Global Policy Forum

Taking on the Speculators - What Would a European Tobin Tax Really Mean?


Nicolas Sarkozy has long been advocating for the introduction of a Financial Transaction Tax (FTT) in Europe. Pursuing the aim of redistributing wealth and influence, the tax is presented as an ideal tool to exert greater control over financial markets while at the same time raising revenues to finance development. This week the French President won the backing of the German Chancellor who, besides facing opposition within her own coalition government,  stated that “personally, I’m in favor of thinking about such a tax in the Euro Zone” if necessary without Britain, Europe's largest financial center.  This Spiegel article explains how a European FTT would work, what its main advantages and disadvantages are and whether it is feasible to think about a European FTT without one of its greatest economic powers.  

By Stefan Kaiser

January 11, 2012

Angela Merkel and Nicolas Sarkozy are pressing forward with plans to introduce a financial transaction tax in the EU -- if necessary without Britain, home to Europe's largest financial center. Critics believe it will cause an exodus of the industry from the euro zone. But a closer look at the proposal suggests the worst wouldn't necessarily come true.

The idea is age-old, but its time may soon be coming. A tax on financial transactions could help to stem short-term speculation on the markets. French President Nicolas Sarkozy wants to push the tax through in Europe -- if necessary even without Britian, which has doggedly resisted such measures. Sarkozy picked up a new ally for the plan this week as well: German Chancellor Angela Merkel is also willing to venture going it alone to implement the tax exclusively within the 17 members of the euro zone. It would not directly apply to London, Europe's most important financial center.

Ironically, it was a Briton who first came up with the idea for such a tax. In 1936, economist John Maynard Keynes suggested using the tax in order to curb speculation. In the 1970s, American economist James Tobin's work on the issue brought the proposed tax to the attention of the left and critics of globalization. The so-called "Tobin tax" was a founding demand of the Paris-based, globalization-critical network Attac, whose acronym stands in French for "Association for the Taxation of Financial Transactions and for Citizens' Action."

In the meantime, the idea has also picked up some prominent advocates, including the American Nobel Prize-winning economist Joseph Stiglitz. Last year, Stiglitz told the Frankfurter Allgemeine Sonntagszeitung newspaper: "I am convinced that if Germany, France, Spain and Italy were to implement the financial transaction tax together, it would work."

But what would the tax look like? What are the objectives behind it? And what are the downsides? SPIEGEL ONLINE answers the most pressing questions.

How Would the Tax Work?

The European Commission, the EU's executive, has proposed implementing a tax starting in 2014 on all transactions involving stocks, bonds and derivatives that are conducted between financial institutions. It would apply to banks, insurance companies, investment funds, stockbrokers and hedge funds, among other financial firms.

The taxes would be paid by both partners in the transaction, the seller and the buyer. For stocks, a tax of 0.1 percent has been proposed. For derivatives, such as, for example, futures or credit default swaps (CDS), the tax would be 0.01 percent.

So, if a bank were to sell stocks worth €100,000 to a hedge fund, each would have to pay €100 in tax on the transaction. If, on the other hand, a manufacturer of heavy equipment were to buy a currency futures contract worth €100,000 to protect itself against fluctuations in the euro-dollar exchange rate, it would have to pay €10, as would the bank that was its party in the contract.

What Is the Tax Meant to Achieve?

The tax has two aims. First and foremost, it is hoped that it will slow down overwrought financial markets. Particularly due to the spread of electronic trading, the number of transactions has increased dramatically in recent years. In 2010, for example, fully $63 trillion (€50 trillion) worth of stock traded hands on the global markets. On currency markets, it was $1 quadrillion. Computer programs send millions worth of securities and derivatives back and forth each second in order to take advantage of the smallest of price differentials. The profits per trade are tiny, but once multiplied by the sheer volume of trades, they become substantial.

But such rapid trading can quickly become a problem for market stability. Because computer traders jump at the slightest of trends, they magnify the market's already-present herd mentality. Prices can spike or plummet within mere minutes.

The planned tax would have a significant impact on such trades. If traders were forced to pay a mini-tax on each transaction, many deals would no longer be worth it. Prices would become more stable as a result, politicians hope.

The second aim is that of forcing the financial world to share in the costs created by the crisis. The European Commission estimates that an EU-wide tax would generate up to €57 billion per year. Without Britain's participation, however, revenues would be much lower.

