What is a Financial Transaction Tax (FTT)?

• The FTT is a tiny tax that would be levied on all financial market transactions. This would cover any financial transactions traded through stock exchanges, futures exchanges or any other facility established for the purpose of trading (“exchange trading”) by financial market actors.What would it cover?
• It would include transactions involving stocks, bonds, foreign exchange, and derivatives (including trade of futures and options related to stocks, interest rate securities, currencies and commodities).
• It would cover all transactions traded on exchanges as well as off-exchange (or “over the counter” (OTC) ).
• It would be limited to transactions between financial market actors. Ordinary consumer transactions such as payments for goods, paychecks and cross-border remittances would not be subject to the FTT. Short-term inter-bank lending and central bank operations would also be excluded from the FTT.What are the “Technical” arguments for an FTT?
• There is excessive trading activity (= liquidity) in modern markets due to the predominance of short-term speculation.
• The most pressing problem is the volatility of asset prices over the long run. Short term trading leads to long term swings in asset prices and, hence, persistent deviations from their fundamental equilibria.
• A uniform tax per transaction makes short-term speculation more expensive. A transaction tax should therefore have a stabilizing effect on asset prices and would thereby improve the overall macroeconomic performance and help to prevent another crisis.
• A transaction tax would provide governments with considerable revenues which could be used for fulfilling social policy goals, particularly on the supranational level.
• Furthermore, it is the only solution capable of generating enough receipts to cover expected fiscal gaps in the coming years.
• FTT would counterbalance financial authorities’ loss of control over global finance. The FTT provides government with regulatory tool that would not be conditioned upon supervisory authorities’ ability to price risk.
• The FTT would bring global banking back to its original function of financing the real economy.
• The FTT is a low cost solution. Collecting the tax is very easy on stock exchanges.
• The FTT is superior to any other similar solution intended to curb speculation and raise revenue, such as an insurance scheme or a fee on large bank balance sheet.What are the technical arguments against an FTT?
  These are largely oriented around beliefs in the efficiency of the market to determine the fundamental equilibria of demand and supply:
• The high transaction volumes in modern financial markets reflect the liquidity necessary for facilitating and smoothing the movements of asset prices towards their fundamental equilibria (price discovery).
• A good deal of short-term transactions are used for hedging and, hence, distributing risk.
• Speculation is an indispensable component of both, the price discovery process as well as the distribution of risks. As part of the former, speculation is essentially stabilizing, i.e., it moves asset prices smoothly and quickly to their equilibria.
• Any increase in transaction costs, e.g. due to an FTT, will cause liquidity to decline which in turn will increase the short-term volatility of asset prices.
• Endogenous (internal) “overshooting” caused by excessive speculation does not exist (i.e. traders don’t trade just to trade). Any deviation of asset prices from their fundamental equilibrium is due to exogenous (external) shocks (mould in Ghanaian cocoa plants).
• Profit margins in some financial transactions (esp. in daily trading) are so low that a tax would put esp. small traders out of business.
• Transaction taxes are hard to implement, in particular taxes on international transactions. In addition, actors will find ways to circumvent the tax.So why a Financial Transaction Tax now?
• It is on the G20 agenda. At the September G20 summit in Pittsburgh, leaders mandated the International Monetary Fund to review “the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burdens associated with government interventions to repair the banking system.” This is seen as a nod to Germany and France, who at the time were publicly supportive of an FTT. Now the UK is on board, and the US even seems amenable with their new Treasury Secretary. Groups are pushing for the IMF to recognize both the technical feasibility of the FTT and its possibilities as a source for substantial revenue for the future.
