The European Commission’s proposed financial transaction tax (FTT), would be imposed in 10 EU countries (including Spain). It is popularly known as the Tobin tax, as it is similar to the one advocated in 1972 by the US economist, James Tobin, although it has a broader scope and serves a different purpose than the original. The FTT aims to levy all financial asset transactions (shares, bonds and derivatives) carried out in the secondary market. It is due to come into force in 2017.

Background

The financial transaction tax takes its name from US economist, James Tobin  (Nobel Laureate in Economic Sciences in 1981) who, in 1972, suggested the idea of establishing a small tax on foreign currency transactions as a way to control exchange rate volatility, put a brake on speculation and stimulate productive investment. His proposal was motivated by then US President Richard Nixon’s decision, one year earlier, to end dollar convertibility to gold and adopt a floating exchange rate system.

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Tobin’s proposal never caught on, and not until more than 20 years later (in the early 2000s) was this concept revived, by anti-globalization movements who considered the free circulation of capital a destabilizing factor in democracy. They even set up a group to demand the introduction of the tax (ATTAC) which, though starting out from Tobin’s original idea, went far beyond it. They proposed using the revenue from the tax for social purposes: as a driver for development; a view that Tobin did not share.

Current situation

The financial crisis of 2008, resulted to a large extent from unsuitable practices by the financial sector and had grave consequences for the economies of many countries. This crisis has provoked a resurgence in the Tobin tax, now redefined as a financial transactions tax (FTT).

The difficult situation caused by the crisis has produced a broad international consensus on the need for the financial sector to internalize the social cost that some excessive or speculative behaviors could have; especially considering the amount of public money pledged in bailouts, in an environment where banks are perceived to be paying low taxes. In this regard, the FTT would create greater equilibrium.

At the same time, the introduction of this tax would also act as a disincentive to the type of high-risk speculative behavior, that, in part, provoked the 2008 crisis.

Finally, a levy of this kind will facilitate the harmonization of the national legislative frameworks and, in this way, reduce the fragmentation of internal markets.

For these reasons, in September 2011, the European Commission suggested a financial transaction tax for all 27 EU members, which was rejected by ECOFIN in July of the following year.

Subsequently, in February 2013, the Commission put forward a new proposal involving 11 EU countries (among them Spain). After four years of negotiations, in December 2015, the same group of countries (with the exception of Estonia) reached a political deal determining the general lines of a financial transactions tax. A final agreement is yet to be reached, but is expected before summer 2016, with introduction of the tax in 2017.

This plan has been directly opposed from the start by the UK, as well as the financial sector, hedge funds and other investors. The G20 also declared itself against the measure.

 What does the Tobin tax involve?

The aim of the FTT is to levy all financial asset transactions (shares, bonds and derivatives) carried out in the secondary market. The tax on sovereign debt activities has been excluded, a line that Spain marked in the sand.

Though the final format is yet to be decided, in the case of shares and bonds, the tax will be levied on all intra-day (securities trading in the same session) and cascade (trades linked to each other) transactions of securities issued by a member country. For derivatives it will involve a combination of the residence principle (if the transaction involves an institution resident in a member country), the issuing country and the counterparty principle (which establishes that a financial entity will be deemed to be established within a territory if they are party in their own name, or that of a third party, to a financial transaction with another entity domiciled in that territory).

The idea is to set low rates and a broad tax base.

Tax rates of around 0.1% for all share and bond transactions, and 0.01% for derivatives have been mentioned.

Tobin Tax: Risks from its introduction

Many market players have come out strongly against the tax. In reality, its imposition brings with it risks that could outweigh the potential benefits.

The most obvious being the following:

-It will distort the competitive equilibrium between EU members, as it provides an incentive for financial transactions to take place outside of those countries which apply the charge; encourage the trading of other exempt products, or even see a move towards shadow banking.

-It will act as a disincentive to buy shares and bonds in the secondary market (thereby reducing liquidity and raising finance costs), and to use derivatives (increasing risk).

-Within an ever stricter regulatory framework, there is a risk of overlap with other initiatives.

-Financial institutions will be the ones responsible for the collection of the tax in the name of the counterparties, which will increase costs and lead to possible conflicts in regulatory compliance.

-It carries with it a risk that the end client who has requested the transaction who ends up paying the tax, through higher brokerage fees.

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Contact: Communications