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Franco-German plans for a Europe-wide tax on financial transactions are popular with many politicians - but less so with banks. While some experts see the tax as a cure-all, others consider it a recipe for disaster.
Can a transaction tax help prevent financial crises?
They had to come up with something to calm the financial markets and take some pressure off the embattled European currency, the euro. So German Chancellor Angela Merkel and French President Nicolas Sarkozy decided on various measures when they met in Paris two weeks ago. Among them: closer coordination of financial and economic policies, a debt ceiling to be introduced by all EU member states, and a financial transaction tax.
The idea has received backing from Austria, Italy, and Spain. The European Parliament already voted in favor of such a tax earlier this year. And the European Commission is currently working on a legislative proposal for a financial transaction tax, or FTT.
The most recent advocates of a financial transaction tax: Angela Merkel and Nicolas Sarkozy
An idea with a long tradition
One EU-member state markedly opposed to a financial transaction tax is Great Britain. Ironically, however, it was an Englishman who first promoted such a levy. Back in the 1930s, John Maynard Keynes, one of the most influential economists of the 20th century, argued that a tax on financial transactions would help thwart speculation on the financial markets.
Some 40 years later, US economist James Tobin proposed a worldwide tax on currency transactions. But the so called "Tobin tax" was never implemented on a multinational level.
Paul Bernd Spahn said introducing a 'Tobin tax' was feasible in 2002
In 2002, a German economist's contribution to the debate caused quite a stir. Paul Bernd Spahn, then a professor of public finance at the University of Frankfurt, assessed the feasibility of the Tobin Tax at the behest of the Federal Ministry for Economic Co-operation and Development. His conclusion was that it would be possible to introduce such a tax – but once again politicians did manage to agree on its implementation.
"Politicians were under pressure from financial institutions, who generally oppose a transaction tax for obstructing their business," Spahn told Deutsche Welle, acknowledging that there was not much of an incentive to introduce such a tax back in 2002. "There was no substantial crisis at the financial markets at the time."
Safety valve or cash cow?
With a view to the current financial crisis and the bailouts governments have committed to in recent months and years, several EU members and the European Commission think a financial transaction tax could help prevent future financial crises.
But banking expert Wolfgang Gerke disagrees. "A financial transaction tax will not prevent financial crises because these crises occur when economic fundamentals are wrong."
Gerke says governments want a transaction tax because it would generate income
Gerke said the tax under discussion, which would be beyond Tobin's levy on currency transactions to cover all financial transactions, is merely an instrument to generate income for the state. "Instead of becoming more efficient, saving money where it is appropriate, and thereby reducing public debt, the government wants to generate income for the state by introducing such a tax," he told Deutsche Welle.
In fact, the European Union expects a 0.05 percent tax on all stock exchange transactions would generate revenues of up to 20 billion euros ($29 billion) annually.
Economist Paul Bernd Spahn said he thinks that's a fair amount. "Today's computerized transactions come at a much lower cost than transactions did 10 years ago. And this tax would still only be a fraction of transaction costs."
High-frequency trading would be particularly hard-hit
The tax is unlikely to have a noticeable effect on long-term investors who regroup their assets only once or twice a year. For speculators, however, it's different story. The tax would especially hurt those engaged in "high frequency trading" supported by computer systems.
"In high frequency trading, trading software puts out orders in a split second," Gerke said, adding that this form of trading would be brought to a standstill if a financial transaction tax were introduced.
And that's where experts start to disagree, with neither side able to back up their views scientifically, according to Gerke. "Some argue that by doing away with high frequency trading, important liquidity would be lost to the market," he said. "But others argue that it would simply straighten out the markets' daily fluctuations a bit."
Sweden introduced a tax on financial transactions in the 1990s
A transaction tax may damage financial centers - or it may not
There is also disagreement about whether an EU-wide introduction of a financial transaction tax would damage the bloc's financial centers. According to UBS analyst Arnaud Giblat, the Swedish stock exchange suffered an 85-percent drop in revenue when national authorities introduced such a tax in the 1990s.
But Paul Bernd Spahn says Sweden does not serve as a case in point because it is a comparatively small economy in which such a tax could indeed lead investors to veer to other marketplaces instead.
"But the example of Great Britain shows the opposite," Spahn argues. "Great Britain introduced a stamp duty, which is in effect a tax on stock exchange dealings, and there is no depreciation because the market is so important."
Going it without Britain?
This British version of a stock exchange tax has existed for over 300 years, but it is levied only on companies headquartered in Britain. So far the British government has opposed all moves to introduce a tax targeting all financial transactions.
British politicians fear a transaction tax would drive business away from London
Angela Merkel and Nicolas Sarkozy have not commented on whether they would - if need be - introduce a financial transaction tax limited to the eurozone, to which the UK does not belong.
But even if London were to give in and drop its opposition to a new EU-wide financial transaction tax, economists like Wolfgang Gerke remain skeptical about the effectiveness of such a levy.
"These days, it's a matter of just one click whether I place my orders at the New York Stock Exchange instead of in Frankfurt," he said, adding that only a global tax would make real sense. And at the moment, that doesn't look like it's going to happen.
Author: Zhang Danhong / ar
Editor: Sam Edmonds