European Union Financial Transaction Tax - Essay Example

? European Union Financial Transaction Tax European Union Financial Transaction Tax The issue of tax is an important aspect in the economic world. The financial transactions tax is on top of the agenda and it proposes an introduction of a financial introduction tax by the European commission amongst its 27 state members by 2014. This tax is meant to have an impact on financial transactions amongst institutions of finance that charge against the bonds and shares exchange across contract derivatives (Alworth and Arachi 2012). This initiative however does not affect businesses and citizens. The proposed transaction tax is different from a resolution levy or bank levy. Some governments have it in mind to impose bank levy in order to insure banks against future bailouts. However, this issue remains a matter of controversy amongst member states of European Union. The executive of the European Commission was to carry out a study to determine if it is appropriate to impose the tax on European Union alone. Tobin-style taxation method was imposed on EU’s sector of finance for purposes of generating direct revenue. The European Commission also suggested reduction of levies existing in the 27 state members. The new transaction tax was to ensure that the financial sector paid its fair share since it had been under-taxed for long (Collins 2011). The proposal effectively introduces a new minimum of rating taxes and harmonizes different taxes that exist in the EU’s financial transactions. This initiative will further aid in reducing competitive single market distortion, will discourage trading activities that are risky, and it will complement measures for regulations that are meant for avoiding crises in the future (Davidson 2002). The taxes will be levied on every transaction between institutions of finance as long as any of the involved parties in the transaction is within the EU location. The targeted institutions include; insurance companies, investment firms, pension funds, banks, hedge funds amongst others. House mortgages, insurance contracts contributions, bank loans to medium and small enterprises, spot transactions of currency exchange and issuance of shares and bonds on primary market will not be subjects to taxation (Mooslechner, Schuberth and Weber 2006). However, taxes will be imposed for secondary markets bond trading (Stigler 1971). The institution of finance is required to pay the rate of tax as per its residential country regardless of the actual trade location. The tax will cover all the transactions involving Europeans firms without considering where the transactions took place. In this case, the brokers transacting on behalf of clients, are in a position to pass the tax unto the client. The European Union is composed of 27 state members amongst whom some are for the implementation of the transaction tax while others like the United Kingdom are opposing it. The government of the United Kingdom threatens to use its veto power to stop the proposal implementation unless it is introduced globally. The member states that are for the implementation suggest that the taxing should be implemented within the few member states euro zone and exclude the states that are reluctant. The general public opinion is that the financial transaction tax should be implemented be it global or within the European Union. People feel that it is a high time the sector of finance helped in repairing the damage resulting from economic crisis. The commission had launched consultations with the public in order to obtain feedback from the stakeholders on the financial sector taxation initiative. The consultations are to aid in testing assumptions, collecting evidence relating to the definitions of problems, assessing impacts of set policy options and consulting on detailed aspects of the design and feasibility of policy options. Critics are stating that, Britain would disproportionately shoulder the negative consequences of the financial transaction tax if it would only implemented within the European Union other than globally. Economists based in Europe estimates that, implementation of the financial transaction tax in UK, could lead to over 100,000 losses of jobs from the London’s sector of finance. The UK’s chairperson of treasury select committee claims that the enactment of the transaction tax will cause losses of total revenue from taxes for Britain. Conclusions drawn from critics are that implementation of financial transaction tax within the European Union would lead to reduction of UK’s total transaction volumes especially the ones that originate from high-frequency trading. In UK’s perspective, this tax will also reduce other speculative and destabilizing patterns of trade in securities like short selling. The UK’s lords’ house has also expressed concerns about the transaction tax impacts stating that, the tax will cripple the economy of the UK by destruction of derivatives trading volume within the city of London (Goodhart 1998). The London city accounts for 