The European Commission has recently proposed a levy on financial transactions, as little as 0.1% for equities and bonds and 0.01% for derivatives. Both parties of the transaction would be entitled to it even for transactions where one trader would be out of EU. It is estimated that the tax could raise about 55bn euro a year for the EU. The idea behind it according to Jose Manuel Barosso: “it is time for the financial sector to make a contribution back to society”. However, the very same Commission has estimated that such a tax could severely harm derivatives and bond trading in Europe (up to 90% of derivatives trading will disappear) and cause a 2% decrease on average of the European GDP in the long run.
The tax is named after a Nobel Prize winning US economist James Tobin who proposed the tax with the idea of an efficient and fair way of raising revenue for the government. In theory the tax is supposed to discourage speculation. In practice, however, it is unlikely to persist.
The main problem behind the Tobin tax is selective implementation. Either everyone has it, or no one has it. A Tobin tax issued in Europe will simply drain the money out of European markets and push it towards off shore financial centres. The traders on the derivatives and bond markets are usually big multinational companies (banks included) who will have no problem of transferring the derivatives trading and currency hedging transactions into some of their international centres such as Hong Kong or New York.
The tax is likely to hit pension funds and middle sized companies which use derivatives to hedge against swings in commodity prices and currencies, rather than other financial institutions. Unlike multinational companies, middle sized companies cannot pass their trading to other markets and will be the only ones left to bear the burden of the tax. This is therefore a tax that will stiff economic recovery even further as it will impose additional costs to the already troubled middle-sized companies which are according to the widely accepted paradigm – drivers of economic growth. It will harm all those manufactures, retailers and import-exporters that use derivatives to hedge against currency and price swings, even for low rates such as these ones. The imposed costs on companies who will have no choice but to bear the burden of the tax will reflect on the prices and competitiveness of these companies and finally the burden will fall on consumers.
As a final consequence, volumes of trading will decrease rapidly, spreads will increase and trading will inevitably move on to offshore “unregulated” markets. Europe won’t benefit at all as the revenues it collects from this tax will be substantially smaller than expected, while the effect on GDP growth will be devastating.
Some estimates say that the market which will suffer the hardest blow is the UK market and London as one of the world’s biggest financial centres. The loss of trading volumes will be up to 33% just on bonds and stocks for the UK, 23% for Spain, 13% for Germany and 12% for France (according to Financial Times). The derivatives market, although with a much smaller tax, is estimated to be completely wiped out from European markets. No wonder that the UK stands firmly against such a proposal. This time, a stubborn stance from the UK is welcomed as the tax can only go through if verified by all 27 EU countries. According to its adverse effects (huge negative impact and a negligible positive impact) it is very unlikely for this to happen.