Financial transaction tax

Overview

A financial transaction tax (FTT) is a levy on a specific type of financial transaction for a particular purpose. The tax has been most commonly associated with the financial sector for transactions involving intangible property rather than real property. It is not usually considered to include consumption taxes paid by consumers. A transaction tax is levied on specific transactions designated as taxable rather than on any other attributes of financial institutions. If an institution is never a party to a taxable transaction, then no transaction tax will be levied from it. If an institution carries out one such transaction, then it will be levied the tax for the one transaction. This tax is narrower in scope than a financial activities tax (FAT), and is not directly an industry or sector tax like a Financial stability contribution (FSC), or "bank tax", for example. These distinctions are important in discussions about the utility of financial transaction tax as a tool to selectively discourage excessive speculation without discouraging any other activity (as John Maynard Keynes originally envisioned it in 1936). There are several types of financial transaction taxes. Each has its own purpose. Some have been implemented, while some are only proposals. Concepts are found in various organizations and regions around the world. Some are domestic and meant to be used within one nation; whereas some are multinational. In 2011 there were 40 countries that made use of FTT, together raising $38 billion (€29bn).

History

The year 1694 saw an early implementation of a financial transaction tax in the form of a stamp duty at the London Stock Exchange. The tax was payable by the buyer of shares for the official stamp on the legal document needed to formalize the purchase. As of 2011, it is the oldest tax still in existence in Great Britain. In 1893, the Japanese government introduced the exchange tax, which continued until 1999. In 1893, the tax rates were 0.06% for securities and commodities and 0.03% for bonds. The United States instituted a transfer tax on all sales or transfers of stock in The Revenue Act of 1914 (Act of 22 October 1914 (ch. 331, 38 Stat. 745)). Instead of a fixed tax amount per transaction, the tax was in the amount of 0.2% of the transaction value (20 basis points, bips). This was doubled to 0.4% (40 bips) in 1932, in the context of the Great Depression, then eliminated in 1966. In 1936, in the wake of the Great Depression, John Maynard Keynes advocated the wider use of financial transaction taxes. He proposed the levying of a small transaction tax on dealings on Wall Street, in the United States, where he argued excessive speculation by uninformed financial traders increased volatility (see Keynes financial transaction tax below). In 1972 the Bretton Woods system for stabilizing currencies effectively came to an end. In that context, James Tobin, influenced by the work of Keynes, suggested his more specific currency transaction tax for stabilizing currencies on a larger global scale. In 1989, at the Buenos Aires meetings of the International Institute of Public Finance, University of Wisconsin-Madison Professor of Economics Edgar L. Feige proposed extending the tax reform ideas of John Maynard Keynes, James Tobin and Lawrence Summers, to their logical conclusion, namely to tax all transactions. Feige's Automated Payment Transaction tax (APT tax) proposed taxing the broadest possible tax base at the lowest possible tax rate. Since financial transactions account for the greatest component of the APT tax base, and since all financial transactions are taxed, the proposal eliminates substitution possibilities for evasion and avoidance. The goal of the APT tax is to significantly improve economic efficiency, enhance stability in financial markets, and reduce to a minimum the costs of tax administration (assessment, collection, and compliance costs). The Automated Payment Transaction tax proposal was presented to the President's Advisory Panel on Federal Tax Reform in 2005. As the EU, European free trade, and Euro came together, various financial transaction taxes were considered openly. One non-tax regulatory equivalent of Tobin's narrow tax, to require "non-interest bearing deposit requirements on all open foreign exchange positions", was considered in particular but rejected. During the 1980s the Chicago School view became dominant, that speculation served a vital purpose in keeping currencies accurately reflecting the prospects of their economies, and that even very short term transactions in response to news could in fact reflect fundamental analysis. Economic literature of the period the 1990s–2000s emphasized that derivatives and other variations in the terms of payment in trade-related transactions (so-called "swaps" for instance) provided a ready means of evading any tax other than the Automated Payment Transaction tax since it uniformly taxed all transactions. Other measures and exemptions from such transaction taxes, to avoid punishing hedging (a form of insurance for cashflows) were also proposed. These tended to lead to generally more complex schemes that were not implemented, in part due to lack of standardization of risk reporting under the Basel I framework, which was itself a response to the 1980s financial speculation crises. However, disclosure had not kept pace with practices. Regulators and policy-makers and theorists by the 1990s had to deal with increasingly complex financial engineering and the "avoidance by a change of product mix... market participants would have an incentive to substitute out of financial instruments subject to the tax and into instruments not subject to it. In this fashion, markets would innovate to avoid the tax" as they were doing with the creation of financial derivatives. "The real issue is how to design a tax that takes account of all the methods and margins of substitution that investors have for changing their patterns of activity to avoid the tax. [as] suggested by Pollin et al. (1999)." – Palley, 2000 The global adoption of a small flat rate Automated Payment Transaction tax whose base included all transactions would eliminate evasion and avoidance possibilities since the tax would apply equally at all substitution margins. Advocates including Pollin, Palley, and Baker (2000) emphasized that transaction taxes "have clearly not prevented the efficient functioning of" financial markets in the 20th century. Many theorists raised the issue that hedging and speculation were more of a spectrum than a distinct duality of goals. "Academic studies (e.g. Bodnar et al, 1998) show that companies usually incorporate predictions of future price levels (i.e. a 'view') when executing hedges (a fact which will come as no surprise to most risk management practitioners). If hedging is really just about reducing risk, then why should our expectations of future market direction have any bearing on our hedging decisions? If we hedge 50% of our exposure, instead of 80% or 100%, because we feel that the price/rate of the underlying exposure is more likely to move in our favor, does this meet the criteria for speculation?... On one level (at the extremes), there is no doubt that hedging and speculation are very different activities. However, once you move beyond the straightforward elimination of open positions, into more nuanced transactions involving complex hedging strategies or tenuous relationships between hedges and exposures, the distinction between a hedge and a bet becomes increasingly vague." To avoid this problem, most proposals emphasized taxing clearly speculative high-volume very-short-term (seconds to hours) transactions that could not in general reflect any change of fundamental exposure or cashflow expectation. Some of these emphasized the automated nature of the trade. FTT proposals often emerge in response to specific crises. For example, the December 1994 Mexican peso crisis reduced confidence in its currency. In that context, Paul Bernd Spahn re-examined the Tobin tax, opposed its original form, and instead proposed his own version in 1995. In the context of the 2008 financial crisis, many economists, governments, and organizations around the world re-examined or were asked to re-examine, the concept of a financial transaction tax, or its various forms. As a result, various new forms of financial transaction taxes were proposed, such as the EU financial transaction tax. The outcry after this crisis had major political, legal, and economic fallout. By the 2010s the Basel II and Basel III frameworks required reporting that would help to differentiate investing from speculation. Economic thought was tending to reject the belief that they could not be differentiated, or (as the "Chicago School" had held) should not be. However, even Basel III did not require detailed enough disclosure of risk to enable a clear differentiation of hedging vs. speculation. As another example of an FTT proposal as a warning to speculators, or a response to the crisis, in March 2016 China drafted rules to impose a genuine currency transaction tax and this was referred to in the financial press as a Tobin tax [1]. This was widely viewed as a warning to curb shorting of its currency the yuan. It was however expected to keep this tax at 0% initially, calculating potential revenue from different rate schemes and exemptions, and no

