Tom Clougherty is executive director of the Adam Smith Institute, whose latestreport ‘Hanging London out to dry: The impact of an EU Financial Transaction Tax’is published today.
Legend has it that Nero played the fiddle while Rome burned. It’s rather less poetic, I know, but G20 politicians are doing much the same thing by discussing a Financial Transaction Tax while the eurozone teeters on the edge of collapse.
Yes, Greece is racing towards a disorderly default. Yes, Italy, home to the world’s eighth-largest economy, might be next. And yes, this could all add up to the greatest economic crash since 1929. But no, let’s not do anything sensible about that; let’s just see if we can squeeze a bit more cash out of bankers. This, effectively, is the mindset of Europe’s political leaders.
But even if there weren’t more important things to be thinking about, the Financial Transaction Tax would still be a harebrained idea. Its rationale is as follows: you put a small, proportional tax on share, bond and derivatives trades, and in so doing you discourage short-term transactions in favour of longer-term ones. This reduces speculation and volatility, advocates argue, and raises significant revenue to boot. If only things were so simple.
In reality, there’s a good chance that a Financial Transaction Tax would increase volatility rather than reduce it. Take derivatives as an example – at the moment, exchanges tend to be rapid, high volume and low margin. This means that new real world information is constantly being incoporated into asset prices, which are continually fine-tuned. But a Financial Transaction Tax would make many of these trades uneconomic: traders would save up trades, and only buy and sell in response to large price movements. That means more volatile markets.
Another problem is that a Financial Transaction Tax would hit growth. Indeed, the European Commission admits as much – its impact assessment projects a 4.5 percent long-run drop in capital investment and a 1.76 percent reduction in long-term growth across the EU. This implies a cost to the UK of £26bn over the next two decades. But the actual impact would likely be much, much higher, given the size of Britain’s financial sector and its dominance of the world’s derivatives market. Let’s be clear about what this means: significant job losses both in the UK financial sector and in supporting industries. It’s hardly a recipe for economic recovery.
The icing on the cake is that a Financial Transaction Tax probably wouldn’t even raise much money. EC President Jose Manuel Barroso seems to believe it will bring in €57bn a year (roughly 10 percent of global banking profits) but he’s been living on cloud cuckoo land for some time now. Look what happened when Sweden put a 0.5 percent tax on trading shares back in the 1980s. They expected the tax to raise more than £300m a year, but its average yield turned out to be little more than £10m – a gain almost entirely offset by falling capital gains tax revenues. Put simply, the tax sparked an exodus of financial activity from Sweden. By 1990, trading for more than 50 percent of Swedish equities had moved to London.
Exactly the same thing would happen with an EU-wide Financial Transaction Tax– trading in equities, bonds and derivatives would shift to New York and Asia. And given the importance of the UK financial sector – which, let’s remember, provides about 10 percent of the government’s tax revenues – we would be hit particularly hard.
For all these reasons, it is vital that George Osborne does not give an inch on the Financial Transaction Tax. If, as has been suggested, eurozone members press ahead without us, then so be it. After all, it’s their funeral.