Introduction

The proposed introduction of a financial transactions tax (FTT) by the European Commission, which would involve levying a tax on financial transactions, has caused widespread political and academic debate, with the UK campaigning voraciously against its introduction.

Reasons for introducing a Financial Transactions Tax

Some argue that the financial sector should make greater financial contributions to society in light of its responsibility for the recent crisis. The crisis resulted in a huge number of businesses becoming insolvent, which in turn increased unemployment and ultimately exacerbated poverty and reduced the living standards of society. These issues were exacerbated by the fact that the government had to allocate an extensive amount of taxpayer money to bail out financial institutions (rather than spending it on social welfare initiatives). This issue was raised during the 2015 ITV Leader's Debate, where statistics indicated 1 million more children will be living in poverty by 2020 as a result of the cuts imposed by the government necessitated by the aftereffects of the financial crisis.

Financial transactions targeted by the proposed FTT are currently exempt from VAT, whereas most other transactions in other industries are not. As such, the financial transactions tax would bring the financial sector's tax burden more inline with that in other industries. Although some items admittedly attract VAT classed as 0%, the proposed tax rate of 1% on financial transactions is still far less onerous than the VAT rate of 5%-20% that applies to a majority of goods and services.

How could the tax revenue raised be used?

Tax revenue raised from a financial transactions tax could be used to help tackle poverty and related issues and perhaps stimulate employment (for instance through providing tax relief to small businesses that take on new employees). This would likely have little impact (in the short-term at least) on the financial well-being of financial institutions (in light of the huge profits City institutions tend to report every year), yet the redistributive effect could have a wide-reaching positive effect on society as a whole.

Funds raised through the proposed FTT could also help to fund adequate safeguards to ensure the industry remains stable and sufficiently risk averse to avoid another crash. Revenue could bring greater stability to the financial markets through funding regulators. If these regulators were funded (through FTT revenue) and run by the government (as opposed to the institutions themselves) this could ensure vital independence that in turn can ensure institutions are more effectively held accountable.

Revenue could also contribute to a fund that could be available in the future in order to bail out financial institutions so that the government does not have to use taxpayer money (which typically results in social welfare cuts to compensate). It is arguable that financial institutions should pay for their shortcomings, not the tax payer; when individual businesses go insolvent, society does not provide a collective fund in order to reinvigorate the ventures despite the potential incompetence or negligence of the bankrupt party.

However, it is arguable that regulations such as Basel III adequately restrict the ability of financial institutions to take unprotected risks that are large enough to threaten their stability, suggesting this may be somewhat of a moot point.

Reasons against introducing a Financial Transactions Tax

Whilst in theory there are numerous positives that could be attributed to the introduction of the financial transactions tax, this is based on the underlying assumption that financial institutions will absorb the financial burden themselves. However, there would be nothing to stop financial institutions (other than competitive forces, although all the major industry players are likely to take similar action) passing on this burden to consumers of their services via reduced returns. Lower profits would most likely equate to smaller dividends for shareholders. Considering institutional investors such as pension funds hold a huge number of shares in financial institutions, smaller dividends could have a detrimental affect on the value of pension schemes of millions of individuals.

The macroeconomic effects could also call into question the viability of introducing of such a tax. When a similar tax was introduced in Sweden, 60% of trading volume migrated to London, which in turn diminished overall tax revenues generated by the Swedish government. The effect on the UK government could be far worse, as the UK financial services industry is much larger both in size and proportionally to other national industries than the Swedish financial services industry. This indicates the UK government is more reliant upon the tax revenues currently generated both directly and indirectly by the industry.

In addition, the financial services industry contributes significantly to employment in the UK. This in turn generates (in light of the wages received by many in this industry) significant income tax revenues, whilst reducing the welfare bill that would otherwise exist if some of those employed were out of work. The projected job losses that could follow the introduction of a financial transactions tax (due to the effect it could have on profitability) is estimated at 1 million (not only in finance but also supportive industries). This in turn could also significantly reduce income tax revenues and increase the government's welfare burden.

Financial Transactions Tax in other jurisdictions

However, a similar tax in Brazil did not seem to deter investor enthusiasm. Moreover, Hong Kong, Madrid, Seoul and Taipei have all imposed FTTs that have collectively raise £12bn, and such taxes have not prevented these jurisdictions becoming the world's fastest growing financial centres.

Moreover, the EU has proposed implementing a consistent FTT across member states, which would apply when only one of the financial institutions resides in one of the member states. This is likely to mitigate the risk of economic activity shifting to other jurisdictions, including non-member states, as a huge number of transactions involve at least one institution residing in European financial centres such as London, Frankfurt and Dublin, and (as mentioned) Asian financial centres such as HK have already imposed the tax. However, the Eurozone still remains divided on this issue (The FT).

Conclusion

Although the potential detrimental effects of such a tax are well documented, evidence in other jurisdictions indicates that the financial services industry worldwide is likely to adapt to such a tax if the additional financial burden it imposes is not too high. The potential positive effects in terms of social welfare and the funding of safeguards are not insignificant.

It must be noted that the proposed FTT is not the only means by which the policy considerations discussed above can be addressed however. Other proposals include the mansion tax and a tax on bankers' bonuses, which perhaps provide a compromise between maintaining economic activity in the UK and ensuring the industry bears at least some of the burden caused by the financial crisis.