Abstract
No subject is more certain to raise the hackles of traders in financial institutions than a financial transaction tax, however small. Measured for unleashing a torrent of abuse, it even edges out, in the City of London,, the question of continuing to be part of the European Union. The traditional banker’s response, something I initially bought into, is to adopt a rather superior air that suggests that the protagonists do not understand the realities of finance. We would, in patronizing tones, remark that it would be a wonderful tax if only it were feasible. But lamentably, finance is now conducted in cyberspace, and cannot be tracked down and taxed.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
I am including in this total the fines on J. P. Morgan for “egregious breakdowns in controls and governance” relating to its London whale-trading debacle in 2012 as well as fines on BNP Paribas, HSBC, UBS, Credit Suisse, and ABN Amro for sanctions and breaches of money laundering as well as aiding tax fraud.
- 2.
Hidden costs are estimated to be in the region of 50–60 basis points. See David Blake, “On the Disclosure of the Costs of Investment Management,” (Discussion Paper PI-1407, London: Pensions Institute, Cass Business School, 2014), www.pensions-institute.org/workingpapers/wp1407.pdf.
- 3.
In a study of approximately eighteen hundred US equity mutual funds from 1995 to 2006, aggregate trading costs were found to be 1.44 percent of assets under management, with hidden costs being around 0.55 percent. See Roger Edelen, Richard Evans, and Gregory Kadlec, “Shedding Light on ‘Invisible’ Costs: Trading Costs and Mutual Fund Performance,” Financial Analysts Journal 69 (2013), pp. 33–44. Similar results can be found in John C. Bogle, “The Arithmetic of ‘All-In’ Investment Expenses,” Financial Analysts Journal 70 (February 2014).
- 4.
The average pension fund turns over its portfolio once every three years, so a 0.1 percent turnover tax on the purchase of a security would be equivalent to a 0.033 percent per annum charge—one-twentieth of current annualized marginal costs.
- 5.
To understand credit counterparty risk, consider that you took out insurance against the default of a supplier. The market risk in this contract is the risk of the supplier defaulting. The credit counterparty risk is the risk that, given a default, the insurance company that promised to pay in the event of a default, has gone bust, perhaps because it had insured too many against the same risk.
- 6.
The existence of a form of stamp duty in Europe can be traced back to Roman times, when Emperor Justinian decreed that there must be certain inscriptions on legal forms in order for them to be enforceable.
- 7.
In reference to these transactions, it is called the stamp duty reserve tax.
- 8.
In England, stock exchange activities began in the coffeehouses in the City of London, like Jonathan’s in the 17th century and later Garraway’s. Long before the white socks and red braces, the coffeehouses had been banned from trading in the Royal Exchange for excessively raucous behavior. The London Stock Exchange was formally established in 1801.
- 9.
The UK government announced that it would abolish the stamp duty and stamp duty reserve tax on transfers of interest in exchange-traded funds, or ETFs, and on transactions in securities admitted to trading on a recognized growth market (like the AIM, or alternative investment market) provided the market is not also listed on a recognized stock exchange.
- 10.
See Stijn Claessens, Michael Keen, and Ceyla Pazarbasioglu, “Financial Sector Taxation: The IMF’s Report to the G-20 and Background Material,” IMF, September 2010, http://www.imf.org/external/np/seminars/eng/2010/paris/pdf/090110.pdf .
- 11.
The banking industry argued that it would be hard to assess. No doubt it also said to governments, as it often does, that it is customers, as in voters, who will pay.
- 12.
See Claessens, Keen, and Pazarbasioglu, “Financial Sector Taxation.”
- 13.
This is a conservative estimate based on a narrow definition of securities transaction taxes. Brazil raises $15 billion each year from different types of financial transaction taxes, the UK $6 billion, and Taiwan $3–4 billion alone.
- 14.
See House of Lords, European Union Committee, “Towards a Financial Transaction Tax?” (HL Paper 287, London: Authority of the House of Lords, 2012), www.publications.parliament.uk/pa/ld201012/ldselect/ldeucom/287/287.pdf .
