Having been a professional economist for the last seven years of my career until I retired, I am continually frustrated by the disinformation and dissembling of politicians on matters of economic policy. It is also disturbing that the press coverage and analysis is so poor in the non-specialist press, especially the broadsheets, who should know better. In an attempt to counter this lack of proper information and analysis I am starting an occasional series on this blog to help readers who do not have any specialist knowledge in economics. I will try to keep these relatively short and simple and apologise if topics are not always covered in the depth they deserve.
Today, I want to look at the so-called Robin Hood Tax or Financial Transactions Tax (FTT). In economic circles, this is also known as the Tobin Tax, after the economist who first proposed it. Initially it was proposed as a transaction tax on foreign currency deals to dampen volatility and deter speculation. Later this idea was extended to other financial transactions.
The fact that it has been dubbed the Robin Hood Tax gives it a spurious legitimacy as it implies that it applies to the rich and benefits the poor. At best this is disingenuous and at worst deception. It is also worth bearing in mind the standard “economic” tests for a good tax. It must be fair, easy to collect, difficult to avoid or evade, transparent (i.e. obvious to the payer) and not produce perverse effects. The FTT fails in almost every respect.
- Easy to collect but easy to avoid. Adding a percentage to a financial transaction is not technically difficult but unless every tax jurisdiction in the world adopts a uniform FTT, transactions will migrate to lowest tax or tax free jurisdictions. This is because financial transaction are electronic and can be executed almost anywhere. It is extremely difficult to force transactions to be made in a location. In a sense this makes it difficult to collect as well. The only exception is property transactions, for obvious reasons, which is why property taxes tend to be high in most countries.
- Makes financial regulation more difficult and increases the risks in the financial system. If transactions are driven away from the “home” jurisdiction, then efficient regulation becomes much more difficult. One of the lessons of the financial crisis is that regulation was deficient and uncoordinated. A FTT would probably make it worse and risks would accumulate hidden away from regulators.
- The customer always pays. Proponents always seem to claim that somehow it is the banks that will pay. The sad reality is that it always the customer who pays. The banks will always pass on the costs either explicitly or implicitly. Almost always, this will be hidden from the customer who will be charged a gross price for a product without the underlying costs broken down.
- The goals of deterring speculation and raising revenue are irreconcilable. The more successful a tax is in deterring transactions, the lower the revenue generated.
- A FTT never raises anywhere near the revenues projected. Allied to the previous point, experience suggests that a FTT often raises a small fraction of the hypothetical revenue. The best example is Sweden in 1984, which imposed a FTT and saw bond market volumes decline by 85% within one week. The tax raised 3% of the projected revenues and eventually was abolished.
- Doesn’t deter speculation anyway. For example, stamp duty on property has never prevented property bubbles. There are much better ways of deterring speculation, for example through margin requirements.
- Raises transaction costs and reduces liquidity. A FTT is often pitched at a very small percentage of the face value of a transaction but this is deceptive. It widens the gap between buying and selling an instrument (technically the bid/offer spread). In many cases this spread is tiny so even a small percentage tax has a huge impact on trading costs and negatively impacts liquidity (because it is more expensive to trade). For example on a Eurodollar futures contract of $1m, a 0.02% FTT increases the cost of trading from $13 to over $400. This might not seem much, but it would dramatically decrease trading and liquidity. Before you say that this might be a “good” thing, futures were not a cause of the financial crisis and are a vital ingredient of the commercial world helping producers and manufacturers hedge all kinds of currency and commodity exposures.
- Reducing liquidity raises volatility. Anyone involved in markets knows this. A FTT, which is designed to dampen volatility, is likely to have the reverse effect by lowering liquidity.
- Reduce asset prices by raising the cost of capital. It has the same effect as raising interest rates. Asset prices fall. Who cares? It’s only the rich that suffer. Well, no, actually anyone who has any saving does. If you have a funded pension or a life policy or indeed any savings that are linked to asset prices you will be worse off. Unfortunately the real impact is usually worse on those with modest savings than those with large savings. The wealthy have a sizeable cushion of excess savings in contrast to poorer citizens to whom every penny is important. Raising the cost of capital also deters investment and growth in the economy.
- Reduces growth and raises unemployment. Allied to the above, slower growth usually raises unemployment. On figures produced by the European Commission, the proposed FTT would reduce long-term growth by 1.75% and increase unemployment by just under 500,000 in the EU.
- Favours public sector pensions over private sector pensions. Because private sector pensions are funded and dependent on asset values, any decline due to a FTT would have a detrimental impact on pension values. Public pensions generally are unfunded and so unaffected by asset values, hence public sector workers would be protected at the expense of private sector ones.
That’s quite a long list and I could include some more technical reasons, but you get the idea. It is not surprising that FTT taxes are rare and often repealed. They are ineffective and have perverse effects. It is a reflection of the economic illiteracy of Merkel, Sarkozy and Barroso that they have persisted with this idea long after countries like the US have rejected it. It certainly won’t work unless it is adopted globally and even then has significant drawbacks.
From a purely UK perspective, it is estimated that an EU FTT would raise approximately 80% of its revenues from London. It would wipe out the derivatives market in the UK and cost £25.5bn. Ask yourself whether Merkel or Sarkozy would agree to an additional tax on Mercedes or Citroen cars. Further you might question Sarkozy’s motives when not long ago he was trying to woo HSBC to relocate its HQ to Paris with tax incentives.
Hopefully, you can now exercise a bit of scepticism when you encounter some of the twaddle about a Robin Hood Tax.