Momentum behind introducing FTTs has been revived by the hugely damaging economic effects of the Covid-19 pandemic leaving financial institutions worried.

Financial transaction taxes (FTT) are back on policy-makers' agendas with a vengeance as national budgets face gaping holes from the economic impact of the Covid-19 pandemic.

For financial institutions, which have for years managed to successfully curb the spread of FTTs, this is a blow. Indeed, even the state of New York, which hosts the world’s largest stock markets, is debating introducing an FTT as it scrambles to find new revenue sources.  

There is strong support for FTTs within the US Democratic Party, which is currently leading in the polls ahead of the November 3 US presidential election. 

Meanwhile, an aim of the six-month German Presidency of the EU is to introduce an FTT across the union to help fund the €750bn EU pandemic recovery programme. 

But some states are not waiting. Since 2019, the Spanish government has been itching to introduce a 3% digital tax and an FTT and Covid-19 has provided the perfect excuse. 

If passed, it would levy a 0.2% tax on share transactions of Spanish listed companies with a market capitalisation of more than €1bn. This would also apply to shares of qualifying Spanish companies traded abroad. Furthermore, it would impact the execution and settlement of convertible bonds, financial derivatives, and other related financial instruments.

Cristina Enache, general manager at the Spanish Taxpayers Union, was critical of the idea. She wrote in a blog that the Spanish government expects to raise €850m a year from the tax, but pointed to the country’s Authority for Fiscal Responsibility, believing €420m to be more realistic. She added that a similar French FTT underperformed expectations on the tax revenue front. 

“Nevertheless, the FTT’s adverse effects on the capital market may end up costing more than its collection,” she wrote, warning that these taxes can create distortions, such as higher transaction costs, lower trading volumes, lower asset prices and potentially shift trading to unregulated opaque markets. She warned that ultimately retail investors bear the cost because they don’t have alternatives. 

FTT opponents routinely trot out Sweden’s failure with FTTs, which ran from 1984 to 1991. Revenues from the tax were disappointing, so Sweden’s authorities jacked the rate up to 1% from 0.5%, which had the effect of driving trade in Swedish shares to London with business being done through non-Swedish brokers and even large domestic investors went offshore to invest in their home companies. This deprived Sweden’s tax authorities of revenue. Eventually, an FTT was even applied to government bonds, which also failed as investors fled to domestically available substitutes and derivatives. However, FTT supporters counter that Sweden’s FTT rates were too high and the scheme was poorly designed. It only targeted Swedish brokers and its application was riddled with loopholes, leaving out offshore trading and certain derivatives, for example. 

The UK experience

Supporters also point to the UK’s 0.5% stamp duty reserve tax levied on most share transactions since 1986. In previous years it had been as high as 2%. 

A unique and somewhat protectionist feature is that the rate rises to 1.5% on depository receipt schemes, namely transactions in UK shares on offshore exchanges, such NASDAQ in the US.

Last year, HM Revenue and Customs bagged £3.62bn ($4.75bn) from these taxes. While London hosts Europe’s largest stock market, it is worth noting that share derivatives such as contracts for difference (CFDs), which circumvent the tax, have flourished. Meanwhile, the UK TaxPayers Alliance has called for their abolition arguing that they add to the cost of capital for companies  

Whereas financial lobbies have successfully fended off FTTs in the US and an EU wide one - only 10 member states supported it - they now fear that they could really happen this time, according to research firm Greenwich Associates, adding that they could damage capital markets. 

According to a poll it published on July 14, 72% of market participants expect harm to retail investors and trading, 65% fear a negative impact on personal portfolios and 70% anticipate a reduction in their firm’s trading. 

But there is also an operational element to consider when rolling out FTTs. 

According to Daniel Carpenter, head of sales and marketing at regulatory solutions firm Merit Software, all these various FTTs have significant cost implications for financial firms operating across borders. 

He explains that each one tends to have its own national flavour. In France they have certain netting rules and taxes do not apply to all types of companies or instruments. In Italy they also apply to derivatives, which significantly multiplies the number of instruments that come within scope.  

Should the EU make FTTs compulsory across the block, it could spark an explosion in individual national FTT schemes causing a headache for financial firms trying to comply with them. 

He explains that up to now, many firms have implemented compliance systems specifically tailored to particular FTTs and that they can’t simply be re-applied to another jurisdiction’s unique tax scheme. 

But that’s not all. “Banks are very stretched at the moment implementing rules such as SFTR [Securities Financing Transaction Regulation] plus there are reviews ongoing for MiFID [markets in financial instruments regulation] and CRD [capital requirement directive],” he says.

Depending on the size of an institution and the scale of its operations, the cost of implementing the compliance systems to cope with a proliferation of FTT schemes is likely to run into the millions of dollars.  

Most economists agree that big tax rises are inevitable to repair public sector balance sheets, it is just a question of where they fall. Politicians may feel that taxing capital markets is an easier public sell, than say, drastically increasing income or sales taxes. However, whether FTTs raise the desired revenues is another matter.   

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