European Countries to Weigh Pros and Cons of Financial Transactions Tax

A financial transactions tax, which was proposed by John Maynard in 1936, may soon be passed and implemented in 11 countries across Europe.

The tax has the multiple purposes of reducing risks and raising revenues from the financial sector. Unfortunately, there is no evidence to show that the tax is capable of achieving these goals.

Finance ministers from 11 European countries will informally discuss this proposal in Brussels this week. It is not chiefly concerned with raising revenue, and both supporters and opponents of this proposal agree that revenue will not be raised as income will be offset by fall in gross domestic product (GDP), which will lead to a fall in tax revenue.

In the eighties, Sweden made an attempt to pass a transaction tax. But it did not raise the desired revenue and 50% of its stock trading had to be sent to the UK. In addition, smaller countries will end up spending more in the implementation of this tax than getting any revenue from it. Therefore, countries that lose because of its implementation will have to be compensated, a point that needs to be discussed.

It also cannot be forgotten that the cost of implementation will be passed to the consumers. In a report of 2010, the International Monetary Fund (IMF) said:

Distorting business decisions reduces total output … A tax levied on transactions at one stage ‘cascades’ into prices at all further stages of production.

There are arguments that the tax will help prevent another economic crisis and stabilize the market, but these arguments hold little water. The tax will not have a huge impact on infrequently traded complex derivatives or mortgage bonds, which had added fuel to the fire of the economic crisis. Instead, the tax will have an impact on equities, currencies, options, and futures, which are actively traded.

But the tax has a larger problem, and that is its inability to differentiate between “the destabilizing transactions of speculators” and “the stabilizing transactions of fundamentalists,” as economist James Tobin would put it. And even if it could differentiate, a certain degree of speculative activity is essential for healthy markets, and nobody can say exactly how much of speculation is essential.

The danger of a financial transactions tax that reduces liquidity and discourages trading is the rise in market volatility. In addition to having no proven benefits, this tax could hurt not only investors, but also the wider economy.