EU Financial Transaction Tax: Will It Become Reality?

The debate over whether a financial transaction tax (FTT) should be imposed in Europe is an old argument — one that resurfaced regularly over the years but never seemed likely to lead to any substantive action. This has changed, however, as the European Commission has now gone so far as to publish on 28 September a proposal for a Council Directive to impose a FTT at the EU level. Even though major obstacles must be overcome by proponents of such a tax, this is a major step forward, making the implementation of such a tax more likely than ever.

Under the EU proposal, the tax would be imposed on all transactions on financial instruments (shares, bonds, derivatives, structured financial products) undertaken between two financial institutions, if at least one of the financial institutions was established in the EU. Taxation would take place in the member state in which the financial institution involved in the transaction is located. The tax rate would be 0.1 percent for the trading of bonds and shares, and 0.01 percent for derivatives products (based on the notional). At these rates, the European Commission estimates that the tax could raise approximately €57 billion per year. The revenues would be shared between the member states and the EU.

Earlier this year, we conducted a poll of 722 CFA Institute members in the EU and Switzerland to obtain feedback on the three taxation models under consideration by the European Commission at the time: the previously mentioned FTT; a financial activities tax (FAT), levied on the sum of profits and wages; and a bank levy (asset-based or liability). Even though the respondents were split on the justifiability of imposing a new tax on the financial sector, the poll results clearly illustrated that the FTT was the least-favoured taxation model and revealed two major concerns:

• Seventy-five percent of respondents said the costs of an FTT would be mainly borne by the end customer.
• If the FTT is not applied globally, the initiative will lead to regulatory arbitrage and undermine the competitiveness of the EU financial sector. In fact, 45 percent of respondents believe that an FTT would not be effective at any level, and 44 percent maintain it would be effective at the G20 level or higher. Only 5 percent think it would be most effective at the EU level.

In its impact assessment, the European Commission itself acknowledges that the main risks of introducing an FTT would be the incidence, or the cost, of the tax (i.e., who would bear the burden), relocation of financial institutions to other countries, economic distortions, and potential loss of competitiveness.

The European Commission is now aiming to apply the FTT across the 27 EU member states, with the backing of two of Europe’s most powerful member states: Germany and France. The Commission, with the support of the current French presidency of the G20, will push for global implementation of an FTT at the G20 summit in Cannes on 3-4 November. The UK however has made it clear that it disagrees with such a tax, as it fears a weakened financial services sector and banks moving out of London.

The first major obstacle will be a vote on the FTT proposal in the Council of the European Union (composed of ministers of the 27 member states), as unanimity is required for it to go forward. This will be hard to achieve given the UK opposition. Negotiations resulting in implementation at the Eurozone level only would make the argument of greater risk for regulatory arbitrage even stronger.