Trifling With Transaction Taxes

Amid European news Wednesday was an update on the proposal for an EU-wide financial transaction tax to be levied starting 2014. A 0.1% tax would be applied to stock and bond trades, while a 0.01% rate would be applied to derivatives contracts. The rates would apply across the 27-member EU and would impact banks, investment firms, insurance companies, pension funds, stockbrokers and hedge funds, among others.

Thus far, the proposal’s drawn mixed reviews, the UK staunchly opposed (not too surprising given their status as a leading global financial center) while French and German officials have spoken out in favor—making the likelihood it’s actually implemented fairly low, given EU regulations require unanimity.

Far be it from us to criticize EU measures aimed at stabilizing a region dealing with its periphery’s financial woes for well over a year now, but this strikes us as a rather ill-advised move. First, consider the motivation behind the proposal—according to European Commission President José Manuel Barroso, the tax is a matter of fairness. In other words, Barroso (among others) is suggesting since EU governments have supported the financial system through its various recent travails, it’s time the financial sector returned the favor and paid more in taxes. But one reason taxes aren’t the great levelers many assume (particularly when it comes to business taxes) is they can usually be passed to consumers—meaning the EU’s attempt to even the score with banks is more likely to effectively result in the EU further running up the score on its own taxpayers.

Which leads to a second problem: There are frequently other options for customers faced with passed-through taxes—and in Europe’s case, there are myriad options available to those seeking to complete financial transactions. Like the US. Or Japan. Or any other financial market where such taxes aren’t levied.

Given some EU nations have been worried about global competitiveness, an additional tax would likely present another incremental barrier hampering competitiveness. The EU visited a similar conversation not too long ago when pressuring Ireland to increase its corporate tax rate. EU officials argued Ireland’s low tax made much of the EU uncompetitive—so out of a sense of fairness, Ireland was supposed to raise its tax and allow everyone else a chance to play ball. Well, Ireland basically told the EU they could take their gloves and bats and play elsewhere. And what’s happened since? Ireland’s made slow but steady progress, and its economy’s returned to growth. Now, that’s obviously not solely due to low corporate taxes, but they’re very likely a tailwind—enhancing Ireland’s competitiveness.

On top of this, consider the proposed tax is in addition to austerity measures already taken at the national level in many countries. Which makes it an added complication—albeit a minor one given the proposed tax’s size—that several EU nations just don’t need at this point.

We’d suggest the EU borrow Ireland’s approach. Rather than imposing taxes in an attempt to wrangle more money from financial institutions, they could lower as many barriers as possible to doing any sort of legitimate business there and encourage companies to set up shop across the pond. (And we’d suggest the US could and should do the same—a race to the bottom when it comes to the cost of doing business is, in our view, a positive that would likely boost global economic activity.)

But at the end of the day, given the tax is fairly small, this is seemingly only an incremental negative—if it’s even imposed. We think there are probably better ways to boost EU business productivity and competitiveness—but there have also been worse policies implemented before. And there will likely be more down the road. Global markets and financial institutions have proven their resilience myriad times through history. Odds are they survive this, too.