74.4% of rates of interest generated from the trade volumes within the scope of the European Union. The success within the European Union is determined by the quality of taxation. The financial tax crisis has exhibited the Member States interdependence, and it highlights the need for coordinated and strong approach towards fiscal policy areas. Being a single market is an asset for the European Union which if built on will lead to countless benefits to citizens, businesses and member states (Michalos 1997). The UK will be a beneficiary of the same tax despite its resistance to its implementation. In this state alone, the tax, as per expected will generate not less than 10bn per year. This amount is significant and if utilized accordingly will consolidate finances, invest in activities promoting growths and contribute to worldwide challenges like climate change and other development. If such an enormous amount is compared to amounts generated from bonuses, the UK will understand how much would be levied via the tax to contribute to the public finances. London is the financial world centre because of people, infrastructure and scales of economy offered there. Therefore, the financial taxes will re- build the confidence of the citizens in the sector of finance by contributing fairly to recovery costs and public finances. The transaction tax will offer an opportunity to the sector of finance to regain the wider population trust and an incentive that will aid in re-focusing its activities towards real economy. Tax coordination policies mean less red tape and more certainty that is a good environment for businesses to thrive. Member states are all in such of new resources and the tax will not in any way hinder prosperity and growth in the single market. The transaction tax will safeguard UK’s ability in applying successful tax policies without being undermined by the approach used by their neighbors’. The tax policy does not threaten national sovereignty. Tax is central in UK’s political agenda (Vittas 1992). The tax policy creates stable and simple business markets, addresses mismatches and tears down barriers to tax. The tax is a tool of joining forces amongst states including the UK to exhibit strength globally. Coordinated tax approach offers member state opportunities to gain quality revenues, more attractive business environment and tax systems that are acceptable to citizens. The system will be optional for business and therefore, the UK retains the right to settle the rates of the taxes. The finance sector will benefit from the transaction tax since they will spare lots of money through inter-governmental information exchange. The UK government views the current financial system as weak. Proposals have been set out to replace that system with a regulatory framework that is new. Currently, no institution has authority, tools or responsibility for monitoring the whole system of finance. A policy committee on finance is currently underway and it is responsible for assessing financial risks and the entire economic in general for the system’s stability (Gray and Hamilton 2006). The targeted reforms will introduce greater focus and judgment to regulating financial firms. The financial service will be dissolved and two new regulators of finance will be created. The new regulators include an independent conduct of business regulator and prudential regulation authority. They will have the mandate of promoting transparency and confidence in services of finance and give consumer protection. The operations of systems of finance are influenced by policy through financial supervision and regulation. Finance is a specialty since it is ubiquitous in the sense that, every organization, individual, enterprise and even the government require it. Finance is also key to any economic development as it is the means for transferring and transforming an economy’s saving towards its investment (Herrin and Litan 1995). A financial sector that is efficient encourages lots of saving, more investments that are efficient, and this result in high-income levels and faster growth. If the financial transaction tax will be implemented, the private sector and the governments of the European Union will be required to embark on material engagement to reduce its impacts that are egregious. The European Union governments, which will be in a position to retain their jurisdiction outside the FTT direct scope, might find opportunities globally from reconfiguration that allows “offshore” to FTT. The transaction tax is applicable to risk transfers, selling or purchasing and amendments of derivative contract. The financial instruments involved in financial transaction taxation include, bonds, shares, unit trusts and structured products. Transactions of stock lending repurchase and sale agreements are on board even without economic ownership of securities. However, the following are not applicable in the financial transaction tax; issues of bonds and shares that are primary, central banks trades with the European Union, deposits and loans, spot