Furthermore, the two aims are, at least in part, mutually exclusive. Should the first aim be reached and the numbers of transactions fall, financial transaction tax revenues would necessarily fall as a result. It is a similar problem encountered by all taxes that are designed in part to control behavior -- such as the environmental tax on fossil fuels in Germany or the tobacco tax on cigarettes.

Financial experts warn against pinning too much hope on the financial transaction tax. It has, they say, little to do with the realities of the current crisis. Such a tax would not have prevented the collapse of the US investment bank Lehman Brothers nor would it have stopped countries, banks and citizens in the Western world from amassing huge piles of public and private debt. The tax, warns Stephan Schulmeister of the Austrian Institute of Economic Research, which analyzed the likely effects of the plan, is not a panacea.

Can the Plan Work without Great Britain?

One of the most important points of criticism of the financial transaction tax is the fear that it will cause an investor exodus from Europe. According to that line of thinking, if the tax were only introduced in the EU, it would merely cause banks and funds to shift their operations to New York, Zurich or Singapore. And if it were only applied within the 17-member euro zone, then London would be the easiest and most logical destination for this migration.

Britain today is already one of the world's most-important financial centers. For example, it is there that more than one-third of all foreign currency transactions are processed. Almost every major bank within the euro zone has a major office in London. Take Germany's Deutsche Bank. The bank's branch in London has become almost as important to the company as its headquarters in Frankfurt.

But the European Commission has already sought to address concerns of a possible exodus with its proposal. Under the plan, the determining factor in applying the tax would not be the place where the financial deal is processed, but rather the location of the participating trading partners. If one side has its headquarters in a euro-zone country, then both partners would have to pay the tax. This would also apply if the transaction were processed in London, Singapore or the Cayman Islands.

This provision would complicate efforts to circumvent the tax. Indeed, Deutsche Bank might be able to move its headquarters from Frankfurt to London without much trouble, but if it wanted to conduct a transaction with a Paris-based bank, it would still have to pay the tax.

Do Any Countries Have Experience with Similar Laws?

Germany itself used to have a stock exchange turnover tax -- with a 0.25 percent tax due on transactions involving stocks and a tax of 0.1 percent on bonds. But German government bonds and trading between banks were excluded from the legislation, and the proceeds remained relatively paltry. The government repealed the tax in 1991.

Sweden had a much worse experience with a similar levy. In 1984, the country introduced a 1 percent stock market transaction tax. In the subsequent years, the amount was increased, but revenues still remained low. Many investors fled the Stockholm stock exchange only to return after the Swedish government repealed the law in 1991. That's one reason that Sweden, along with Britain, is one of the most vehement opponents of the tax. The Danes, who currently hold the rotating six-month presidency of the EU, are also skeptical of the plans by Merkel and Sarkozy.

Britain itself still has a tax on trading of shares -- the so-called Stamp Duty Reserve Tax of 0.5 percent of the sale price. It currently generates revenues of around €5 billion per year. With the introduction of a Europe-wide transaction tax, the charge would also be applied to other securities and to foreign exchange markets. Indeed, that is precisely what the British government wants to prevent.

What Disadvantages Would the Tax Have?

Critics of financial transaction taxes fear considerable negative effects. They argue there is a danger not only of investors fleeing to financial centers outside of Europe, but also that they might eschew established stock exchanges and instead conduct deals directly with each other. Under the European Commission proposal, such over-the-counter trades (OTC) would still be subject to the tax. But in practice it could prove tough to enforce, because the transactions are difficult to monitor and detect.

German exporters also complain that the tax would make the currency trades they conduct in order to safeguard their foreign sales against exchange rate fluctuations more expensive.

Private investors could also be affected. Their dealings would not be directly taxed, but financial industry players have already made clear that they will pass the rising costs on to consumers. When an investor buys stock worth €1,000, he or she can expect that the €1 due in taxes will be passed on.

Another point of criticism starts with one of the declared goals of the advocates of the tax, which is to prevent wild fluctuations in the financial markets. If the tax were to cause the number of traded securities to decrease, the critics argue, the fluctuations would increase. A simple assumption lies behind that reasoning: When there are fewer buyers and sellers in a market, price fluctuations will be stronger than if there were many participants. The advocates of the tax reject this argument. They assume that, despite the tax, there will be enough traders in the market to ensure stabile prices.


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