• To reduce the overall size of the financial sector relative to the real economy and help curb speculative trading. The casino economy – in which money becomes the commodity to be traded, not goods and services – has exploded in the last two decades. This has divorced real growth, production and job creation from the majority of financial transactions, which are purely speculative, and end up generating “bubbles.” In 2008, for example, the trading of financial transactions was approximately 74 times higher than nominal global gross domestic product. In 1990, it was only 15 times higher. Just in the past decade, the trading of derivatives and foreign exchanges has far surpassed global trade. It would help to limit socially undesired transactions and thus internalize negative externalities and correct market failures (Pigou tax) .
• The financial sector is currently relatively under-taxed. While the financial sector has expanded dramatically over the past decades and has become a predominant economic actor its tax contributions remained minimal. A Financial transaction tax will ensure that the financial sector, which was at the core of the crisis, contributes to balance the tax burden.
• There is a huge shortfall in resources needed. Needs for additional finance by governments have never been so high. This includes tackling high deficits, financing stimulus packages and social security, as well as huge gaps for financing the MDGs and additional measures to cope with climate change). Economics professor Bruno Jetin has estimated $170 bn will need to come from OECD governments for climate change in 2012-2014 and again in 2014 to 2017 ($70bn adaptation, $100bn mitigation). 360 billion will be needed for climate tackling the MDGs.
• The financial sector should pay their fair share. People should not pay twice for a crisis triggered by the banks. In the coming years, when governments need to expand their revenue base and find their way out of a recession, there will unlikely be little public support for increasing personal or corporate income taxes, for increasing indirect taxation (through VAT and property taxes) or for increasing premiums to unemployment insurance. Broadening the tax base to include the financial sector is likely the best option.Who supports the FTT?
• Much of the support for the FTT is coming from Europe. Most recently, French President Nicholas Sarkozy and German Chancellor Angela Merkel called for a debate on the FTT at the September G20 Pittsburgh summit. Austria and Belgium have also expressed support for a taxation of currency transactions in the past.
• The EU parliament and European Commission have spoken out in favour of the FTT.
• Moreover, Adair Turner, the head of the British Financial Services Authority, which regulates the world’s second biggest largest banking center after New York, said that he is “happy to consider taxes on financial transactions” if increased capital requirements are insufficient to help shrink a swollen financial sector.
• At the November G20 finance ministers meeting in Scotland, UK Prime Minister Gordon Brown made a dramatic announcement of his support for an FTT, which elicited opposition from the head of the IMF (later partially retracted) and the finance ministers of Canada and the U.S.
• Some in US Congress support a small tax on stock transactions, with legislation being discussed.
• Academics Joseph Stiglitz, Paul Krugman, Dani Rodrik, Geffrey Sachs, Paul Volcker support the idea.
• Influential financiers George Soros and Warren Buffet.Who is opposed?
• The US administration, the US treasury and finance ministries generally.
• Significant parts of the UK government.
• Some EU member states such as Sweden because of negative past experience and new member states in favor of liberal tax policies
• The City of London and Wall Street, business and banking lobbies.
• The Economist and the Financial Times.Why are civil society organizations supportive?
• For their part, civil society groups are interested in the FTT for several reasons:
• Revenue: Since it covers a broad array of financial instruments, even a minimal tax would help generate significant resources that could be use for stimulus packages North and South, as deficits and public debts balloon, and to help fill the funding shortfall for achieving the Millennium Development Goals and climate change adaptation and mitigation. The Austrian Institute for Economic Research has estimated that a global transactions tax of 0.05% could yield between $447bn and $1022bn a year, even assuming a drastic reduction in market activity by 65%.
• Reliability of development finance: Furthermore, after the first few years, and the market has responded to the introduction of the tax, the amount revenue generated would likely be fairly predictable – helping governments plan for the future.
• Justice: A tax on financial transactions is a measure of political fairness and social justice. It will shift the burden of crisis resolution from the general public to the financial sector. It will balance taxation from wages and consumption to capital thus making the overall tax system more equitable. It would avoid unnecessary social sacrifices.
