Financial Transaction Tax Would Be a Problematic Experiment

Prof. Dr. Michael Schröder, head of the Research Department "International Finance and Financial Management" at ZEW, comments on the introduction of a financial transaction tax which is currently under discussion: the introduction of a financial transaction tax (FTT) would reduce the volume of short-term trading activities at the capital markets involved and would lead to an increase of tax revenues. On the other hand, it would probably increase the price for corporate financing. A quick migration of financial transactions to trading centres which are not subject to the tax might be slowed down by the location principle proposed by the European Commission.

There is uncertainty about the further impacts of a FTT, since these impacts depend on the exact shaping of the tax and the reaction of those who are affected. A tax which only implies stocks, bonds, and derivatives, as proposed by the European Commission, could lead to the creation of new financial products, which are not (yet) subject to taxation. To prevent such an avoidance strategy, a FTT should include all kinds of transactions. But thereby, the negative effects for the real economy would increase. There is even dispute about the impacts on the market volatility, since by a strong reduction of the liquidity a high tax rate can even widen the fluctuation range of rates.

Since there cannot be identified any steering effect of a FTT, which would lead to more stability on financial markets, as well as there cannot be seen any contribution to the solution of the current state debt crises (except from an increase of tax revenues), the closure of a systematic loophole remains a further motive for the introduction of a FTT, because many worldwide transactions are exempt from value added tax. But for the closure of this loophole, the so called financial activities tax (FAT) would be more appropriate. With the FAT, the assessment base is the added value of banks and other financial service providers. It can be compared to the usual VAT on private consumption. With a FAT, not single transactions are subject to taxation, but the total wage bill and the profits. But also with this tax, international banks can create strategies to avoid taxation.

The numerous uncertainties and the imponderability concerning the impacts of the two financial taxes suggest that it would be better to first test the effects in a most realistic possible laboratory experiment. But if politicians decide to make the risky introduction of such a tax, a relative low tax rate should be chosen to reduce possible negative effects of this real experiment.

For further information please contact

Prof. Dr. Michael Schröder, Phone +49 621/1235-140, E-mail schroeder@zew.de