currency exchange and physical commodity trade (Howard and Green 2008). The financial transaction tax has its amount of charge whose minimum is 0.1% of total consideration or value of market for financial instruments and 0.01% minimum of derivatives notional value. This is irrespective of contract length or the likely profile of payment. The UK as a member state can opt to increase the rates. Amounts of the derivative notional are vast and therefore, the financial transaction tax is high. Collateral movements in support of transactions that are derivative leads to multiple charges for single transactions. On trade execution, the institutions of finance immediately generate transaction tax. In a transaction, if one party of the institutions of finance is a member of the European Union, each of them is entitled to pay and therefore the transaction tax doubles. The FTT does not exempt transactions that aid liquidity of markets or financial intermediaries. The financial transaction tax has its effects when closely evaluated such as in volatility whereby, it is asserted that, the tax proponents will lead to reduction of price volatility (Clifford 1993). The tax is said to have effects that are beneficial in curbing instability that is secondary to speculation. The resources diversion into the economy’s financial sector is reduced and the corporate managers’ horizons are lengthened. Through financial transaction tax, the volatility is further reduced by reduction of noise traders (Thirsk 1997). In some studies carried out, the relationship between short-term volatility of price and the financial transaction tax is ambiguous. The studies also find that, higher costs of transaction result to more than less volatility (Shavell 1984). The measures of volatility could underestimate the security transactions’ destabilizing role since they also reduce liquidity supply that is stabilizing. However, there was no significant effect on the UK prices equity on volatility in 1997. In 2011, a study paper was published and argued that, securities transaction tax leads to reduction of trading volume may lead to liquidity decrease and may lead to increment of price impact to trade. This tends to increase price volatility. An abolition of the UK’s stamp duty could result in liquidity increment that s non-negligible and this would further reduce capital cost of companies listed in UK. The financial transaction tax also affects price discovery. The financial transaction tax natural effect of reducing trading volume is meant for liquidity reduction, which in turn slows price discovery. The discovery of price is the process used by financial markets to incorporate the new information effects into prices of assets. The financial transaction tax would lead to slow incorporation of information into trades and this would create greater returns of autocorrelation. This process might impede the market’s ability in preventing asset bubbles. The transaction’s deterrence could slow down the upswing cycle of the asset and slow prices correction towards their actual values (White 1996). Revenue varies according to covered transactions, effects of tax on transactions and tax rate. According to Swedish experience in 1984-1991 of transaction taxes, it shows that, tax revenues’ net effect can be challenging to estimate and might be negative because of decreased trading volumes. After examining the nature and scale of derivative transactions and various payments nature, some analysts concluded that attempts to increase a considerable gross domestic product percentage in revenue from financial transaction tax that is broad based could fail in rising less revenue as per expectations and generating economic behavior change (Shavell 1984). The effects could include restructuring of activities of the financial sector but not in ways relating to particular forms of overtrading financially were most particular in contributions to the financial crisis that is ongoing. Such taxes usually deliver less effective benefits and less revenue. If the transaction tax is implemented internationally, revenues will be considerably increased because it will be difficult for traders to escape tax by transacting in other locations. The UK stamp duty has a negative impact on share prices. Most frequently, shares that are traded are highly affected than shares of low turnover. Therefore, the revenue from tax capitalizes to an extent in share prices that are currently low. For firms whose sources of finance are equity, the above aspect may increase costs of capital because the new shares price would be less than it should without the tax (Habermeier and Kirilenko 2001). In conclusion, both the European commission and the UK aspire to enactment of a financial transaction tax that is global. In order to attain this, the European Union should be on the frontline implementing it themselves. They have pioneered in global policies enactments that have resulted to success like in the climatic changes issue. The European Union policy on tax is a debate that should be