- 15.
Euroclear also provides central clearing and settlement services for Belgium, Finland, France, Ireland, Netherlands and Sweden across around nine hundred thousand different securities.
- 16.
See Chapter 3.
- 17.
J. Bradford DeLong, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann, “Positive Feedback Investment Strategies and Destabilizing Rational Speculation,” Journal of Finance 45, no. 2 (1990), pp. 379–95.
- 18.
See Elroy Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists: 101 Years of Global Investment Returns (Princeton, NJ: Princeton University Press, 2002).
- 19.
Arthur Cecil Pigou was a 19th-century Cambridge economist who made substantial contributions to the discussion of the divergences between the socially optimal outcome and the one left purely to market forces—negative externalities. See A. C. Pigou, “Divergences Between Marginal Social Net Product and Marginal Private Net Product,” in The Economics of Welfare (1932; Memphis: General Books, 2010).
- 20.
See “Times Topics: High Frequency Trading,” New York Times, December 20, 2012.
- 21.
For a useful survey of alternatives, see European Commission, Taxation Papers: Financial Sector Taxation (Working Paper 25, Luxembourg: Publications Office of the European Union, 2010), http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_papers/taxation_paper_25_en.pdf . See also the earlier reference to the IMF’s 2010 report to the G-20—Claessens, Keen, and Pazarbasioglu, “Financial Sector Taxation.”
- 22.
See Avinash Persaud, Liquidity Black Holes (Discussion Paper 2002/31, Helinski, Finland: UNU/WIDER, 2002).
- 23.
This piece of reality is not part of the model in DeLong et al’s paper. However, their results would not change if the model was augmented with the simple idea that noise traders don’t have one strategy but learn quickly. They adopt contrarian strategies when market are directionless and momentum strategies when they exhibit strong movements in one direction or the other.
- 24.
Studies and surveys of market behavior at a particular point in time.
- 25.
This reminds me of the economist joke where one night a man comes across an economist looking for his lost wallet under a streetlight and offers to help. After some time looking, the man asks the economist if he is sure he dropped it there and the economist says, “No, I didn’t drop it here but this is where the light is.”
- 26.
Based on the most recent data from the European Commission as well as the Bank for International Settlements, the sources of financing companies are assumed to be: primary equity issuance (10 percent), retained earnings (55 percent) and debt (35 percent). Among the total debt of nonfinancial corporations, the share of debt securities could be estimated at about 15 percent (or about 5 percent of total financing). This mitigating factor is now incorporated into the second version of the model (see Julia Lendvai, Rafal Raciborskiz and Lucas Vogel, Securities Transaction Taxes: Macroeconomic Implications in a General Equilibrium Model, Economic and Financial Affairs, Economic Papers 450, EU Commission, March 2012, Brussels), which has brought down the estimated growth effects of FTT to –0.2 percent of GDP.
- 27.
Ibid.
- 28.
See Carmen M. Reinhart and Kenneth S. Rogoff, The Aftermath of Financial Crises (NBER Working Paper 14656, Cambridge, MA: NBER, 2009).
- 29.
Moving corporate headquarters is a major deal and when this is done merely for tax purposes, such as in the case of mergers motivated by tax inversions, the tax authorities can sometimes neutralize the tax effect of the inversion, as was the case with US-headquartered AbbVie’s 2014 proposed $54 billon takeover of rival drug maker Shire.
- 30.
This is known as the strike price of the option.
- 31.
This is known as the option expiry date.
- 32.
This is the notional value of this option.
- 33.
This is the option premium.
- 34.
In Chapter 7, we noted that the connection between insurance and derivatives was not lost on the insurance firm AIG, especially where the capital requirements on the net insurance exposures of highly rated packages of credit insurance were lower than the capital requirements a bank would have needed for loans to those same credits. This provided an arbitrage opportunity across banking and insurance lines. AIG bulked up on both writing and buying insurance on highly rated packages of credit risks. This strategy exploded when the financial crisis hit, at which point AIG’s insured events coincided with the collapse of the credit quality of those who sold the offsetting insurance contracts. The corporation’s exposure moved from a tiny net position to the larger gross position.
