Europe Is Working On A Financial Transaction Tax

by: The Long Road
Summary

In the recent month, there were some news regarding a potential agreement of a FTT.

If implemented as proposed, Europe would play into the hands of Great Britain.

Longer-term implications are difficult to estimate, but would probably weaken Europe’s already-crumbling banking system while saving European leaders’ public image in case of potential government bank bail-outs.

The transaction tax may ultimately harm private savers and investors, while larger institutions may remain in Britain or move elsewhere.

While the European financial transaction tax has been on and off the table for several years, there was some movement in the past month. According to several sources, European finance ministers have agreed on the basics of a financial transaction tax that may be implemented at the beginning of 2018.

While there is no definite agreement yet, and while there still are evaluations to be made (especially regarding the effect on pension funds), the recent announcement was arguably the most noteworthy piece of news in the on-going 5-year battle for a financial transaction tax.

Initially conceived as a pan-European transaction tax, it has been stalled by objections by the United Kingdom, Sweden and several other European countries, mostly based on the argumentation that a financial transaction tax weakens the European banking sector and the economic appeal of the bloc as a whole. As a result, a group of 10 European countries were as of most recently the only ones left with the ambition to implement the descendant of the so-called "Tobin Tax". The countries who are now in the final evaluations are Germany, France, Belgium, Italy, Greece, Spain, Portugal, Austria, Slovenia and Slovakia.

Early information pointed towards the fact that stock and bond transaction should be taxed at a rate of 0.1% of the transaction volume, effectively being 0.2% if you take into account both the acquisition and disposal of a position. For derivatives, the European Commission's proposal suggested a tax rate of 0.01% per trade. The most recent news indicates that the tax should initially be applicable only to shares of the G10 countries, with extension to all shares after a "transition period".

According to preliminary information, the tax shall apply to entities located within the European Union's 10 countries (principle of residency), and/or to transactions taking place within the jurisdiction of financial instruments listed or headquartered in Europe. By that, the European Commission tries to circumvent that e.g. Daimler shares will be traded in London, or that an entity relocates to trade EUREX futures from elsewhere.

Discussion

The argumentation provided publicly by European politicians is that the financial sector should contribute to the losses it has caused during the 2007 world financial crisis. The issue is that - should the transaction tax really come into effect - the costs will more than likely be covered rather by private investors who reside in these 10 countries. Regardless of whether investing in ETF's, mutual funds or constructing an own retirement portfolio (and arguably it is even worse for those who live off day-trading), the transaction tax will ultimately cost a certain share of already-taxed income, on top of a capital gains tax (27.5% in Germany, for instance). What is more, ETF's and mutual funds will most likely roll over the costs of the transactions within their portfolio to the clients via higher management fees. Should private investors thus not be excluded from the financial transaction tax, they will get to carry the burden of the tax twice while larger institutions may simply relocate their business elsewhere.

The second issue I see with such a tax is that it undermines an already-weak investment culture in continental Europe. In Europe, with an already far more risk-averse and conservative financial culture than in the U.S., a tax like that essentially tells you it's bad to invest actively. Those that have not already retreated from personal investing will increasingly find themselves more penalized for taking care of their own financial wealth as opposed to relying on social transfer mechanics.

Furthermore, I would not have expected this initiative to move on right now after the recently announced split between the EU and the United Kingdom. After all, this would have been a great chance for Europe to leverage their position for attracting financial institutions now contemplating to relocate business activities to Paris or Frankfurt. A tax like that likely undermines these advantages, ultimately gives the United Kingdom more bargaining power and bears the risk that major financial institutions will rather relocate to New York or elsewhere. For those institutions that are located in the Eurozone, the tax could not come at a worse point in time. Already crippled with bad balance sheets, overregulation and intensely negative public opinion, European banks will face another burden.

But then again, this financial transaction tax comes in very well-timed. With Deutsche Bank (NYSE:DB) in the spotlight and opinions of a government bail-out circulating - and other European lenders with similarly-worrisome situations - this financial transaction tax may strengthen Merkel's public opinion should she have to approve government funds for bank bailouts.

On another note, the financial transaction tax is arguably aimed at reducing trading volume. The argumentation is that frequent transactions contributed to the collapse of the financial environment of 2007, but that is questionable. In my opinion, reduced trading volume will ultimately spark more volatility in the financial markets, and may thus enable precisely what the Commission plans to avoid.

Summary

The European FTT's effects are questionable and in my opinion based on debatable assumptions. The main share of the cost may be carried by private investors. While the costs may be well-concealed (e.g. via slightly higher fund management costs), ultimately they can discourage private investment and motivate relying more heavily on social transfer mechanics. For the U.S. and the U.K., these are good news, as it strengthens their attractiveness for financial institutions and leverages their bargaining power over trade negotiations. Certainly, you can argue that the effective tax rate will probably be low in absolute measures, but in my opinion the key issue is that it adds to a relatively large set of tax burdens in the EU and more importantly forces more regulation when more liberty could be needed to encourage the economy.

It has to be seen how such a financial transaction tax will ultimately look like, since as for now there are only few details available, and as such a more complete conclusion can only be drawn later on. For now, the news seem discouraging and ultimately penalizing, and potentially Europe is continuing what helped lead to the disintegration of its community: Perceived centralized legislation and perceived overregulation. In my opinion, more of the opposite is needed to both restore trust in the European economy and to strengthen European banks, so that they can - maybe at one point in the future - be competitive once more.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.