Financial Transaction Tax: Sand in the Wheels?

The European Commission formally endorsed the financial transaction tax agreed to by eleven of the 27 members.  The tax will be set at 0.1% for stocks and bonds and 0.01% for derivatives.  The tax will go into effect at the start of 2014, by which time the participating countries will give it formal approval. 

There seems to be two purposes of the tax.  The first is to raise revenue.  The EC projects the tax will raise 30-35 bln euros annually where ever and whenever an instrument from eleven is traded.  This would seem to block the ability to avoid the tax by moving transactions out of the eleven countries.  It reinforces the "residence principle".  This essentially means that if some one is a resident of the eleven countries, or acting on behalf of a resident, the transaction will be taxed anywhere it takes place. 

The other purpose is to deter the high frequency trading, which some officials see as largely unnecessary and potentially destabilizing.  Although Keynes advocated a financial transaction tax in 1936, the American economist James Tobin is often blamed credited with the idea.  He argued that wheel of capitalism turn too efficiently.  A small tax specifically on foreign exchange transactions, he argued, would help stabilize the foreign exchange market immediately after the collapse of Bretton Woods. The EC estimates that the tax could lead to a 15% drop in equity trading and a 75% drop in derivative trading.  

Although the UK will not participate in the FTT, the UK has long tax financial transactions.  The stamp tax goes back to late 17th century and reports suggest this is the oldest tax still in existence in the UK.  

There are some exemptions that are noteworthy.  Day-to-day transactions by individuals and non-financial firms will not be taxed.  Primary offerings of stocks and bonds will not be taxed; nor will transactions with official entities, such as central banks and the ESM.    It does appear that repurchase agreements will be covered by the new tax, though apparently in a different way that transactions with outright buyers and sellers. The EC estimates that 85% of the transactions covered by the tax are between financial firms. 

The eleven countries that have expressed interest include:  Germany, France, Italy, Spain, Belgium, Austria, Greece, Portugal, Estonia, Slovenia, and Slovakia.   The one country that is notably absent is the Netherlands.  It typically favors greater integration and harmonization.  Its finance minister (Dijsselbloem) is now the head of the Eurogroup (of euro area finance ministers) and would also want to participate.  

The sticking point for the Dutch is that pension funds come under the purview of the new financial transaction tax.  EU officials counter that the tax could make pension funds safer by encouraging them to buy bonds in the primary market and hold until maturity.   

The US has indicated it will study the proposal, but unofficially does not support the European FTT on grounds that it would harm US investors who bought the securities that will be taxed.  The US itself has a small financial transaction tax on equities.  The tax (Section 31 fee) is used to support the SEC.  It is set at 0.0034% and typically raises some multiple of the SEC's budget.  From 1941-1966, there was a federal tax on stock sales of 0.1% at issuance and 0.4% on transfers.