- 35.
Complex options are nothing more than the layering of a series of vanilla options. For instance, I may pay you if the price of BP shares rises above £5.50 as before, but now we might add an overlapping option where you will have to pay me the same amount if the price rises above £6.00, so that my exposure only lies between £5.50 and £6.00. Known as a collar, buyers of these options tend to be those with a view that prices will move within a small range and are really placing more of a bet on volatility being low than on a specific price being reached.
- 36.
A scrip or bonus issue is one where a company’s cash reserves or part are converted into shares and distributed proportionally to existing shareholders.
- 37.
A rights issue is one where a company issues new shares and gives existing shareholders a first right of refusal in taking up those shares, and therefore does not suffer a dilution in the proportion of the outstanding shares that they own.
- 38.
See the European Commission, “Taxation of the Financial Sector: The Proposal of 14 February 2013,” European Commission, last updated April 14, 2014, http://ec.europa.eu/taxation_customs/taxation/other_taxes/financial_sector/index_en.htm#prop .
- 39.
Note that in the assessment of capital gains tax on shares, in those jurisdictions that have capital gains taxes, information is required and already routinely disclosed on purchase and sale prices and times.
- 40.
Clearing describes the activities that take place between the time a trade is agreed upon and the time when all the relevant payments are completed. Where millions of trades are agreed on daily, prices move around substantially through a day, and, as it takes 24–48 hours to settle trades, there is a potential for many a trade to slip twixt the cup and the lip. During clearing, one of the parties may go bust, leaving the other without the security it has paid for, or, having transferred the security, without the cash that is owed. Given that a small number of financial institutions are party to the majority of trades, it is safer and cheaper to have a centralized place—the central clearinghouse—where exposures between approved counterparties may be netted out so there only needs to be collateral and cash to cover the small net exposures and not the large gross exposures.
- 41.
The “double Irish” scheme is a tax minimization strategy that appears to rely on the fact that Ireland does not levy significant taxes on income booked in subsidiaries of Irish companies that are outside of Ireland.
- 42.
See Michael Findley, Daniel Nielson, and Jason Sharman, Global Shell Games: Testing Money Launderers’ and Terrorist Financiers’ Access to Shell Companies, Griffith University, October 2012, www.griffith.edu.au/__data/assets/pdf_file/0008/454625/Oct2012-Global-Shell-Games.Media-Summary.10Oct12.pdf .
- 43.
See OECD, “Convention on Mutual Administrative Assistance in Tax Matters,” last updated October 2014, www.oecd.org/tax/exchange-of-tax-information/conventiononmutualadministrativeassistanceintaxmatters.htm .
- 44.
See IRS, “Foreign Account Tax Compliance Act,” last updated September 15, 2014, www.irs.gov/Businesses/Corporations/Foreign-Account-Tax-Compliance-Act-FATCA .
- 45.
See, for example, PricewaterhouseCoopers, “Soon to be Released Common Reporting Standard Promises New FATCA-Type Obligations Around the World,” PricewaterhouseCoopers, January 9, 2014, www.pwc.com/en_US/us/financial-services/publications/fatca-publications/assets/pwc-tax-insights-common-reporting-standard.pdf .
- 46.
The purpose of this requirement is to limit the systemic risk caused by the failure of a single counterparty. During good times, the counterparty may appear to present a small risk, but this may be because it is engaged in a large number of back-to-back transactions. If the counterparty fails and all of these underlying transactions fail, the system could fail. However, if there is an agreement through a clearinghouse on how this will be managed in the event of failure and how back-to-back contracts that net out will be handled and the net risk insured against, the risk of systemic failure could be avoided. The confidence this brings will spur activity.
- 47.