• Regulation: It would counterbalance financial authorities’ loss of control over global finance, and bring global banking back to its original function of financing the real economy. (Unlike previous iterations of a Tobin tax and Currency Transaction Tax (see below) – the rate being proposed for an FTT is relatively speaking much higher – anywhere from 0.01 to 0.5 per cent.) A Financial transaction tax at a rate ranging from 0.01 to 0.5 per cent is expected to be small enough to not have an impact on individuals investing in the stock market to diversify their personal income. But it is also big enough to stem at least short term speculative trading, done by day traders (who hold stocks for only minutes or hours) and create some stability to exchange trading.How is it different from a Currency Transaction Tax or Levy (CTT or CTL)?
• A CTT is a tax on currency transactions (i.e. exchanging money from one currency to another).
• A Currency transaction levy (CTL) was proposed in the context of innovative resources for financing development. It is a currency transaction tax at a very low rate. The purpose of the tax is purely to generate revenue, not to stem any speculative trading. Research has shown that a levy of 0.005% on all foreign exchange transactions in dealer markets would at most widen the spread by one basis point. A permanent increase of one basis point, as a result of the introduction of a CTT would conform with existing fluctuations in major currency markets. At the same time, a CTT of 0.005% on each transaction in major currencies would yield roughly US $33 billion annually.
• The two- tier CTT (Spahn tax) proposed by the German economist Spahn was developed after the Asian crisis and proposed a CTT at a very low rate for normal currency exchange, and a higher normalization duty that would kick in during periods of high currency volatility in order to stop speculative attacks on currencies.
• An FTT differs from a CTT or CTL in that a) it would cover all financial market transactions, not just currency transactions, and b) carry a significantly higher tax rate, with the intent of curbing speculation. Due to the volume and multitude of transactions the tax could yield significant revenue at a rather low rate (but not as miniscule as the CTL suggests).And what about the Tobin Tax?
• The Tobin Tax is the same as a CTT. It was first proposed in the seventies by economist James Tobin with a higher tax rate as a way to discourage currency speculations.How much are the proposed taxes?
• Different groups have proposed different rates, but generally the range falls between 0.01% and 0.5%. For the most part, groups do not see a single rate for all transactions, but varied rates depending on the type of transaction. (Some experts, such as Rodney Schmidt, have suggested a single rate for all transactions relative to underlying transactions costs , voicing concerns that different rates for different transactions could lead investors to pick the transaction with the least tax.)
• Using these figures, trading $1,000 of stocks or bonds, would cost an individual $0.1 or $5 respectively. Furthermore, for most individuals this tax would be spread out over a relatively long time horizon (on the occasion when you buy and sell your stocks). For day traders, the expense would be further compounded by the relatively short time horizon of their trades (daily or even hourly). The rate should be sufficient to have little impact on casual traders, but some impact on speculative exchanges done by day traders.How much would it raise?
• The amount of revenue generated would depend both on how widely the tax was adopted and what rate applied to different transactions. The Austrian Institute for Economic Research has estimated that a global transactions tax of 0.05% could yield between $447bn and $1022bn a year, even assuming a drastic reduction in market activity by 65%.
• The Center for Economic and Policy Research (CEPR) estimates that a varied tax (0.5% for stock transactions, 0.01 for bond trading, and 0.01 for swaps) would generate approximately $350 billion alone in US markets alone.
• Both the Austrian Institute for Economic Research and CEPR anticipate a drop in trading as a result with even a 50% drop in trading still generating more than global official development assistance.Will it create stability and stem speculative trading?
• Day traders will likely be discouraged from trading as a result of the tax. The FTT may also discourage the spread of complex derivative instruments, since the buyer could end up paying the tax at several different points, producing a stabilizing effect.
