dieci (2006)

Decrease

Ehrenstein (2002, 2005)

Decrease, as long as the tax rate is not too high to affect the liquidity

Mannaro et al. (2008) Decrease, but only in presence of noise traders in the market

Kaiser et al. (2007) Decrease

Bianconi et al. (2006) Decrease but depending on market size

Volatility and a FTTThe Swedish Experience

January 1, 1984 Introduction of a round-trip tax of 1% of the value of exchanged securities (i.e., taxes of 0.5% on both purchases and sales).

July 1, 1986: The tax was increased to 2% 1991, Removed.

The Stamp Duty in UK The stamp duty is a tax on “change” in ownership which must

be registered in UK.

Its rate changed over time: 1694: introduction August 1963: lowered from 2% to 1% May 1974: increased from 1% to 2% April 1984: lowered from 2% to 1% October 1986: reduced to 0,5%.

Saporta and Kan (1997) compare the performance of the UK stock market before and after the announcement of an increase or decrease of the Stamp duty.

They find no significant effect of UK Stamp duty imposition on volatility of equity prices.

Volatility: Conclusion In theory, a Tobin like tax could reduce volatility –

several theoretical models suggest that it should

However, most empirical studies find a positive relationship between transaction costs and volatility, both in equity and forex markets

However, these studies are heavily focused on intra-day volatility – this may not be the type of volatility that really matters

Certainly no clear evidence that increasing transaction costs via a tax would reduce volatility

3. Is the Tobin Tax feasible?“… a tax could not be practically enforceable given the multiple avenues for avoidance, and the consequently heavy regulatory and implementation costs such a tax would require.” (Ivan Lewis MP, Economic Secretary 2006)

The Tobin tax “could be implemented relatively easily and cheaply, using existing market infrastructure and networks” (Kapoor, 2006)

Country Stocks Corp Bonds Govt Bonds FuturesArgentina 0.60% 0.60% 0.60% 0.60%

Australia 0.3% 0.15% - -Austria 0.15% 0.15% - -Belgium 0.17 0.07% 0.07% -

Brazil 0.3% [0.38%] 0.3% [0.38%] 0.3% [0.38%] -

Chile 18% V 18% V - -

China 0.5% or 0.8% [0.1%] 0 -

Colomia 1.5% 1.5% 1.5% -Denmark [0.5%] [0.5%] - -

Ecuador [0.1%] [1.0%] - -

Finland 1.6% - - -

France 0.15% See note -Germany [0.5%] 0.4% 0.2% -Greece 0.6% 0.6% - -

Guatemala 3% 3% See note

Hong Kong 0.3% + $5 SF [0.1%] [0.1%] -

India 0.5% 0.5% - -Indonesia 0.14% +10%V* 0.03% 0.03% -Ireland 1.0% - - -

Country Stocks Corp Bonds Govt Bonds FuturesItaly [1.12%] - - -Japan [0.1%], [0.3%] [0.08%], [0.16%] - -Malaysia 0.5% 0.5% 0.015% [0.03%] 0.0005%Morocco 0.14% +7% V 7% V 7% V -Netherlands [0.12] [0.12] 0 -Pakistan 0.15% 0.15% - -Peru [0.1%], 0.08% + 18% V [0.1%], 0.08% + 18 V [0.1%], 0.08% -Philippines [0.5%] + 10% V - - -Portugal [0.08%] [0.04%] [0.008%] -Russia 0.08%† - 8% V - - -Singapore 0.05% + 3% V - - -South Korea 0.3% [0.45%] 0.3% [0.45%] - -Sweden [1%] - - -Switzerland 0.15% 0.15% 0.15% -Taiwan 0.3% [0.6%] 0.1% - 0.05%UK 0.5% - - -Venezuela 0.5% [1%] - - -Zimbabwe 0.45%V - - -

Three challenges to implementation

1. At what point in the system to levy the tax?

2. What instruments to tax?

3. How do you avoid migration to untaxed locations?

At what point in the system to levy the tax? There are thousands of dealers and intermediaries across many

countries …but the same is true of retailers in countries who still manage to

charge sales tax/VAT

However one might be able to levy at settlement The Continuous Linked Settlement Bank (CLS Bank) settles 55%

of global foreign exchange transactions (rest through High Value Domestic Settlement systems of individual countries)

More than 60% of all sterling and euro transactions are settled in the CLS system. The majority of the remainder processed through the UK’s CHAPS and the ECB’s TARGET System for their respective currencies.