The European Parliament and Council issued this regulation on July 4, 2012, and it entered into force on August 16, 2012. The implementing standards were published in the Official Journal of December 21, 2012. The main obligations of EMIR are the central clearing for certain (vanilla) classes of OTC derivatives; the application of risk mitigation techniques for non-centrally cleared OTC derivatives; the reporting of all transactions to trade repositories; the application of organizational conduct of business; prudential requirements for central clearinghouses; and the application of requirements for trade repositories, including the duty to make certain data available to the public and relevant authorities.
- 48.
Bank for International Settlements, ISDA 2010 Market Surveys and Booz and Company Analysis (2009).
- 49.
See Avinash Persaud, “Look for Onshore, Not Offshore Scapegoats,” Financial Times, March 4, 2009, and Avinash Persaud, “Power & Politics: How Small States Should Respond to OECD, FATF and G20 Initiatives,” Comsure (address at the IFC Conference, Barbados, September 2014), www.comsuregroup.com/power-politics-how-small-states-should-respond-to-oecd-fatf-and-g20-initiatives/.
- 50.
The first Eurobond was issued in 1963 by Italian motorway network Autostrade. S. G. Warburg arranged the issue in London. By issuing US paper outside of the United States, the instrument attracted US investors but was free of national withholding tax.
- 51.
The title track of Bob Dylan’s 1964 album.
- 52.
See Tom Brathwaite, John Paul Rathbone, and Gina Chon, “JP Morgan Shuts Foreign Diplomats’ Accounts,” Financial Times, May 6, 2014.
- 53.
See ISDA, www2.isda.org/ .
- 54.
As we go to press, an even-more-ambitious ISDA clause is being discussed. Under pressure from the Financial Stability Board, the ISDA is considering including automatic standby clauses in derivative contracts when a bank is in trouble to stop a self-feeding panic about counterparty risk. Where there is a will, there is a way.
- 55.
See European Commission, “Common Rules for a Financial Transaction Tax—Frequently Asked Questions,” last modified September 28, 2011, http://europa.eu/rapid/press-release_MEMO-11-640_en.htm .
- 56.
Churning is the frequent turning over of an investment portfolio and, as is often associated with tax avoidance, the speculation on short-term events, awarding trading commissions and more. The average pension fund completely turns over its portfolio once every two years. Some high-frequency traders turn over their portfolios many times a week or even within a day.
- 57.
See Roger Edelen, Richard Evans, and Gregory Kadlec, “Shedding Light on ‘Invisible’ Costs: Trading Costs and Mutual Fund Performance,” Financial Analysts Journal 69 (2013), pp. 33–44 and John C. Bogle, “The Arithmetic of ‘All-In’ Investment Expenses,” Financial Analysts Journal 70 (February 2014).
- 58.
The proposed rate of the Bill proposed by Senator Harkin and Representative DeFazio and introduced to the Senate on November 2, 2011.
- 59.
Estimate from Deutsche Börse Group, see: http://deutsche-boerse.com/dbg/dispatch/en/kir/dbg_nav/home . See also Amit Desai and Jussi Tahtinen, Getting Fit for Clearing: Pursuing the OTC Central Clearing Market, PricewaterhouseCoopers, 2011, www.pwc.co.uk/en_UK/uk/assets/pdf/pursuing-the-otc-central-clearing-market.pdf .
- 60.
Estimates are from PricewaterhouseCoopers and Deutsche Börse Group.
Author information
Authors and Affiliations
Rights and permissions
Copyright information
© 2015 Avinash D. Persaud
About this chapter
Cite this chapter
Persaud, A.D. (2015). Financial Transaction Taxes. In: Reinventing Financial Regulation. Apress, Berkeley, CA. https://doi.org/10.1007/978-1-4302-4558-2_12
Download citation
DOI: https://doi.org/10.1007/978-1-4302-4558-2_12
Publisher Name: Apress, Berkeley, CA
Print ISBN: 978-1-4302-4557-5
Online ISBN: 978-1-4302-4558-2
eBook Packages: Business and EconomicsEconomics and Finance (R0)Apress Access Books