London, December 17, 2011 - The European Commission has recently proposed the imposition of a Financial Transactions Tax. This is completely the wrong priority and would especially harm the UK. As Conservatives we have an instinctive distrust of higher taxes and this article sets out the theoretical, historical and practical reasons to oppose this tax.
Growth stalling, confidence plummeting, credit restricted. So what does Europe want to do? Introduce a financial transactions tax that by its own admission could wipe out almost 2% of EU GDP. Plans for such a tax demonstrate either breathtaking naivety, an unbelievable ignorance of basic economics or just plain stupidity. Perhaps most disheartening is that it is Conservative European leaders such as Angela Merkel and Nicolas Sarkozy who are some its loudest supporters. The plan, which is to introduce a tax on all trades in shares and bonds at a rate of 0.1% and all derivative contracts at a rate of 0.01% may seem, at first sight, to be an equitable way to punish reckless bankers. However, such a superficial analysis is dispelled upon a further consideration.
The European Commission, in proposing this new policy, which of course has already been supported by the tax and regulation obsessed European Parliament, is creating a grotesque self caricature of unaccountable European institutions willing to sacrifice hundreds of thousands of jobs in the name of “solidarity”. Not only does this policy fly in the face of economic logic and the lessons of history but it is actually a naked and contemptible act of populist short-termism.
This tax is yet another example of unelected bureaucrats thinking they know how to spend our money better than we do ourselves but it is especially pernicious because of the disastrous consequences it could have on lending. Small and medium sized enterprises are, of course, the engines of growth and without sufficient fuel (ie lending) they won’t be able to expand as easily. By reducing the real rate of return on bonds and thereby forcing investors to demand higher interest rates to compensate, this tax would inevitably raise the cost of borrowing. The result of this would be reduced lending and credit creation which would harm our investment and export orientated growth strategy. Moreover, we will suffer from a lower underlying trend rate of economic growth because of less capital investment leading to less scope for productivity improvements. If we make it harder to provide the fuel and more expensive to get, we are risking a sharp breakdown in the middle of the road.
Just about every business survey continues to show, restricted access to credit remains an impediment to business expansion. However, in the context of a global slowdown in growth and widespread concerns about a new credit crunch, the financial transactions tax makes even less sense. The 3-month LIBOR interest rate, (London Inter Bank Offered Rate) which is essentially a measure of confidence between banks has risen sharply to 1.03% which is the highest it has been since July 2009. This reflects an appreciable deterioration in lending conditions reminiscent of the beginning of the Credit Crunch. The European Commission couldn’t have found a worse time to introduce this tax.
The failure of much of the financial sector to cope adequately with the crash has created a large burden on taxpayers and an underlying moral hazard for those businesses still reliant on an implicit or explicit state guarantee. However, desperate politicians in the midst of the seemingly perpetual crisis in the Eurozone, do nothing to relieve this burden by hiding behind growth-sapping measures such as this. Furthermore, the hammer would fall particularly hard on the UK as almost 80% of Europe’s financial services are based in the City of London. Financial services remain one of the UK’s comparative advantages and according to a recent PWC report, it provides a million jobs and generates 11% of all tax receipts. We would be foolish to act in a way which jeopardises those jobs.
Taking a closer look at the UK economy, business confidence is low and falling; the Business Trends Output Index from BDO for November showed output falling to 92.6, a level well below the threshold of 95 which is associated with positive growth and well below 100 which is associated with average trend growth. To put in place a new business tax at such a time would further weaken confidence and exacerbate already fragile willingness to invest. Indeed, the Commission’s own impact assessment suggests an upper bound of a 1.76% permanent reduction of the Continent’s long term real output. Europe’s desire to self-harm is truly disturbing.
The evidence from Sweden (the one country where a real financial transactions tax has been introduced) is utterly unambiguous. It was a total disaster. Initial estimates of the revenue that would be raised were wildly over-optimistic. Not only did government borrowing costs rise and capital gains tax receipts slump but huge swathes of Sweden’s equity, bond and derivatives markets were destroyed, or fled to London. Bond trading fell 85% in the first week, futures trading fell 98% and options trading was entirely eliminated. Sweden abolished the policy and now warns against the current proposals.
The lesson is clear, if such a tax were imposed, it would drive away one of the UK’s most important sectors to less taxed, less regulated places, taking with it, tens or even hundreds of thousands of jobs and billions in taxes. What is more, any revenue that is eventually raised would not be distributed proportionately which means the UK would face 80% of the pain but receive a much smaller percentage of the revenue. Even if this tax was applied universally, there is a serious danger of it causing greater market illiquidity, reducing transactions and driving up borrowing costs making it harder to raise money and thereby harming us all.
Countries in the European Union don’t have a revenue problem, they have a spending problem. This tax won’t hide the fact that profligate governments have spent taxpayers’ money too freely across Europe for years and that monetary policy rigidities resulting from the single currency have clearly exacerbated the problems in the Eurozone by preventing recovery through devaluation. The EU should be focussing instead on boosting growth by for example taking an axe to the Common Agricultural Policy and reducing some of the perverse incentives that it creates; giving back control of employment, social and financial regulations to national governments to promote greater competition and more flexible labour markets; moving towards a single market in services and energy and pushing for faster and more far-reaching free trade agreements with China, India and other emerging economies.
Despite the UK’s former Labour Prime Minister Gordon Brown’s repeated attempts at persuading others of the virtues of a financial transactions tax at various G20 meetings, the current Labour leader Ed Miliband’s enthusiastic cheerleading for it during his leadership campaign and sadly the support it is getting from many European Conservatives, the UK’s Conservative-led Coalition Government has thankfully made clear that it will veto this idea. Whilst it can hopefully be stopped from being introduced in the UK, there is still the danger of it being rolled out across the Eurozone and then imposed on the UK at a later date. There is also the problem of UK banks trading in the Eurozone being subject to the tax and there is also the possibility of London branches of European banks also being subject to it. The financial transactions tax is the wrong tax, for the wrong place, at the wrong time. Conservatives should resist it in every way possible.
Article by Adam Memon is Economics Vice President at the University College London Economics and Finance Society – Article originally posted at the Young Conservative Transatlantic Alliance