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Financial regulation

Towards a Financial Transactions Tax?

UK Parliament House of Lords, European Union Committee – Twenty-Ninth Report.

This Committee has undertaken a detailed analysis of the European Commission’s controversial proposals for a Financial Transaction Tax (FTT). We have been disappointed in what we have discovered. We have found the Commission’s proposed model wanting in many respects, and unlikely to fulfil the objectives that the Commission itself has set. We find the Commission’s proposed residence principle to be impractical and unworkable, and conclude that there is a significant risk that financial institutions would relocate outside the EU if an FTT is introduced. In the light of these flaws, it is our view that the Government should refuse to agree to this proposal. Yet the debate on taxation of the financial sector should not be lightly dismissed. It has been suggested that an FTT may be adopted by some or all euro area Member States, or that a tax of a similar kind to the UK Stamp Duty might be pursued. The implications for the UK and the EU as a whole are considerable, and we urge the Government to redouble their efforts to ensure that the UK is able to influence the ongoing debate.

The continuing debate over the introduction of a Financial Transaction Tax has been highly contentious. Commission President José Manuel Barroso has justified it as a “question of fairness”. A number of Member States, led by Germany and in particular France, have pushed hard for its introduction. And a high-profile group of economists, trade unions, celebrities, charities and faith groups, has spearheaded a vocal campaign for the introduction of a tax. Its advocates argue that a Financial Transaction Tax is desirable to recoup the costs of the financial crisis from those who bear responsibility for it. Yet leading economists have criticised the concept as fundamentally flawed, and the financial sector has been fervent in its opposition to the idea.

It is in this feverish atmosphere that the House of Lords European Union Committee has conducted this inquiry into the European Commission’s proposals for a Financial Transaction Tax (FTT). Our conclusion is that there are significant shortcomings in the Commission’s proposal.

The Commission sets out five objectives behind its proposal: i) To avoid fragmentation of the internal market for financial services; ii) To ensure that financial institutions make a fair contribution to covering the costs of the recent crisis and to ensure a level playing field in taxation; iii) To deter transactions that do not enhance the efficiency of financial markets; iv) To generate money for the EU budget; and v) To contribute to the development of an FTT at global level. We are not convinced that the proposed model would meet any of them.

Given the opposition to an FTT in the USA, the suggestion that the Commission proposal will pave the way for a global tax is in our view wholly unrealistic, whilst the case for using an FTT as a new revenue stream for the EU budget is contentious even amongst its supporters, many of whom favour revenue being put to other uses such as tackling global poverty and climate change. Whilst there is a stronger case for asking the financial sector to make a contribution to the costs of the financial crisis, or indeed for seeking to deter certain transactions, in neither case is the Commission’s position compelling. Whilst we acknowledge the strength of public anger against the financial sector, and the widespread view that those who contributed to the current financial crisis should contribute to its costs, we fear that a Financial Transaction Tax is the wrong way to meet such demands.

In particular, the design that the Commission proposes has significant flaws. The ‘residence’ principle is impractical and unworkable. There is a significant likelihood that financial institutions will relocate outside the EU in order to avoid the tax. It is uncertain who will shoulder the burden of the tax incidence. A cascade effect threatens to increase the potential tax burden. We are alarmed at the degree of criticism to which the Commission’s Impact Assessment has been subjected. And, most concerning of all, the proposal seems destined to lead to a reduction in EU-wide GDP. In the context of the current financial crisis and the economic pressures being faced by many Member States, this is highly undesirable. If a proposal on a question of such importance as this is to be seriously contemplated then it is imperative that any proposed tax is as technically well-designed as possible. Given the flaws in the Commission’s proposed design, we conclude that the Government should refuse to agree to this proposal.

That is not to say that the debate on whether and how the financial sector should be taxed can be ignored. It has been suggested that an FTT could be taken forward by some or all of the euro area Member States. Other models have also been put forward. There is increasing political momentum, led by President Sarkozy of France, behind the adoption of a tax on the trading of shares, similar to the UK Stamp Duty model. It remains to be seen whether there is any prospect of the adoption of such a tax more broadly across the EU, or what the consequences would be for the UK Stamp Duty regime.

Whatever shape the debate takes in the future, the implications for the UK are extremely significant. The UK financial sector, based in the City of London, is of fundamental strategic importance, not only for the UK economy, but also for the EU as a whole. The Chancellor of the Exchequer has said that an EU-wide tax would be “a bullet aimed at the heart of London”, but on the other hand the Government maintain that they have no principled opposition to a global tax. In the evidence they put to us, the Government’s support for a global tax was lukewarm at best. We find this distinction unconvincing. If the Government’s true position is that they oppose a Financial Transaction Tax outright, then they should say so.

Whatever the Government’s view, it is imperative that they remain engaged in the debate. Much uncertainty remains about the impact of any financial taxation proposal on the UK, whether it is established at EU level or amongst euro area States alone, or whether an alternative model on the basis of the UK Stamp Duty is proposed. Given the vital role of its financial sector not only for the UK but for the EU as a whole, the UK must seek to play a constructive role in the continuing discussions on the introduction and design of any proposal for taxation of the financial sector. The implications for the UK are far too great for the debate to be dismissed.

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Source: UK Parliament House of Lords

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