Bursting the Bubble

The FTT – coming to an unsatisfactory end

13 March 2014 | by

Despite widespread popular support in the EU, the introduction of a Financial Transaction Tax (FTT) signed up to by 11 member states in September 2012 has hit a few bumps on the road towards implementation, getting further watered down with each jolt it takes. Support from the new German coalition government and upcoming elections to the European Parliament means that the journey is finally coming to an end, but most supporters of the FTT will be disappointed with the outcome. 

Initially, the Commission proposal for an EU-wide FTT, dubbed the ‘Robin Hood’ tax, which surfaced in September 2011, took the broadest approach possible; applying the tax to all markets (regulated and over-the-counter), all actors (banks, shadow banks, asset managers, etc.) and all instruments (shares, bonds, derivatives). The scope of the proposal was unacceptable to many member states and a unanimous agreement in ECOFIN proved impossible to reach.

A Rocky Road

Nevertheless, a year later, a group of 11 member states including France, Germany, Italy and Spain (EU11) requested the use of enhanced cooperation to introduce a tax that mirrored the initial proposal. It was finally implemented by a Commission proposal on 14 February 2013. Given their willingness to push forward with these 11 members, it is surprising that the development of the FTT has been so slow, compounded by setbacks and mired with disagreements.

Legal Challenges

The first setback to the FTT came through the UK’s legal challenge. Britain’s important financial services industry means it will be particularly affected by the tax. In April 2013, the HM Treasury mounted a legal challenge before the CJEU. This application is not public but reportedly based on the use of enhanced cooperation in this context. The Treasury asserts that the proposed tax infringes on the rights and competences of non-participating member states and distorts competition within the EU, undermining the single market. If it is the case, under EU law, enhanced cooperation cannot proceed. It is unlikely the UK’s legal challenge will affect negotiations between the EU11 since the FTT will have considerably changed by the time the case comes before the CJEU in a couple of years. However, it will have certainly delayed its introduction.

Opponents of the tax thought it had been well and truly buried in September 2013 when the Council legal service issued a damning verdict on the proposed tax. Council lawyers questioned the legality of the ‘residence principle’ of the FTT whereby trades are taxed according to where the headquarters of the trading company is based rather than where the trade is made. Non-participant member states oppose this principle because of the negative spillovers. For example, the tax would be applied to a trade between a British firm and a French bank headquartered in London. Applying the tax outside the EU11 was deemed to overstretch national jurisdiction, discriminate against non-participating member states and breach EU law by infringing “upon the taxing competences of non-participating member states”.[1] The opinion of the Council legal service is non-binding but such a strong legal critique is rare. The residence principle is now unlikely ever to come into existence. While the Commission insists on the legality of its proposal, these legal challenges present significant hurdles that need to be overcome before introduction.

Poor results from national FTTs

Moreover, poor results from national versions of FTTs have done nothing to further encourage progress with the EU11 tax. Trade volumes have been particularly affected. The introduction of an Italian FTT on March 1, 2013 caused a significant drop in share trading.[2] National versions have also struggled to match expected revenue. In France, the tax only brought in half of the anticipated revenue. The least successful example appears to be in Sweden where the tax generated only 3% of the expected revenue with trading volumes also sharply declining.[3] These outcomes dampened the initial enthusiasm of the EU11 for a harmonized tax.

Delays and disagreements

In June 2013, faced with mounting opposition from member states concerned with the spillover effects of the FTT, the Commission accepted the tax would not be introduced by its initial January 2014 target. It was delayed to mid-2014 in the hope that a political agreement could be found by the end of 2013. Significant differences in EU11 preferences for an FTT have so far prevented an agreement. Some share Germany’s preference for a broad basis and low rates while others, like Estonia, want to narrow the original plan’s scope to only the riskiest trades. Their lack of a realistic approach was recently criticized by Commissioner Šemeta in a speech to the European Parliament.

With no agreement forthcoming, amendments were informally discussed but with no clarity. By July, the Commission had accepted – for the first time – amendments in order to reach an agreement. Exemptions are now considered for market makers providing liquidity, government bonds, pension funds and repos.  Some of these featured in the Lithuanian Presidency’s compromise proposal which exempted collateral management and repo markets such as government bonds. There is as of yet no agreement, but consensus is building on certain issues. It is now certain that government bonds and pension funds will not be taxed by an FTT.

The danger is that as the plan becomes increasingly watered down, the tax will not raise the €35bn revenue initially set out and its support will shrink. Koen Geens, the Finance Minister of Belgium (part of the EU11) is the latest to raise concerns about the most recent proposal for the FTT claiming that it would create less income than the existing Belgian tax on trade.

The road may be coming to an end

Nevertheless, there is yet cause for optimism for supporters of the tax. Since last December, the FTT has re-emerged. The UK House of Lords gave opponents a stark warning of this in a report on the tax published in December entitled ‘alive and deadly’. Its resurrection was a key factor in fermenting the coalition between the German Social Democrats and Merkel’s Christian Democrats / Christian Social Union. It is now firmly on the agenda and has been made a priority issue by the Greek presidency.

During a Franco-German government summit in mid-February, Hollande and Merkel agreed in principle that the FTT would cover all derivatives, not only equities, and pledged to strike a deal before European Parliamentary elections in May. Germany and France are desperate to force through a deal before the elections. Francois Hollande expressed this sense of urgency by claiming: “I prefer an imperfect tax to no tax at all”.[4]

The need for results despite the inability to agree on all the issues means the FTT will be introduced in several stages. This phased introduction is encouraged by Commissioner Šemeta who is eager for any deal.[5] The tax would then likely first take the form of a stamp duty on equities and equity derivatives, later to be expanded to apply to other instruments. If an agreement on the first stage is reached in May, under enhanced cooperation, a law can be fast-tracked and could be in force by 2015. France and Germany have as of yet been unable to bridge their differences on the second phase of the tax so its future form remains unclear.

Conclusion

Legal challenges, poor results from existing FTTs and the inability to find an agreement amongst participating member states have been significant stumbling blocks for EU11 members and the Commission to overcome. However, with EU citizens support for the FTT at 64%[6] ditching the tax altogether would carry too high a political cost for EU11 governments.

Now with European Parliament elections coming up, the EU11 are pushing hard for an agreement. Necessary compromises over contentious parts have changed the initial proposal for the tax beyond recognition. In order to reach an agreement, the EU11 and the Commission have agreed the FTT will now be phased in gradually. The tax itself will first take the shape of a stamp duty on equities and equity derivatives only while the scope and form of second stage is unknown.

Supporters of the tax may welcome the news that an agreement on the FTT is close but they will be very disappointed by its outcome. With the riskiest trades exempt, the FTT’s original purpose of curbing speculative trading is not satisfied. Opponents will rue both its introduction and its open-ended nature.

 

Additional Sources:

Bloomberg News: EU Financial-Transaction Tax’s Support Wanes on Scope

European Commission: Taxation and Customs Union, Taxation of the financial sector, the FTT

European Commission: Taxation and Customs Union, Taxation of the financial sector, FTT background

UK House of Lords: Financial Transaction Tax: alive and deadly

PWC: Financial Transaction Tax: the impacts and the arguments – a literature review

 

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