t to impose the actual tax unless speculation increased. Also in 2016 US Democratic Party presidential nominee Hillary Clinton asserted that speculation had "placed stress on our markets, created instability, and enabled unfair and abusive trading strategies" and that as President she would seek to "impose a tax on harmful high-frequency trading and reform rules to make our stock markets fairer, more open, and transparent.". However, the term "high-frequency" implied that only a few large volume transaction players engaged in arbitrage would likely be affected. In this respect, Clinton was following the general 1990s trend to focus on automated transactions, in particular, those which could not reflect any genuine human-reviewed fundamental risk or hedge analysis. She also vowed to "Impose a risk fee on the largest financial institutions. Big banks and financial companies would be required to pay a fee based on their size and their risk of contributing to another crisis." How much fees would be assessed, and whether they amounted to a tax, were an active topic of speculation in the financial community, which expected them to follow Basel III definitions with further refinements.

Purpose

Although every financial transaction tax (FTT) proposal has its own specific intended purpose, some general intended purposes are common to most of them. Below are some of those general commonalities. The intended purpose may or may not be achieved.

Curbing volatility of financial markets

In 1936, when Keynes first proposed a financial transaction tax, he wrote, "Speculators may not harm bubbles on a steady stream of enterprise. But the situation is serious when enterprise becomes the bubble on a whirlpool of speculation." Rescuing enterprise from becoming "the bubble on a whirlpool of speculation" was also an intended purpose of the 1972 Tobin tax and is a common theme in several other types of financial transaction taxes. For the specific type of volatility in specific areas, see each specific type of financial transaction taxes below. An exception to the purpose of "curbing of volatility" is likely the "bank transaction tax".

