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Why a Financial Transactions Tax Is Bad for Everyone

Amid the wailing and gnashing of teeth that are governments’ attempts to confirm the long-term viability of the euro project, we are also witnessing an attempt to introduce a financial transactions tax (FTT) or “Tobin Tax” in the European Union.

That is a pity. First, because it’s a very bad idea. And secondly because it takes up precious government and bureaucratic time that is better spent addressing more pressing and genuinely important economic issues.

The tax is named after Professor James Tobin, an economist who in the 1970s first proposed a tax on foreign exchange transactions, as a means of “throwing sand in the wheels” of the currency market to limit the number of speculative transactions and reduce market volatility. Extending it to all financial assets makes it the FTT that the EU is proposing now.

There is plenty of formal academic and practitioner literature on this subject, so I’ll present a different angle. I’ll start by talking aboutpayroll taxes, a favorite topic of this column. In just about every developed economy, governments levy a tax on companies for every employee.

As well as paying each employee a salary, the company has to pay a tax, usually a percentage of the staff member’s salary, to the government. All else being equal, canceling such a tax, or freezing it for a year, would generate jobs because companies would be incentivized to hire more staff.

Is there a “cost” to the taxpayer of such a measure? If one assumes that each new job would have been generated without the payroll tax freeze, then yes the government loses out on this tax revenue. But this is an unrealistic assumption, to put it mildly. If, as is much more likely, the new hire would not have occurred but for this tax freeze, the government hasn’t “lost” anything, and in fact it gains from the income tax that is being paid by each new person added to the payroll.

Now let's move to the FTT. Absolutely no-one seriously thinks that imposing a transaction tax in one jurisdiction, on an industry that can easily transact electronically anywhere in the world, would not simply drive that business to another location.

And the experience of countries that have introduced FTTs – Sweden is a case in point – shows that transaction volumes fall significantly, only to be restored when the FTT is removed. A unilateral FTT in the EU will mean reduced business in the EU financial industry.

How would that benefit the taxpayer? Lower volumes and disappearing business means only lower profits for the industry, which means, critically, lower tax revenue for the government. Just like the flawed logic that suggests that a freeze in payroll taxes costs the government money, when in fact it results in a rise in income tax and not a loss to the taxpayer, an FTT will actually produce lower government revenue due to falling profits in the financial industry.

And that benefits precisely no one.

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The author is Professor Moorad Choudhry is Head of Business Treasury, Global Banking & Markets, Royal Bank of Scotland.