1 June 2013
Financial Transaction Tax: a never ending story?
Policy makers have been living with the idea of taxing the financial sector for many years. But as the idea becomes a reality, enthusiasm makes place for fear for what the impact of such a measure will be on the economy.
When the European Commission first presented its proposal for an EU wide financial transaction tax (FTT) in September 2011, it not only triggered a storm of criticism from the financial industry but also from governments and most notably from EU’s financial heart, the City of London. The industry advocated that a unilateral FTT (imposed by the EU only and not introduced globally) would drain market liquidity, drive trading away from Europe, negatively impact funding possibilities for businesses and governments and ultimately hamper growth of European countries that are already fighting a financial and sovereign debt crisis. The industry stood firm, and was supported by a number of governments who refused to agree with the tax proposal that was driven by France, Germany and the European Commission. During the Economic & Financial Affairs Council meetings (ECOFIN) in June and July 2012 it was ascertained that the required unanimity to adopt the FTT proposal did not exist in the Council.
Determined to make the financial sector pay its equal share for the crisis, eleven Member States decided to proceed. They officially requested the Commission to submit a new proposal that could be adopted on the basis of enhanced cooperation. The eleven countries were Austria, Belgium, France, Estonia, Germany, Greece, Italy, Portugal, Slovenia, Slovakia and Spain. Enhanced cooperation is a procedure that allows a minimum of nine Member States to move ahead with a legislative proposal presented by the European Commission when it proves to be impossible to reach an unanimous agreement with all Member States on it (Article 20 of the TEU and Articles 326 - 334 (TFEU)). The Commission gave a positive assessment, which was backed by the European Parliament in December and agreed by European Finance Ministers at the ECOFIN in January 2013. A new proposal was presented in March 2013.
A new legislative proposal
According to the Commission’s optimistic predictions, the new FTT under enhanced cooperation would generate about €30-35 billion a year. The scope and content very much mirror the initial FTT proposal. It sets out a broad-based FTT, with a levy to be introduced on the purchase and sale of financial instruments, and all derivative transactions. A rate of 0.1% would apply to share and bond trades and a 0.01% rate to derivative transactions. Primary market trades in shares and bonds will be exempted from the scope. The tax would be based on the residence principle in order to decrease the chances of avoiding the FTT by moving to jurisdictions that do not apply it. Additionally, it is worth mentioning that the tax will have a ‘so-called’ cascade affect. The tax will be levied on each party – except for the central counterparty – in a series of linked transactions. This means the actual tax rate will accumulate and can be much higher than the 0.1% or 0.01%.
The latest political developments have been watched anxiously by the industry and the central question remains what the impact of an FTT will be on the industry. Although it is difficult to predict in what direction the negotiations will go, it is clear that due to the broad scope of the current proposal the financial and non-financial industry in both the participating Member States and non-participating Member States will be affected. Firms outside the FTT zone will not be spared as the tax would be levied on all shares and bonds issued in the FTT countries. This means that two non-European firms trading stocks of a European company outside of Europe would each have to pay a tax in Europe. The industry and governments outside the ‘zone’ have been - rightly - concerned about the extra-territorial reach. In April 2013 the UK filed a lawsuit before the European Court of Justice to challenge the FTT proposal which illustrates their concerns but also – to some extent – their incapacity to influence the proposal through the political process. That is worrying for the (financial) industry relying often on the UK to defend their interests.
It is clear that an FTT will increase costs for the financial services industry - including investment firms, organised markets, credit institutions, insurance and reinsurance undertakings, collective investment undertakings and their managers, pension funds and their managers, holding companies, financial leasing companies, special purpose entities and others. In addition, it is expected that under the current proposal the effects of the FTT will be felt beyond the financial services industry. In particular, the proposal states that “all undertakings, institutions, bodies or persons carrying out financial activities with a significant annual value of financial transactions” will be levied. This directly affects the real economy. Treasury companies as well as companies involved in substantial risk management activities such as hedging of foreign exchange or commodities will be taxed – regardless of the sector they are involved in. This means that operational costs for food manufacturers, energy companies, transport firms, and other businesses will increase. More indirectly, the real economy will also feel the consequences as financial institutions will increase their lending costs (in order to cope with the tax) and hence funding and investment for companies will become more expensive. Recent warnings expressed by German giants Siemens and Bayer illustrate the growing concerns within the non-financial industry.
At the moment it is still unclear in what direction the proposal will head and when the FTT will be applicable in the Member States. The proposal foresees the application of the law from 1 January 2014, however recent comments coming from German officials made it clear that this date is highly optimistic. German Finance minister Wolfgang Schäuble said in early May that the introduction of the tax is not an urgent matter and recently a senior official from the German Social Democrats (SPD) – the party that has been a major driving force behind the legislation – expressed its reservations towards the tax. Without the support of the German SPD, a stalemate in the decision making process can be expected.
As German support for the tax is waning, it appears that the other participating countries are also becoming aware of the potential pitfalls of an FTT. Recent rumours suggest that the initial proposal will be scaled back substantially and would a redesigned to a tax that would only generate 1/10th of the initial plan. For the first time since the presentation of the proposal the European Central Bank also officially intervened in the debate. Benoît Cœuré, ECB executive board member, said that the ECB is “willing to engage constructively with governments and the European Commission to ensure that the tax has no negative impact on financial stability”. Christian Noyer, Governor of the Bank of France, said that “the immediate effect will be either to destroy financial sectors”, or lead to a situation in which “the cost of borrowing in the real economy will increase for everyone.” Although the economic arguments receive strong opposition from experts, there is still much political will to pursue the introduction of a financial tax (in any form). Recent developments, however, illustrate disagreements between Member States regarding the scope of the tax, how to distribute revenue and whether certain industries such as pension funds should be exempted. Moreover, the lack of data on how the tax on sovereign-bond transactions would affect governments' borrowing costs also worries Member States.
Given the political sensitivity, clear progress will probably not be made before the German elections on 22 September. However, this does not mean that the proposal is off the table. On the contrary, in light of their quest for budgetary balances, an FTT (or any tax on the financial sector) is a politically attractive measure to generate income for governments. Although many hurdles appear to exist, consensus remains that a tax – maybe a limited tax on shares as a first step – could be introduced. Hence, the concern of the industry remains legitimate.
What can the industry do?
H+K Strategies believes that the current political situation offers an opportunity for the industry to contribute to the content of the proposed legislation. Given the importance of the proposal for the financial and non-financial sector, it is important that the voice of the industry is accurately conveyed to the right audience. Decision-makers need to understand the full impact of the legislation they will adopt
Therefore, proactive engagement with the relevant decision makers in the European Commission (DG TAXUD responsible for tax matters, and the cabinet of EU Commissioner for Taxation Algirdas Semeta), European Parliament (the key members of the Economic & Monetary Affairs Committee dealing with financial services regulation), national authorities and EU/national regulators (ESMA, EBA and national counterparties,) as well as national ministries and Parliaments will be of strategic importance.