Curbing speculation without discouraging hedging

The role of large numbers of individual speculators willing to take both short and long positions without prejudice does play some role in preventing price bubbles and asset inflation. However, excess speculation is often deemed not only a source of volatility but a distraction of talent and a dangerous shift of focus for a developed economy. By contrast, hedging is necessary for the stability of enterprises. Tax schemes, in general, seek to tax speculation – seen as akin to gambling – while trying not to interfere with hedging (a form of insurance). The differences summarize that:

hedging protects an existing investment against unforeseen price changes, while speculation takes on the additional risk the investor could have avoided hedging is a means to manage or limit price risk, while speculation actually relies on taking a risk for profit (and is in this respect similar to gambling) hedging protects against price changes and makes them less relevant to the overall price of outputs sold to the public, while speculation incurs risk to make a profit specifically from price volatility hedging is a form of insurance for risk-averse investors, speculation is for those seeking more rapid returns through higher risk It can be difficult to draw a clear distinction between hedging activities and speculation "if the actual exposure cannot be clearly ascertained, then differentiating between a hedging transaction and a speculative trade can become very complicated; if the impact of the underlying exposure is opaque, then the risk-reducing impact of the hedge becomes obscured (if it ever existed)...once you move beyond the straightforward elimination of open positions, into more nuanced transactions involving complex hedging strategies or tenuous relationships between hedges and exposures, the distinction between a hedge and a bet becomes increasingly vague". In general the advocates of financial transaction tax point to Basel III and other treaties and regulations that have increasingly required disclosure to make it easier to ascertain the degree of hedging or speculation in a given transaction or set of transactions. The sheer duration of a holding is the most cogent clue: Day traders all engage in speculation by definition.

More fair and equitable tax collection

Another common theme is the proposed intention to create a system of more fair and equitable tax collection. The Automated Payment Transaction tax (APT tax) taxes the broadest possible tax base, namely all transactions including all real and financial asset transactions. Instead of introducing progressivity through the tax rate structure, the flat rate APT tax introduces progressiveness through the tax base since the highest income and wealth groups undertake a disproportionate share of financial transactions. In the context of the 2008 financial crisis, many economists, governments, and organizations around the world re-examined, or were asked to re-examine, the concept of a financial transaction tax, or its various forms. In response to a request from the G20 nations, the International Monetary Fund (IMF) delivered a report in 2010 titled "A Fair and Substantial Contribution by the Financial Sector" which made reference to a financial transaction tax as one of several options. According to several leading figures, the "fairness" aspect of a financial transaction tax has eclipsed, and/or replaced, "prevention of volatility" as the most important purpose for the tax. Fraser Reilly-King of Halifax Initiative is one such economist. He proposes that an FTT would not have addressed the root causes of the United States housing bubble which, in part, triggered the 2008 financial crisis. Nevertheless, he sees an FTT as important for bringing a more equitable balance to the taxation of all parts of the economy.

Less susceptible to tax evasion than alternatives

According to some economists, a financial transaction tax is less susceptible to tax avoidance and tax evasion than other types of taxes proposed for the financial sector. The Automated Payment Transaction tax (APT tax) employs 21st century technology for automatically assessing and collecting taxes when transactions are settled through the electronic technology of the banking payments system. Joseph Stiglitz, former Senior Vice President and Chief Economist of the World Bank affirmed the "technical feasibility" of the tax. Although Tobin said his tax idea was unfeasible in practice, Stiglitz noted that modern technology meant that was no longer the case and said that the tax is "much more feasible today" than a few decades ago, when Tobin disagreed. Fraser Reilly-King of Halifax Initiative also points out that the key issue and advantage of an FTT is its relatively superior functional ability to prevent tax evasion in the financial sector. Economist Rodney Schmidt, principal researcher of The North-South Institute, also concurred that a financial transaction tax is more technically feasible than the "bank tax" proposed by the IMF in 2010.

Types

Transaction taxes can be raised on the sale of specific financial assets, such as stock, bonds, or futures; they can be applied to currency exchange transactions, or they can be general taxes levied against a mix of different transactions.

Securities transaction tax

John Maynard Keynes was among the first proponents of a securities transaction tax. In 1936 he proposed that a small tax should be levied on dealings on Wall Street, in the United States, where he argued that excessive speculation by uninformed financial traders increased volatility. For Keynes, the key issue was the proportion of 'speculators' in the market, and his concern that, if left unchecked, these types of players would become too dominant. Keynes writes: "The introduction of a substantial Government transfer tax on all transactions might prove the most serviceable reform available, to mitigate the predominance of speculation over enterprise in the United States. (1936:159–60)"

Currency transaction tax

A currency transaction tax is a tax placed on a specific type of currency transaction for a specific purpose. This term has been most commonly associated with the financial sector, as opposed to consumption taxes paid by consumers. The most frequently discussed versions of a currency transaction tax are the Tobin tax, Edgar L. Feige's Automated Payment Transaction tax and Spahn tax. The Automated Payment Transaction tax requires that all transactions be taxed regardless of the means of payment. As such, it proposes a unique tax on currency transactions collected at the time currency leaves or enters the banking system. Since each transaction mediated by currency can not be directly taxed, the APT tax proposes a brokerage fee on currency deposits and withdrawals that is some multiple of the flat transaction tax rate applied to all payments made via electronic payments mechanisms.

