Yves here. On the one hand, this article clears up some popular, and in many cases, lobbyist-propagated misconceptions about a transaction tax. Oddly, it fails to make the most important argument in their favor: that more and more studies are finding that outsized financial sectors are bad for growth, and that secondary market trading (as in buying and selling of financial assets in the market, as opposed to their original sale to raise money for the company and/or its owners) is the most unproductive activity.
Troublingly, this post also makes much of the money-raising potential of a transaction tax, that is not its main purpose. A transaction tax, like a carbon tax, is a Pigovian tax. Its primary purpose is to reduce undesirable activity, like high frequency trading. Generating meaningful revenues is not their main goal, although that may happen too.
Needless to say, these arguments about the desirability of a transactions tax for the bank-heavy UK also apply to the US.
By Avinash Persaud, Emeritus Professor of Gresham College. He is a former senior banker at J. P Morgan, State Street. He has been a member or chair of international commissions of experts on International Financial Reform. Originally published at openDemocracy
The Institute for Fiscal Studies (IFS) has said that the Labour Party will probably raise less than the £8.8bn it predicts by extending the UK Financial Transaction Tax (FTT). The reasons it cites are the same general criticism of FTTs posed by lobbyists.
Labour cites my work in their tax design, a design that reduces the specific risks the IFS cites and makes conservative assumptions on impact and collection. It is fake news that FTTs are hard to do and raise little. Labour’s proposal borrows from the best examples of the 40 countries that already raise £30bn per year from FTTs. They exist in the biggest financial centres like those in the US, Switzerland and Hong Kong, and in the fastest growing markets like India, China and Singapore.
The best FTTs, unlike a 1980s Swedish brokerage tax, are not based on where a transaction takes place. Currently, anyone who switches from trading a UK share in London to Hong Kong, still pays the 0.5% stamp duty on share purchases because their transaction will be legally unenforceable if they do not. No investor wants to save 0.5% of an investment to risk losing the other 99.5% of it. The UK stamp duty on shares has one of the lowest levels of evasion.
Previous governments have allowed the tax-take from the existing FTT to slip by allowing high frequency traders to claim that they are market makers. High frequency traders buy and sell shares when liquidity is already plentiful but when markets are sliding, they use a combination of superior technology and conflicted interests to run ahead of long-term investors and sell more, using up liquidity and making markets fragile and volatile. Labour proposes to end the abuse of the market making exemption.
Where a derivative instrument is issued is easy to shift and so extending the FTT to derivatives needs to be done on the basis of whether the beneficial owner is a UK tax resident. This limits the amount that will be collected but also ensures there will be no relocation of trades out of London. A UK tax resident will not save tax by shifting the trade abroad and foreigners aren’t paying the tax on derivatives so they wont shift their trades either.
British tax residents already pay UK income and capital gains taxes on foreign held shares and this has not caused everyone to leave and live in Zug. And today financial regulation and anti money laundering rules make it hard for financial firms to fudge residency for tax purposes. Jurisdictions where financial institutions do not ask who the beneficial owner is or have not signed up to the mutual sharing of tax information get black listed and excluded from all financial transactions.
The IFS repeats a claim from so-called experts that taxing derivatives is hard to do. But new regulations require almost all derivative transactions to be netted, cleared and settled in a central place. The private clearing houses that do this charge a small fee for every individual derivative they clear. This fee is similar in size to Labour’s proposed tax. The economic impact of a fee that contributes to the bottom line of a private clearing house or a tax that boosts government revenues is the same. These fees have proved easy to collect and have not caused any noticeable reduction or relocation of market turnover. Investors will want to show they have paid the new tax as clearing houses will not accept instruments where potential tax evasion makes the legal enforceability of the transaction in doubt.
Given that VAT is not levied on financial transactions and given the enormous cost of financial regulation and bank bail outs, the financial sector is under-taxed. Labour’s FTT will deliver a fairer contribution. But it will do far more.
It will rebalance the economy towards long-term investing, boosting sustainable growth. FTTs do this because transaction taxes do not fall on all consumers of finance equally, but on those who trade most frequently. Pension funds and insurance companies will pay least and hedge funds and high frequency traders most. Turnover of high frequency trading will drop.
Taking this froth out of the markets will make UK markets more stable and inviting to long-term investors. This tax on churning will have the added advantage of shining a torch on all of the other transaction costs that the industry charges consumers, often via the excessive churning of investment portfolios they manage.
Fast finance has led to a misallocation of investment away from the productive sectors and a secular decline in the rest of Britain. Let us reverse this trend and build a new citadel of long term finance in London.