• Volatility of asset prices? Research linking the introduction of transaction taxes to higher price volatility are inconclusive, and have generated a mixed bag of results. That said, the tax rates currently being considered are relatively modest. Trading costs have fallen sharply over the last three decades due to improvements in computer technology. Therefore, with FTTs in place, transaction costs would rise to the level of two decades ago in most markets. Insofar as high transactions costs actually do increase volatility, the set of FTTs being considered would only raise levels of volatility back to their 1980s level. Stephan Schulmeister estimates that a small FTT (between 0.1 and 0.01 percent) would mitigate price volatility not only over the short run but also over the long run. This means a reduction in excessive liquidity stemming from very short term -oriented transactions (“day-trading”).
• Market liquidity? Critics of FTTs have argued that they will reduce the levels of liquidity in financial markets, making it more difficult for investors to sell assets. An FTT will raise transactions costs and therefore reduce trading volumes. This means that markets will be somewhat less liquid, but since transactions costs would just be driven up to their 80s level, there is no reason to believe that markets will be any less liquid than they were in the 80s – when capital markets were vibrant. Industries are supposed to become more efficient as the economy develops. It is only finance that is becoming less efficient due to its ever-growing complexity.
• Less efficient markets? While lower trading volume could in fact lead to less efficiency under normal circumstances, it is important to realize the limited impact of this effect – it would likely be over the short term and in keeping with standard market fluctuations (no research has been done to model long term impacts). Moreover, since trading costs would just be pushed up to their 1980s level, markets will be no less efficient than they were then. As a practical matter, the issue is likely to be a question of whether prices adjust in a single day or over a couple of days. Conversely, you might also argue that the frequency and severity of volatility resulting from large trading volumes undermines market efficiency.

That may be the case, but this little tax won’t stop all speculative trading!

• We are not saying that it will. The FTT is not a silver bullet. It is part of the solution, not THE solution.
• Accordingly, the FTT should be introduced alongside the regulation of financial instruments – in particular “over the counter” instruments – that don’t get captured by the tax.But then won’t it discourage investment and destroy Wall Street and the City of London?
• Investors with mid-term and long-term intentions will continue to trade. A small increase in trading costs would be a manageable burden for those who are using financial markets to support productive economic activity.
• That said, the US and the UK are home to most of the transactions, so they would take the biggest hit, but would also gather the biggest amount of revenue from such a tax. The majority of financial services would be unaffected at either rate.
• The UK already has a tax on stock trades (trades of derivatives and other financial instruments are untaxed) for decades and London is still one of the largest financial centers in the world.
• The US has “fees” applied to transactions in publicly traded securities and exchange traded futures and options. The long standing transactions fee for securities of 0.0033% was lowered in January 16, 2002, when President Bush signed into law H.R. 1088 that lowered securities transactions fees to 0.0012% (or $12 per $1 million) of the value of the transaction in securities.But won’t it lead to “emigration of trading” from one asset to another or one exchange to another, unless accepted internationally? Won’t our country lose out?
• If not introduced globally and for all financial instruments, there will likely be some efforts to shift the type of asset owned and the location of trading to evade the tax; but the tax will be applied to all financial transactions, and the impact on the revenue collected of such shifting will likely be relatively limited.
• In big financial marketplaces, actors benefit from network externalities (e.g. important partners in proximity, infrastructure etc.). As long as the tax rate does not exceed the costs of relocation, financial institutions would probably pay the tax rather than move to another location.
• For example, there are already large difference in transaction costs between countries, yet trading does not flee to the lowest cost country. Traders will balance the security of major exchanges in the US, UK, Europe and Japan and the network externalities, with the costs of such a tax. The British “stamp duty” on stock transactions, even at a comparatively high tax rate of 0.5 percent, has not done any harm to the attractiveness of the London market place.Won’t it hurt companies at a time when we are trying to kick start the economy?
• The tax is on the trade of financial transactions, not on companies themselves.
• The tax is geared more towards the size of stock markets and short-term trading of financial instruments, rather than the real economy. There is no inherent reason why there should be a tax on buying a car but not on buying a derivatives contract.But this is more taxes for me to pay. Aren’t we paying enough?