Tobin tax In 1972 the economist James Tobin proposed a tax on all spot conversions of one currency into another. The so-called Tobin tax is intended to put a penalty on short-term financial round-trip excursions into another currency. Tobin suggested his currency transaction tax in 1972 in his Janeway Lectures at Princeton, shortly after the Bretton Woods system effectively ended. In 2001, James Tobin looked back at the 1994 Mexican peso crisis, the 1997 Asian financial crisis, and the 1998 Russian financial crisis, and said: "[My proposed] tax [idea] on foreign exchange transactions... dissuades speculators as many investors invest their money in foreign exchange on a very short-term basis. If this money is suddenly withdrawn, countries have to drastically increase interest rates for their currency to still be attractive. But high interest is often disastrous for a national economy, as the nineties' crises in Mexico, South East Asia and Russia have proven...." It is intended to put a penalty on short-term financial round-trip excursions into another currency

Spahn tax Paul Bernd Spahn opposed the original form of a Tobin Tax in a Working Paper International Financial Flows and Transactions Taxes: Survey and Options, concluding "...the original Tobin tax is not viable. First, it is virtually impossible to distinguish between normal liquidity trading and speculative noise trading. If the tax is generally applied at high rates, it will severely impair financial operations and create international liquidity problems, especially if derivatives are taxed as well." However, on 16 June 1995 Spahn suggested that "Most of the difficulties of the Tobin tax could be resolved, possibly with a two-tier rate structure consisting of a low-rate financial transactions tax and an exchange surcharge at prohibitive rates." This new form of tax, the Spahn tax, was later approved by the Belgian Federal Parliament in 2004. It has a two-tier rate structure consisting of a low rate financial transactions tax and an exchange surcharge at prohibitive rates.

Special Drawing Rights On 19 September 2001, retired speculator George Soros put forward a proposal, issuing special drawing rights (SDR) that the rich countries would pledge for providing international assistance and the alleviation of poverty and other objectives. According to Soros this could make a substantial amount of money available almost immediately. In 1997, IMF member governments agreed to a one-time special allocation of SDRs, totaling approximately $27.5 billion. This is slightly less than 0.1% of the global GDP. Members having 71% of the total vote needed for implementation have already ratified the decision. All it needs is the approval of the United States Congress. If the scheme is successfully tested, it could be followed by an annual issue of SDRs and the amounts could be scaled up "so that they could have a meaningful impact on many of our most pressing social issues".

Bank transaction tax

Between 1982 and 2002 Australia charged a bank account debits tax on customer withdrawals from bank accounts with a cheque facility. Some Latin American countries also experimented with taxes levied on bank transactions. Argentina introduced a bank transaction tax in 1984 before it was abolished in 1992. Brazil implemented its temporary "CPMF" in 1993, which lasted until 2007. The broad-based tax levied on all debit (and/or credit) entries on bank accounts proved to be evasion-proof, more efficient, and less costly than orthodox tax models. It often applies to deposits and withdrawals from bank accounts, often including checking accounts.

Automated Payment Transaction Tax

In 1989, Edgar L. Feige proposed the synthesis and extension of the ideas of Keynes and Tobin by proposing a flat-rate tax on all transactions. The total volume of all transactions undertaken in an economy represents the broadest possible tax base and therefore requires the lowest flat tax rate to raise any required amount of revenue. Since financial transactions in stocks, bonds, international currency transactions, and derivatives comprise most of the Automated Payment Transaction (APT) tax base, it is in essence the broadest of financial transaction taxes. Initially proposed as a revenue-neutral replacement for the entire federal tax system of the United States, it could alternatively be considered as a global tax whose revenues could be used by national governments to reduce existing income, corporate and VAT tax rates as well as reducing existing sovereign debt burdens. If adopted by all of the developed nations, it would have the advantage of eliminating all incentives for substitution between financial assets and between financial centers since all transactions would universally be taxed at the identical flat tax rate. The foundations of the APT tax proposal—a small, uniform tax on all economic transactions—involve simplification, base broadening, reductions in marginal tax rates, the elimination of tax and information returns, and the automatic collection of tax revenues at the payment source.