The EU financial transaction tax (EU FTT, aka the “Tobin Tax”)

The EU financial transaction tax (EU FTT, aka the “Tobin Tax”)

The tax that divides Europe. “Any US or Asian institutions trading securities issued in France, Germany, Italy or Spain would also be taxed”.

Aims: Raise new revenues for the EU, thus plugging gaps in national budget deficitsand hit speculative trading.

Which transactions: Most of transactions involving one or more financial institutions will be taxed (shares, depository receipts, bonds, money market instruments, structured products and exchange-traded derivatives are among the hit instruments). In order to prevent circumvention by operating outside the taxable zone, the EU plan adopted the so-called “Residence plus Issuance” solution: the EU-FTT would cover all transactions that involve a single European firm, no matter where they are carried out. That means, for example, that a German stock traded in London or New York would still be taxed. How to enact this principle remains an open question: EU tax authorities cannot levy tax outside their jurisdiction so it is still unclear how they can levy such a tax on London or New York without having the British parliament or the Congress impose a FTT as well. The proposal excludes day-to-day transactions by individuals and non-financial firms, together with the issuance of shares/bonds, trades with several official institutions (i.e. Central Banks), spot currency transactions, units in retail funds known as Ucits and the exchanges of stock in mergers.

Tax rate: Each taxable party will be charged 0.01% of the Notional Value for derivatives and 0.1% of the Market Value for other financial instruments.

Pros: Potential gains at a time when many countries are facing budgetary pressures due to the financial crisis. The tax would contribute to the desired fiscal consolidation without (at least according to those experts supporting the EU-FTT) a direct impact on already compromised real economy. The expectation is for revenues of about €35bn annually, of which two-thirdswould be levied from derivative transactions.Moreover, by discouraging excessive speculation on the markets, the Tobin tax could also promote market stability and long-term investing.

Cons: Critics highlighted a potential reduction in market liquidity and higher price volatility. This could eventually lead to an increase in the cost of capital (risk premia rise according to market volatility) and a fall in total investments. Moreover, it is argued that international investors would find an escamotage to avoid the imposition: taxing financial transaction can harm local markets if the levy is not extended to the whole global market. Look at Sweden’s experience after introducing a FTT in the mid-1980s: the massive displacement of financial transaction led the country to abolish the tax after a few years, a huge failure. In addition to that, it could be difficult to track transaction outside the EU and collecting the tax in countries that do not agree with such imposition. Thus the effective feasibility of the so-called “R plus S” solution must be verified.

Who pays: Financial institutions will be in charge of collecting the tax. According to a survey that CFA Institute Members in Europe carried out in July 2011, most of the burden will eventually be passed on to end investors. Investment vehicles whose strategies imply frequent trading are going to suffer the most.

When: Ceteris paribus, the FTT becomes law in the eleven adopting EU states (Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia) from January 1st 2014. Concerns about the territoriality of the tax, the hit range of transactions and the possibility of exempting some institutions (i.e. pension funds) could delay the implementation. Meanwhile, the US Treasury Department is firmly opposing the EU tax, warning about the effects on U.S. investors.

Italy, a case of early Implementation: In Italy the Tobin Tax has been introduced in March 1st 2013 on both equities and derivatives. The tax rate is 0.12% for stocks traded in Borsa Italiana and 0.22% for those exchanged in OTC-markets. As a result, average daily trading for Italian stocks has almost halved compared to the previous month. Despite the fact that experts believe it is too early to fully understand the implications of this tax and Italian inconclusive elections have definitely played a role in these data, one cannot avoid asking whether a territorial levy would effectively be more harmful than beneficial.