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Posts Tagged ‘Financial Transaction Tax’

If I live to be 100 years old, I suspect I’ll still be futilely trying to educate politicians that there’s not a simplistic linear relationship between tax rates and tax revenue.

You can’t double tax rates, for instance, and expect to double tax revenue. Simply stated, there’s another variable – called taxable income – that needs to be added to the equation. This simple insight is what gives us the Laffer Curve.

This is common sense in the business community. No restaurant owner would ever be foolish enough to think that revenues will double if all prices increase by 100 percent. People in the real world know that this would mean lower sales.

At best, revenues will rise by much less than 100 percent in that scenario. And if sales drop by enough, revenues may actually fall.

Perhaps because so few of them have business experience, it seems that politicians have a hard time grasping this simple concept.

The latest examples come from Europe, where the never-ending greed for more revenue has resulted in the imposition of financial transaction taxes.

So how’s that working out? Are politicians collecting the revenue they expected?

Hardly. Here are some of the details from a City A.M. column.

…taxes on financial transactions across Europe have devastated market activity and failed to raise as much as politicians hoped, according to new figures out yesterday.

The article cites three powerful examples, starting with Hungary.

Hungary implemented a 0.1 per cent tax at the start of the year. But it raised less than half the revenue the state had hoped for, bringing in 13bn Hungarian Forints (£36m) in January.

Wow, less than 50 percent of the revenue that politicians were expecting. But the politicians probably don’t care about the collateral damage they’re imposing on the economy because they’ll get to buy votes with another 13 billion Forints (about $55 million).

Popeye Laffer CurveNow let’s see how the French are doing.

France forged ahead on its own, introducing a 0.2 per cent tax on sales of shares of major firms. But that only raised €200m (£169.4m) from August to November, well below to €530m expected.

Gee, what a shame, the politicians in Paris are only getting about one-third as much money as they were expecting. That’s even worse than Hungary.

But they’ll surely squander that bit of cash as fast as possible.

Our last example comes from Italy. There are no revenue numbers yet, but the decline in financial activity suggests this tax also will be a flop.

And Italy launched its FTT this month. Figures from TMF Group suggest it has cut trading volumes by 38 per cent already

Though politicians may decide it’s a success since they may get more than 50 percent of what they were originally estimating.

That kind of forecasting error would get somebody fired at any private business, but being a politician means never having to say you’re sorry.

And it certainly never means learning from mistakes. The evidence on the Laffer Curve is ubiquitous, with powerful examples in Ireland, the United Kingdom, Italy, France, Spain, as well as Bulgaria and Romania. Or states such as IllinoisOregonFlorida, Maryland, Washington, DC, and New York.

P.S. Even President Obama has sort of acknowledged the supply-side principles that are the basis of the Laffer Curve.

P.P.S. Remember that the goal of good tax policy is NOT to maximize revenue.

P.P.P.S. I warned the European Union’s Taxation Commissioner about the dangers of a tax on financial transactions last year. Needless to say, my sage counsel appears to have been ignored.

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I’m periodically asked about proposals to impose “small” taxes on transactions.

There are a couple of versions of this idea. In some cases, such proposals are designed to tax every economic transaction and supposedly generate enough money to replace all other taxes.

In recent years, though, I’m usually asked about levying a “Tobin Tax,” which would be an additional tax imposed on some or all financial transactions. This particular scheme is becoming more of a threat because European politicians such as President Sarkozy of France want to impose the levy.

For every question, the answer is always more taxes

I’ve always said such plans are unrealistic because anything that collects a big amount of revenue is bound to have negative effects, particularly since much of what occurs in financial markets can easily escape to other jurisdictions. Heck, these taxes are so misguided that even the Obama Administration is opposed to them.

Everyone should reject these taxes. Two professors, one from Stanford and the other from NYU, recently explained why transactions taxes would undermine investment in a column for the Wall Street Journal.

Our research shows unambiguously that higher trading costs depress the prices of stocks and bonds. A transactions tax will end up punishing Main Street, hurting the economy and reducing U.S. Treasury revenues in the next few years. It will thus exacerbate the effects of the financial crisis. We estimate that a 0.25% transaction tax on stocks will lower their average price by about 10%. The effect will vary across stocks, being more depressive for large-cap stocks, like those in the Dow Jones Industrial Average. These highly-liquid stocks trade very frequently with a bid-ask spread of a penny. According to a report by Investment Technology Group, the total transaction cost on U.S. large-cap stocks averages 0.32%, so a 0.25% transaction tax will increase the transaction cost by about 80%. For the average U.S. stock, with a total transaction cost averaging of 0.46%, the increase is almost 50%. Most bond trades have significantly lower transaction costs, so if they too are taxed, the increase in costs will have a larger negative effect on prices. The drop in stock prices means that companies will have to earn more on stock-financed investments to make them worthwhile. Similarly, a transaction tax on corporate bonds will make their price fall for any given coupon rate that they offer, meaning that the borrowing cost for companies will rise. All of this means a rise in the “hurdle” rate that investments must earn to make them profitable. As a result, companies will forgo investment projects that could have been financed if they could fund them at lower cost.

The authors also make a very strong point about competitiveness.

A tax on transactions will naturally discourage trading and lead to a reduction in the volume of trades in U.S. markets. But today’s electronic trading networks transcend national boundaries. Trades are routed to the computer that offers them the highest liquidity and the lowest transaction costs. Trading will migrate to trading centers that are not subject to the tax, and companies may choose to list on foreign exchanges. Over time, the loss of trading will threaten the U.S. leadership in financial services and reduce employment in the broker-dealer and affiliated industries.

The column also makes good points about the tax resulting in less revenues for the government in the short run (the Laffer Curve strikes again!) and the fact that such a tax would not reduce market volatility.

The one thing missing in the article is a discussion of why tax increases – of any kind – would be misguided. But the column is so helpful that I’m willing to overlook that sin of omission.

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