• In fact it is just the opposite. The tax is geared more towards speculative traders than non-professional long-term investors.
• Most middle class investors trade their portfolio relatively infrequently. Their goal is to save for specific purposes such as retirement, not generate income through constantly flipping stock and other assets. This means that the small fixed cost of such a tax is spread over a long-time horizon. The impact on investment returns would hardly be noticable.
• Why should the public pay $1.50 to withdraw money from different banks when we don’t require bankers to pay a banking fee when they speculate?
• Governments have the choice between massive cuts in public expenditure (which might bear high social costs and deepen the crisis) or search of income. Increasing mass taxes such as VAT would be regressive i.e. disproportionably hit the poor and hamper economic recovery.So how would the money be collected?
• The money could be easily collected (and at little expense) through centralized clearing or settlement systems that are used on all important exchanges through which all financial transactions (including OTC transactions) must already pass. All large-value transactions are made in three steps: trading, clearing and settlement. A simple electronic tag would automatically transfer the tax to the relevant tax office.
• Stocks and some derivatives are traded on exchanges. It is technically easy to collect a financial tax from exchanges because all three steps to financial transactions are essentially combined.
• Since clearing and settlement are highly formalized and globally centralized, a tax on OTC instruments can be collected at the point of clearing or settlement, and it would apply to all agents regardless of where in the world the trade is made.
• Effective enforcement of financial transactions taxes requires only the policing of a relatively small number of very large transactions in a small number of globally centralized systems.
• On a practical level, its introduction could be gradual, starting with domestic exchanges and exchanges on organized markets.Won’t an FTT be easy to evade?
• No. Evasive actions by market participants would be almost impossible if the G20 stood united in implementing the FTT. Besides the costs of evading the tax would likely be higher than the benefits.Will the FTT have to be implemented at an international level for it to work?
• No. Similar taxes already exist in several countries. The UK has a “stamp duty” on stock transactions of 0.5 percent. Even with the Stamp Duty, the UK stock exchange is one of the world’s largest. Also, country specific financial transaction taxes also exist in Austria, Greece, Luxembourg, Poland, Portugal, Spain, Switzerland, Hong Kong, China, and Singapore. The US-state of New York levies a stamp duty on Wall Street (New York Stock Exchange and NASDAQ) on all firms based there, although at the extremely low rate of 0.003%.
• Even just introducing such a tax just in Germany and the United Kingdom alone would capture 97% of all trading in Europe.
• To make the FTT a true success, large economies such as the United States, Germany and the United Kingdom will need to participate. But that shouldn’t prevent countries from unilaterally moving ahead on this. It is possible for a country to apply securities and OTC transactions tax unilaterally, without significant flight to exchanges in other countries, as long as the tax is designed appropriately.Would this work without the US?
• Clearly it would be important to include such a large partner as the US, but there is no reason why the FTT can’t be introduced unilaterally. “See “emigration trading arguments above).
• Stephan Schulmeister estimates that if only the UK and Germany were to participate, it would capture 97% of European Union transactions.Isn’t the US already going it alone with Obama’s new tax on large financial institutions? And what about the UK?
• The US’s Troubled Asset Relief Program (TARP) – the $700 billion financial-bailout bill from 2008 – contained a provision to “recoup” its “investment” from the financial-services industry in case there was a shortfall in the repaying of money. During his election campaign Obama, too, said in a speech in Wisconsin on October 1, 2008: “I’ve proposed a Financial Stability Fee on the financial services industry so Wall Street foots the bill — not the American taxpayer.“
• The levy on the country’s largest banks will help recover some of the money ($90 billion over 10 years) lost under the TARP program.
• UK initiativeDoesn’t this then negate the need for an FTT?
• The tax on the banks will not come close to recovering the losses incurred in the bailouts (which include the bailouts for Fannie Mae and Freddie Mac – which can now exceed $400 billion if events turn out badly.
