Saturday, January 14, 2012

The EU Financial Volatility Tax

The European Financial Transaction Tax (FTT) has gained traction within the European Union. Last fall, the measure won support in both European Commission and the European Parliament. The legislation was argued in the Economic and Monetary Affairs Committee, where it won support from MEPs from a wide plethora of parties. Despite passing the parliament, the FTT has gotten bogged down in the European Council. The purposes of the financial transaction tax are two-fold:

1: Financial Market Stability
A small financial transaction tax serves to moderate volatility in the financial markets. Because the size of the tax should be very small –pennies per share– the amount of the tax becomes negligible to the small investor. This is especially true for the smallest investors, who face large brokerage fees far outweighing  the proposed tax, and for whom brokers might even leave transactions costs un-altered. Institutional investors such as pension funds and oil fund, whose main wealth management strategies focus on shareholder activism, as well as long-term buy-and hold strategies, will also barely be affected. Passively managed portfolios will also remain virtually unaffected.

Hedge funds, large speculators, and other highly-leveraged players meanwhile, would be more seriously affected by this measure due to the size and frequency to which they change their financial positions. While these are parties the main contributors to volatility, their contribution to growth is somewhat questionable compared to more conservative investors. The slowing of their speculator activity is projected to contribute a great deal of overall stability in the market.

The proposed legislation, supported by S&D, the European Parliament’s Social-Democrat alliance aims to set the tax rate at 0.05% of the transaction.

2: Revenue
Given the sheer amount of financial transactions, even a somewhat reduced financial transaction volume would give rise to massive revenues. A further positive aspect of FTT revenues is their progressive nature, given that the burden of this tax would fall mainly on the wealthy and on wealthiest players in the financial industry. Given that we are in a period which is known for sovereign debt uncertainties, this might serve to alleviate budgetary problems across the OECD.

Nevertheless, the revenue-gathering effectiveness of this tax is a somewhat complex matter, and there are administrative challenges. In 2011, the IMF conducted a study on the administrative feasibility of the FTT. It concluded that while exchange-traded financial instruments can be taxed relatively easily, there lies some difficulty in the taxation of OTC products and derivatives, leading to some level of product substitution. Nevertheless, the study finds that these difficulties are not wholly insurmountable. Revenue maximization however should only be seen as a secondary objective of the FTT, after stability has been financial market stability taken into consideration.

Austrian WIFO Study on FTT Feasibility
The Austrian Institute for Economic Research (WIFO), a Vienna-based think-tank has undertaken a feasibility study on the FTT. It asks whether the volume of transaction is sufficiently large to justify such a tax. It also examines the effect on speculators versus the effect on real investment.

The study finds a remarkable discrepancy between the levels of financial transactions and the levels of the "underlying" transactions in the "real world". The volume of currency transactions is found to be nearly 70 times larger than trade of goods and services. Moreover, the transaction volume of interest rate securities is even several hundred times greater than overall investment. Moreover, said discrepancy has increased dramatically since the 1990s.

IMF Study on FTT
Last year, the IMF published two studies on the feasibility of the FTT. In Brondolo 2011, the administrative feasibility of the FTT is analyzed by the IMF. It examines the various ways in which an FTT could be structured, as well as the possible obstacles.

While financial product substitution may become an issue and OTC markets are somewhat more difficult to tax, the FTT can nevertheless be feasibly instituted in a coherent fashion.
About the Authors:
The Austrian Institute for Economic Research – WIFO was founded by Friedrich August von Hayek and Ludwig von Mises in 1927. Its brief is to analyse economic developments in Austria and internationally, thereby contributing to the establishment of a sound basis for economic policy and entrepreneurial decision-making.

The IMF is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.


  1. Greetings from Washington!

    Very good explanation of the pros and cons of the volatility tax although I would have liked to hear your personal opinion.

    Take care and keep up the good work.

  2. Thanks!

    My opinion is that this tax is a good idea for Europe and for most advanced economies. It would provide both stability and revenue, as well as a more progressive tax system.

  3. A scramble for cash to keep the Eurozone afloat. This tax will not work unless it is implemented on a world wide scale.

    I can see companies moving out of zones/areas that have implemented such measures. Where would that leave us?

  4. Personally, I have a hard time seeing how a .05% tax on trading a company's stock would encourage them to leave the EU and complicate their access to the EU massive consumer and producer market, which even grants subsidies to strategic sectors. In terms of the cost/benefit analysis, it just doesn't make sense.

    In addition, I have a hard to seeing how companies would leave the EU when a massive portion of the EU financial market is actually owned by institutional investors, many of whom have rules stating they must have a certain percentage of their assets invested locally. In other words moving might cause the institutional investors to sell en masse.

    Also, moving over seas is no guarantee. Do you suppose that china doesn't have have operating rules that make it difficult to work in?

    No, if I were a large firm in the EU that got slapped with this tax, I would rather stay put for the moment.