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April 15, 2013 7:20 pm
Europe is making a mistake. In February, the European Commission published a proposal for a financial transaction tax – also called a Tobin or “Robin Hood” tax – in the EU. Eleven states have been granted the right to impose a minimum 0.1 per cent tax on equity and debt transactions and a minimum 0.01 per cent charge on derivatives transactions. If the experience of Sweden’s use of such a tax is anything to go by, this move is extremely unwise.
One aim of the proposed tax is to improve the efficiency of financial markets by reducing speculation. Another is to generate tax revenues. Those were also the reasons why Sweden introduced a transaction tax in 1984. At that time, the outflow of capital from Sweden was limited by foreign exchange controls, which meant that Swedish investors were restricted in moving capital to foreign markets. Even so, investors fled the tax regime.
Initially, the tax rate was 0.5 per cent in connection with the purchase and sale of shares. In mid-1986, the rate was doubled and the tax base was broadened to cover share options and convertibles. The trading volume on the Stockholm stock exchange changed dramatically when the tax was increased. Average turnover fell 30 per cent during the second half of 1986 and throughout 1987. The turnover in the 11 most traded shares fell 60 per cent. It seems unlikely that this sharp decrease reflected a decline only in speculative trading.
Later, in 1989, the tax base was broadened to include bonds. This, in turn, led to an 85 per cent reduction in bond-trading volume and a 98 per cent reduction of trading volume in bond derivatives. The increase in tax revenues resulting from the broadening was less than 5 per cent of what had been expected.
By 1990, shortly after the last vestiges of the currency controls were abolished in Sweden, more than 50 per cent of the trading in Swedish shares had moved to London. Conversely, once the tax was abolished in December 1991, trading on the Stockholm stock exchange recovered. In 1991, 40 per cent of trading in Swedish shares took place on the Stockholm stock exchange; in 1992, this number had increased to more than 50 per cent.
Even investors that stayed in Sweden found their way around the tax. There were problems in defining what should constitute a taxable transaction: for good reasons, some derivatives and debt instruments were not taxed. But this resulted in increased trading in these instruments. This gives reason to question the extent to which the tax really reduced speculation.
This conclusion is reinforced by studies on the effects of the Swedish tax, which suggest that it reduced market liquidity but not volatility. Since increases in speculative trading tend to be associated with more volatility, this also suggests that the tax had little substantial effect on speculative trading.
There are some lessons to be learnt from the Swedish experience. First, on open financial markets it is easy to move transactions to untaxed markets. The intensified use of automatic trading makes it easier to do so, which erodes the tax base.
Second, it is legally problematic to determine what constitutes a taxable transaction. This makes tax inspection difficult – and will increase trades in the financial instruments that are untaxed.
Third, it is unlikely to make much money. If the tax improves the efficiency of the market, the tax base will shrink as a result of the decline in trading. Even if the volume of transactions is not affected by the tax, the tax may not necessarily generate much since transactions may move to untaxed instruments.
Taxes generate revenues, but also entail costs in the form of distortions that reduce economic activity. When choosing between different taxes, the starting point ought to be for public expenditures to be funded at the lowest cost to the economy.
From this perspective, and according to the Swedish experience, a transaction tax is a poor way of generating revenues. Rather than merely reducing speculative trading, the Swedish tax tended to reduce and redirect financial investments that reflected other needs than speculation.
So Europe should learn from Sweden: a transaction tax is likely to lead to distortions in the form of short-term and long-term transactions migrating to other countries, and to untaxed financial instruments – or they might come to a complete halt.
The writer is a former economist at the Swedish ministry of finance and the country’s Riksbank
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