• It will also do nothing to change the way that the banks do business. The money lost in the TARP program is just a small fraction of what the banks’ greed cost the United States – an estimated $4 trillion in output in this downturn, more than 40 times the projected revenue from the tax over the next decade. In addition, the $9 billion that is projected to be collected each year is equal to about 5% of their annual profits and bonuses. It is unlikely to have any noticeable impact on the way they do business. In other words, we can still expect them to be pursuing short-term profits and giving little consideration to long-term investments. For this we will need a larger financial speculation tax.
• The efficiency of such risk-based tax would be conditional upon the supervisory authorities’ ability to control effectively the risk exposure of banks. Because complex derivatives and structured products have been left unscathed, risk will be difficult to assess and banks will still have a lot of opportunities for regulatory and tax arbitrage.This fee will be difficult to implement and costly.What about an insurance scheme? Isn’t it better than the FTT?
• No. Under an insurance scheme, risks are pooled or transferred from private to public operators, but risks are not reduced as such.
• A prerequisite for any insurance scheme is the ability to price risk, which in turn presupposes the ability for the insurer (the regulator) to conduct proper risk assessment of the insured (the banks) and to proceed so at reasonable costs. This ability seems out of reach for the G20 regulators which lack information and data to understand where the risks actually lie.
• Additionally, the Basel II framework gives the bankers the extra degree of freedom to assess themselves and their risk exposure. The banks would essentially be acting as the insurer and the insured.
• Regarding revenues, an insurance scheme needs by definition to be pre-funded. Insurance fees are kept aside and would not be reallocated to fiscal sustainability and global public goods.
• An insurance scheme is also passive measure. Such a scheme would still not prevent sudden market swings, and may in fact help replicate them. There is an element of moral hazard to an insurance scheme – knowing you are insured against a future crash may make Banks take even more risks than they might otherwise. Regulators would wait for the next speculative asset bubble to explode and then would try to put out the fire.Where does the IMF stand regarding the FTT?
• The FTT is discussed as one of the options within a broader IMF mandate to consider “how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system.”
• This entails 1) paying for current crisis and 2) providing a tax/regulatory framework to minimize the likelihood and cost of future crises.
• The IMF is assessing the rationale, feasibility and implications of the FTT.How would the money be used and by whom?
• Since the major financial centres (the UK, US, Japan, Singapore, Switzerland, France and Germany) will collect the lion’s share of the revenue, there will unlikely be support for the tax unless considerable revenues are
• Available to the US and UK where most of the transactions take place
• Used at least partly to finance reducing the deficit in rich countries and preventing cuts in social programs
• Spread around the rest of the G20 to enable them to agree.
• There are a couple of proposals supported by civil society organizations, but most groups in Europe and North America are supportive of the following:
• 50% of the money generated will go towards fighting the deficit and paying off the public debts in the country where the tax has been generated and in some of the other G20 countries; 50% will be divided evenly between helping developing countries achieve the millennium development goals, and adapting to and mitigating against the impacts of climate change.How would distribution of the money be governed?
• The revenue generated needs to be administered in a responsible and accountable manner. Democratic governance of funds is imperative. Decisions with respect to the administration and allocation of revenues should be made in a multilateral setting, based on equal rights of all actors and inclusion of a wide range of stakeholders to ensure joint ownership, transparency and accountability.
• Many groups see the UN as the only institutional framework with the legitimacy to administer funds dedicated to global purposes.
• Some groups have proposed that the Global Fund to fight AIDS, Tuberculosis and Malaria, represents a positive model. Using that idea, the fund would operate on a demand-driven basis – governments submit proposals to the fund based on national MDG plans developed in collaboration with civil society organizations (and the private sector; once the proposals have been received, the resources are identified. Its performance-based funding can be regarded as a model for global governance and the provision of financial resources to global public goods.