It is incredibly naïve to think that ‘the banks’ are something which can simply be raided for resources with no effect on how they behave or consequences for the wider economy. Nowhere does this ring as true as with the financial transactions tax (FTT) which has been included in the Labour programme and unveiled last Saturday. This tax will inevitably also hit other industries whilst failing to raise anything close to the forecast as its highly mobile tax base relocates.
Labour is proposing an extension of the existing stamp duty on shares levied at 0.5 per cent to bonds and high-frequency trading instruments such as derivatives - essentially tradable products ‘deriving’ its value from an underlying asset such as currency, commodity, equity etc. They are also considering scrapping the ‘intermediaries’ relief’, which is an exemption from the stamp duty reserve tax (stamp duty on shares transferred electronically and not ‘stamped’ by HMRC) for market makers such as investment banks dealing on behalf of clients and not out of their own book, since the former boosts liquidity by providing access to the financial markets.
Labour claims this ‘Robin Hood’ tax – labelled as such due to a belief that it will fall squarely on the profits of rich financiers who owe the people for the 2008 bailout, and is a ‘small contribution…to fund our public services’ – will raise £26 billion over 5 years, or between £4.6 billion and £5.6 billion per year.
Except it will do neither of these things and instead will mostly ‘rob’ from pension funds and other long-term investors such as insurers and corporates issuing debt.
Why? Because unlike banks and hedge funds they are less able to relocate volumes outside a given jurisdiction at short notice – for instance, corporates decide on where to locate based on factors relating to their business model rather than ability to raise debt, and insurers rely on their knowledge of and deep ties to the domestic market. In other words, they are bound to the ‘real economy’. By contrast, according to an estimate prepared by consultancy Oliver Wyman on the 2011 EU FTT proposal, 70-75% of tax-eligible trading volumes would migrate outside the jurisdiction if the legislation was adopted.
So what will be the effect on those unable to move? Evidence from the IFS and the Forsyth Commission shows that stamp duty on shares depresses the price of securities it is levied on, which in the case corporate bonds will mean higher costs of raising capital for all domestic corporations, including SMEs. Result? Slower growth, lower investment and eventually lower wages.
For pension funds and insurers it will mean higher charges and lower returns, hitting all sectors they are exposed to. Less returns on savings, smaller pension pots, decline in economic activity. Bottom line: it is impossible to disentangle the financial sector and the so-called ‘real economy’ in this way.
By contrast, traders are trading their money on their own research – something they can do from anywhere in the world. The gaping hole in Labour’s forecasts is that they assume the tax will have limited effect on the trader’s behaviour, but this is simply not true for highly mobile industries that count every penny in their pursuit of fast returns. Indeed, the original FTT, the EU’s ‘Tobin Tax’, was intended as a behavioural ‘nudge’ to reduce the volatility of the exchange rate. It was never designed to raise revenue because James Tobin thought that losses resulting from hitting this sector will be offset by greater stability of the Euro. But since the shift to floating exchange rates such volatility is no longer an issue since it was precisely the persistent attempts to fix them – for example, in the form of the European Exchange Rate Mechanism – that caused the price to jump unexpectedly.
Evidence from Sweden, Switzerland, Germany and France – countries which experimented with similar measures in the 1990s – suggests the results were a drastically lower trading volume and an exodus of activity to Luxembourg and London, which completely obliterated the intended tax base. Lower volume of transactions meant that not only the FTT failed to raise the forecasted revenue, it also depressed the take from capital gains taxes.
The fact that the EU is once again considering an FTT simply means a failure to learn from previous mistakes and is no good reason for introducing it in the UK. It is far from certain that the final draft of the proposals – due by mid-2017 – will be adopted and indeed there is no reason to think that anything has changed substantially since the last time the proposals were kicked in the long grass.