ignored and concentration geared towards tax coordination. Aspirations can be drawn from a single market that is business friendly, fair and attractive to investors through simple taxation (Matheson 2011). The taxpayers and the public sector have been on the receiving end in supporting the sector of finance in financial crisis. It time the financial sector bears its share for the same through financial transactions tax. Some financial sector activities with serious risks will be discouraged since they could lead to considerable economic damages. Several European Union countries have already adopted measures of national tax implementation to avoid distortions and fragmentation of the European Union single market like non-taxation, double taxation, harmful competition on tax and cumulative effects. The financial transaction tax will help in providing stability in the system of finance by discouraging activities that are highly risky. Society will benefit at large from this tax since the sector of finance will be mandated to contribute a fair share of costs incurred by crisis. UK as one of the member states will benefit as this new public revenue will directly finance their budget and possibly reduce their contribution to the budget of the European Union since revenues generated from financial transaction tax will cater for the European Union budget. The providers of financial services from the single market will be beneficiaries of a more harmonized treatment of tax to all transactions conducted within the European Union. Transaction taxes of individual nations might warrant removal or adoption. The tax harmonization should be conducted at European Union level since national policies that are uncoordinated could cause harm to the functions of a single market. This would also minimize risks related to relocating from different financial markets. The harmonization by the directive will only be to the necessary extent and fixing of minimum rates that will be applied in all member states. Since institutions and markets of finance are globally organized, the implementation of financial transaction tax within the European Union is a pragmatic initial step (Laporta 1998). The daily financial activities conducted by businesses and citizens will not be affected by the financial transaction tax. Mortgage lending, insurance contracts, business, and consumer credits are not inclusive in the transaction tax scope. The tax is applicable to transactions conducted by institutions of finance, which include investment firms, banks, collective investment undertakings and insurance undertakings (Peltzman 1976). A good number of financial instruments are covered by the financial transaction tax like bonds and shares. References Alworth, J.S. and Arachi, J., 2012. International Book Taxation and the Financial Crisis. Oxford, UK: Oxford University Press Michalos, A.C., 1997. Good taxes: the case for taxing foreign currency exchange and other financial transactions. Toronto: Dundurn Press Ltd Honohan, P., 2003. Taxation of Financial Intermediation. Washington, DC: World Bank Publications Shavell, S., 1984. A Model of the Optimal Use of Liability and Safety Regulation. Rand Journal of Economics, 15(2), pp671-80. Stigler, G. J., 1971. The Theory of Economic Regulation. The Bell Journal of Economics and Management Science, 2(1), pp.3-21. Clifford, W., 1993. Economic Deregulation: Days of Reckoning for Micro economists. Journal of Economic Literature 31(4), pp.1263–1289 White, L. J., 1996. Competition versus Harmonization: An Overview of International Regulation of Financial Services.Washington, DC: American Enterprise Institute Peltzman, S., 1976. Toward a More General Theory of Regulation. Journal of Law & Economics 19(5), pp.211–40. Laporta, R. and et al., 1998. Law and Finance. Journal of Political Economy. 106(12). Pp.1133–1155 Matheson, T., 2011. Taxing Financial Transactions: Issues and Evidence. Washington, DC: International Monetary Fund Habermeier, K.F. and Kirilenko, A., 2001. Securities Transaction Taxes and Financial Markets. Washington, DC: International Monetary Fund. Davidson, P., 2002. Financial Markets, Money, and the Real World. Cheltenham, UK: Edward Elgar Publishing Thirsk, W.R., 1997. Tax Reform in Developing Countries. Washington, DC:World Bank Publications Howard, D. and Green, D., 2008. Global Financial Regulation. Cambridge, UK:Polity Gray, J. and Hamilton, J., 2006. Implementing Financial Regulation. Hobken, NJ:John Wiley & Sons Vittas, D., 1992. Financial Regulation: Changing the Rules of the Game. Washington, DC:World Bank Publications Goodhart , C.A.E., 1998. Financial Regulation: Why, How, and where Now? New York:Routledge Herring, R. and Litan, R.E., 1995. Financial Regulation in the Global Economy. Washington, DC:Brookings Institution Press Mooslechner, P., Schuberth, H. and Weber, B., 2006. The Political Economy of Financial Market Regulation. Cheltenham, UK:Edward Elgar Publishing Collins, P.S., 2011.Regulation of Securities, Markets, and Transactions. Hoboken, NJ:John Wiley & Sons. Read More