Why the UK Needs a Financial Transaction Tax

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.

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  1. vlade

    The UK already has an securities FTT, called “stamp duty“.

    Cleared derivatives can have FTT attached easily – and, to an extent, cleared derivatives would be the place to put it, as these are where majority of the interbank transactions take place, which is majority of the market.

    There would be an interesting corrolary to that. One reason why there’s a lot of cleared say IR swaps is that banks (and others) rehedge their books on daily basis (because the hedges are dybamic portfolio hedges). Increasing the cost of this (via FTT) would increase the cost of re-hedging, which could lead to overall higher costs and thus less of it.

    That said the corporate users of derivatives are very often highly unsophisticated (technical term is “muppets”). They cannot tell whether a swap that their bank told them they have to have with their loan is fair, or not fair, or whatever, and it’s more and more common that the banks make the money not on the loan, but on the derivative the company has to buy with it.

    In the larger scheme of things though, the company will look at all-in price (that they can see), and a few bps (1bp = 0.01%) tends to make little difference to them.

    That said, I’d still think the better way of dealing with too large banks is to tax their balancesheet/RWA, progressively, and punitively over certain sizes. IIRC there was a certain size of the bank that was optimal, and it was IIRC quite low.

    1. Colonel Smithers

      Thank you and well said, Vlade.

      Persaud is one of the good guys and was hired as an adviser by Adair Turner.

      His proposals are not new and were made a decade ago. Needless to say, New Labour and its Cameroon heir were not interested and short circuited the careers of Turner and Persaud.

      I am typing from the FT’s banking conference. The speakers and attendees still seem to exist in a bubble.

      1. Conrad

        That said the corporate users of derivatives are very often highly unsophisticated (technical term is “muppets”).

        The banks here in New Zealand sold swaps to dairy farmers. It didn’t work out so well.

        1. vlade

          NZ classical example from early 90s IIRC was banks selling the farmers futures, w/o explaining they would have to margin them. Bankrupted a lot of people.

  2. notabanktoadie

    Since only individual citizens have an inherent right to store and USE their Nation’s fiat FOR FREE and then only up to reasonable limits on account size and transaction rate, then non-individual-citizens and individual citizens who exceed those limits may properly be charged for doing so.

    Btw, not only could negative interest on large and non-individual-citizen fiat accounts be used to fund an equal Citizen’s Dividend but a fiat transaction tax could do so as well.

    Of course presently, individual citizens MAY NOT USE* their Nation’s fiat and that must be remedied unless one thinks equal protection under the law should not apply to finance.

    *Except for mere coins and paper CB Notes (e.g. Federal Reserve Notes).

    1. Carla

      I believe there’s no need for a monetary sovereign to “fund” anything from taxes or fees. The sovereign can (and does) simply spend money into existence to achieve its policy goals.

      1. notabanktoadie

        Good point – a monetary sovereign can, of course, create all the fiat it desires.

        However the fiat system is a public good and non-individual-citizens have no inherent right to use it for FREE nor do individual citizens have an unlimited inherent right to use it for FREE.

        Another public good is a Citizen’s Dividend equally to all citizens whose expressed goal would be to counter price deflation in a just manner.

        And just as fees for large and non-individual-citizen use of the fiat system would be collected by the Central Bank, the Central Bank might also distribute the Citizen’s Dividend into inherently risk-free debit/checking accounts for all citizens at Central Bank.

        1. skippy

          After all these years do you ever tire of concoting stuff deductively out of whole cloth …

          What ever happened to your C-corp equities as money workaround …

          See its the same axiomatic ex ante base just rebranded for a new sales pitch … ugh … that would be fine except your proselytizing can unfortunately suck in the ignorant, that I do care about.

      2. notabanktoadie

        Speaking of funding, MMT says taxes don’t fund sovereign spending BUT that they may be used to curb consumption and thus control price inflation.

        However, do the rich consume enough that curbs on their consumption will make a significant difference?

        Hence taxes to curb consumption MUST fall on the non-rich to effectively control price inflation.

        Otoh, de-privileging the banks would increase the demand for fiat at the expense of demand for private bank deposits and thus increase, all other things being equal, the amount of fiat that can be created for the general welfare, including a Citizen’s Dividend, for a given amount of price inflation risk.

        But let’s assume that all other things are NOT equal and that bank deposit creation is less likely to cause price inflation (indeed, bank deposit creation may decrease prices by financing productivity gains) than sovereign spending. Still:

        1) Sovereign spending is for the general welfare, not for the private welfare of the banks and the most so-called “credit worthy”, the rich.

        2) Even 100% private banks with 100% voluntary depositors might safely create SOME deposits.

        3) Even 100% private banks with 100% voluntary depositors could serve as loan brokers between inherently risk-free accounts at the Central Bank.

        So I really can’t see ANY legitimate reasons for not de-privileging the banks in a responsible manner.

  3. AEL

    A somewhat related mechanism to re-balance towards longer term investment would be a small tax on *cancellations* of transaction offers within some human scale time period of making the bid. High speed traders could still take a position very quickly, but it would cost them money to withdraw from that position.

    This would considerably reduce the “churn” of bids and retractions taking place faster than the human eye can perceive.

  4. Matthew G. Saroff

    Credit where credit is due, this tax, originally proposed to reduce currency speculation, is also called a Tobin Tax, named after (not really) Nobel Prize economist James Tobin.

    He determined that enforcement was easy, because any significant trade needs to settle in only 2 or 3 locations, where the tax can be assessed. (The money traders in a Cairo market are not hit, but who cares)

    In the year 2000, “eighty per cent of foreign-exchange trading [took] place in just seven cities. Agreement [to implement the tax] by [just three cities,] London, New York and Tokyo alone, would capture 58 per cent of speculative trading.”

    1. Tim Smyth

      True, but the issue is not per say that money traders Cairo are not hit but for example, Toronto or Sydney will see this as an opportunity to jump into the big leagues and refuse to go along with a tax(because Canadians are jerks at heart)

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