A single clearing system, SWIFT and its affiliates, is used for all large-value financial transactions, allowing tracking of transactions

What instruments to tax? Foreign exchange spot? Forwards?

Futures? Options? Swaps? All derivatives?

They have dramatically different costs so you would have to tax at different rates (RHT propose

0.005% for forex and for bond and derivative markets; and 0.5% for equity)

Financial markets are extremely innovative!

This imposes a cost on tax authorities keeping up with avoidance

How do you avoid migration to untaxed locations?

Migration risk is real Almost 60% of the trading volume of the 11 most actively

traded Swedish shares migrated to London because of the Swedish tax!)

Long-run effects are larger than short-run effects Shifts in institutional capacity and expertise take time.

But

Avoidance is harder than it used to be New centres have higher settlement risk (HERSTATT

Risk) They must follow Basel III rules and comply with money

laundering regulations which is expensive

Bottom line on ImplementationIdeally

Get everyone in the world to agree! Impose penalties on non-compliant states

In practice “only” need agreement of 6 big players (UK, US,

Euro, Switzerland, Hong Kong, Singapore) In theory could even go it alone.

if you tax immobile resources …and the big players complied then can still raise revenue

“The FTT should not be dismissed on grounds of administrative practicality” (IMF, 2010)

4. How much money will a Tobin Tax raise?It depends on one’s assumptions about:

Tax rate Reductions in trade Avoidance Scope of application

MARKETWorld ($ bn)

UK ($bn)Business

days (average)

TAX RATE

%

Transaction Cost (pre-tax average)

%

FISCAL EVASION

(average) %

ELASTICITY OF

VOLUME (average)

TOTAL ANNUAL

REVENUE World ($ bn )

TOTAL ANNUAL

REVENUEUK

($ bn )

Equity market

456 18 250 0.116 1.163 20 0.58 100 4.0

Derivative 4933 1335 250 0.004 0.039 20 1.5 33 8.9

Forex 2914 1269 250 0.005 0.047 20 0.606 26 11.1

OTC 2544 1094 250 0.076 0.761 20 1.5 336 144.3

Total With OTCTax rate 10% TC

495 168.4

  Without OTCTax rate 10% TC

159 24.1

Revenue % of GDP

With OTCTax rate 10% TC

0.85% 7.71%

Without OTCTax rate 10% TC

0.27% 1.10%

Meta analysis of revenueConstructing revenue estimates by taking median estimates of key parameters

Who pays the bill?

Bid-ask spreads

•Firms needing access to foreign exchange

Returns on

equity

•Pension funds and other long-run investments

Interest rate

s

•Government and corporate bond borrowing

Banks

•Profits of banks and other financial firms?

5. Conclusions The objective of a Tobin Tax is a good one – financial

markets are excessively volatile, so there could be strong gains from greater stability

The evidence that a Tobin Tax would reduce volatility is weak – if anything it might increase it

Implementing a Tobin Tax would be difficult … but certainly not impossible

A Tobin Tax would raise significant revenue

A significant share of the cost would likely be passed to owners of capital … but this is still more progressive than many other forms of tax e.g. VAT

The Systematic Review can be obtained from:http://www.ids.ac.uk/go/idsproject/assessing-the-tobin-tax

http://www.ntd.co.uk/idsbookshop/details.asp?id=1180

Panel discussion: Can we make a FTT work?

Who would end up paying a FTT?Rodney Schmidt, Chief Operating Officer and Director of Research, North-South Institute  Is a FTT feasible?Ian Harrison, Managing Director, Association for Financial Markets in Europe  Should the money be used for development?Michele Maynard, Policy and Advocacy Officer, Pan African Climate Justice Alliance Max Lawson, Head of Development Finance and Public Services, Oxfam GB

Closing Remarks

Jean SaldanhaPolicy & Advocacy Officer

CIDSE