Mulling a Mulligan on the Tobin Tax

Angela Merkel and Nicholas Sarkozy are probably both considering a mulligan on the Tobin Tax. Photo by Getty Images News.

Taxes are, to some extent, necessary. But they are often evil, in our view—they can sometimes distort free markets’ pricing mechanism and create myriad, frequently unintended, consequences. And it appears some European officials are just now starting to fathom the full implications of the EU’s proposed Tobin Tax, otherwise known as the Financial Transaction Tax (FTT).

In early January, 11 eurozone nations got the green light to enact a French-inspired transactions tax under the auspices of “making banks pay their fair share” for 2008’s government bailouts. The measure was approved under the EU’s “enhanced cooperation” procedures, which allow countries (more than 9) to pursue a common policy without full-EU adoption. And last month, the European Commission (EC), tasked by the 11 countries’ finance ministers to write the rule, delivered a 39-page draft rule, the potential impact of which is only now being debated in the EU (and because of its wide-ranging implications, elsewhere).

Under terms drafted by the EC, the FTT places a tax on the value of transactions in any stock, bond, money-market instrument, mutual fund, structured product, derivative or financial contract—nearly every financial instrument you can imagine. What’s more, under the proposal, the tax will be levied on any financial instrument domiciled in any of the 11 participating states—the “issuance principle.” Meaning, the tax will cover stocks, bonds and other assets issued in the 11 countries taking part, even if they are traded in a country not taking part in the FTT. For example, a New York company selling a share of a German-domiciled company to a bank in China would still be hit with the tax. And banks aren’t the only target. Pension plans, financial institutions, mutual funds and individual investors—potentially the world around—would be subject to the tax if trading financial instruments issued in those 11 states. (See MarketMinder staff writer Elisabeth Dellinger’s column, “The EU’s Transaction Tax Follies” for a full recap.)

But Thursday, the heads of the French and Italian debt agencies discovered they, too, were in the FTT’s crosshairs. Internal EC documents revealed the FTT could drain sovereign debt market liquidity, subsequently driving up yield spreads and debt costs across Europe—likely not the outcome envisioned by the original proponents of the measure given Europe’s recent sovereign debt woes. The EC’s proposal exempts sovereign governments, central banks, international organizations and bailout funds from the FTT, but nevertheless, drying up liquidity in markets generally could thin the market for these sovereign securities even if they’re not directly taxed.

Of course, it’s easy to see how the tax might impact other aspects of the economy too. Liquidity and trading volume in shares of companies domiciled in the 11 participating countries might drop as well—perhaps not precipitously or dangerously—but there’d likely be some impact felt by folks seeking to avoid enriching the EU’s coffers unnecessarily. Then too, there’s the possibility companies in those 11 countries reissue their securities elsewhere—perhaps New York—or better yet, the UK or Ireland’s welcoming shores, taking headquarters, jobs and tax revenue with them. In fact, a study last year by accounting firm Ernst & Young estimated the FTT could leave a €116 billion hole in Europe’s public finances due to lost growth from lower financial activity in the region.

So, although the FTT might raise €35 billion a year for the 11 participating countries, as proponents like EU Tax Commissioner Algirdas Semeta herald (Is there a Tax Commissioner out there who’s not a fan of new taxes?), the costs to Europe’s economy may be much greater too. The good news, however, is the FTT must still be passed unanimously by all 11 countries to go into effect—a high hurdle given the myriad unintended consequences and hiccups being revealed lately. Then too, it’s possible international pressure on the EU scraps the whole thing. For example, a couple hours after the French and Italian debt agency chiefs spoke about the FTT’s unintended impact on their countries debt markets, news broke Cyprus’ finance minister ruled out the FTT as part of any rescue package the beleaguered country may accept from the EU. Smart move.