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The drawbacks of the Financial Transactions Tax

    The Financial Transaction Tax (FTT), popularly dubbed as the Robin Hood Tax, received large support from the Labour Party this election season. The party claimed that through the imposition of the FTT on derivatives, its government would be able to generate revenues of £26bn over the course of a 5-year parliament.

    The FTT has certainly gained popularity post the 2007/8 global financial crisis and is often cited as an appropriate form of ‘payback’ from the financial services sector. However, as the International Regulatory Strategic Group (IRSG) report indicates, the premise of the FTT is not sound. The tax does not differentiate between High-Frequency Trading (HFT) and other forms of trading, allocating too much economic value to HFT. Mortgage Backed Securities, Collateralised Debt Obligations, Credit Default Swaps and leverage of the banks were the assets which led to the crisis. However, none of these assets will be covered under the FTT, which is instead aimed at HFT. 

    In fact, the real effect of such a tax will be borne by pensioners, savers and other long-term investors. The application of the FTT would result in lower returns on savings and could ultimately lead to a decline in economic activity. The tax often dubbed as progressive is far from being so in practice. The estimated figure of £26bn which the Labour Party claims the FTT would generate is unlikely to ever materialise. A derivative of the FTT was imposed in Italy and France in 2012, however, neither country has managed to generate even a quarter of the expected revenue from the imposition of the tax.

    Supporters of the FTT forget the adverse effects it is likely to have. These stem from two key factors – its implementation costs and its behavioural impact on financial agents. Centre for Economic and Policy Research (CEPR)’s empirical model highlights that if the elasticity of trading is greater than one, the loss in trading revenue to the financial services sector from the imposition of the FTT would be much larger than any gains made in taxation revenue. The U.K is already spending beyond its means and cannot afford to undertake further borrowing for the imposition of the FTT is estimated to result in a rise in the cost of issuing debt cost by £4bn.

    A tax like the FTT was implemented in Sweden but was widely branded a failure. Instead of having beneficial outcomes, it resulted in investors either taking their business elsewhere or finding their way around the tax. Research by Oliver Wyman identifies reallocation to be one of the major behavioural effects of the FTT. With Brexit, a reallocation of the financial services sector to other parts of Europe or even to Asia will be detrimental to the U.K economy - the sector contributes significantly in terms of incomes, jobs and taxes. In fact, in a bid to attract firms to their countries, European Nations, who strongly supported the FTT, have realised its adverse effects and are now shying away from implementing it.

    The stamp duty – a 0.5% tax on financial transactions - unique to the U.K has proven to be relatively effective in terms of revenue generation. However, unlike the stamp duty, the FTT would serve as a blunt instrument due to its large implementation costs, adverse behavioural impacts, particularly if it is to be applied solely in the U.K and the potential burden it would impose on pensioners and savers.

    Government and regulatory authorities need to devise the right incentives to ensure that agents in the finance sector abide by the rules. A lot of the damage during the crisis was caused by Over The Counter(OTC) financial transactions which led to the emergence of shadow trading and shadow banks. Devising measures such as the introduction of central clearing houses and a general requirement for OTC transaction will help increase transparency and improve the basis for tax collection.  

    Shruti Dayal is a CPS Summer 2017 Economic Research intern. She graduated in 2017 with a degree in Economics (Hons.) from the University of Warwick, and is interested in working in consulting and research. 

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