The controversy about the proposed financial transaction tax (FTT), otherwise known as the “robin hood” or “tobin” tax, is gaining momentum. Malta, together with other states, expressed reservations on the idea at the last EU meeting for finance ministers. Pressure will naturally intensify, particularly in the eurozone over the coming weeks, and Malta may find itself in a difficult position.
The Commission estimates 1.5 per cent of European GDP growth will be throttled if the plans go through- Max Ganado
The strategy adopted by some proponents needs to be understood because it is seriously confusing the discussion. Any proposal can always be vociferously advocated if placed on the pedestal of just outcomes. In the case of the FTT, the argument being advocated is to make banks contribute for the assistance they received during the 2007 banking crisis. The proposal is being framed as part of an effort to curb greedy bankers and usher in comprehensive banking regulatory reform aimed at preventing excessive risk taking and speculation which is perceived as the cause of current economic woes. Who can argue with this?
However, this method of argument can easily mask a bad measure and confuse everyone. It is difficult to blame anyone for failing to see any problem with the FTT proposal. If the aim is good why object to it? This is what is happening where people are cloaking the proposal in a laudable aim and precluding discussion on whether an FTT is an effective and intelligent measure or not. The ends suddenly justify the means and so why discuss the means at all!
We should assume we all agree on the moral argument, that is, that the current behaviours in the financial system need to be addressed. This will clear the air and allow us to discuss proposed measures and their effectiveness. Malta must continue focusing on the substance of the real issue.
The following discussion is an attempt to review the proposal itself.
The European Commission is proposing to tax day to day transactions between financial institutions. The tax – at a rate between 0.01 per cent and 0.1 per cent – would be levied on banks, insurance companies, pension funds, the fund industry and other special entities which raise capital to be used to lend to business and customers or protect from risks, among others.
Under the proposals, if any of these parties purchase, sell or even agree to supply certain financial instruments such as shares, money market instruments, instruments used for hedging risk and interests in funds, they would be subject to tax. The list of proposed instruments which would be subject to tax captures nearly every facet of European financial activity. The tax will be due whenever a party to a transaction is resident in the European Union. Under the proposal, member states will collect the tax for each other and will share the revenue with Brussels.
It does not follow that because important issues need to be addressed relating to certain financial transactions or practices, we should be introducing a rule which applies to all financial transactions indiscriminately. Nor will the simple imposition of a new tax in Europe alone serve to meaningfully address certain aspects of international financial activity, such as high frequency trading and the like.
What is excluded?
The tax would not apply to transactions carried out primarily by individuals or by central banks. This means that some small domestic transactions in shares and bonds on the Malta Stock Exchange would appear to be excluded. Admittedly, the exclusion of individuals from the list of taxable parties is a relief.
The suggestion that an exemption for individuals will save them from the impact of the measure is an illusion, because all transactions in the world of finance are intimately related by a long chain of cause and effect, and when operating costs increase (such as by new taxes), banks and financial intermediaries will simply channel these costs to the client.
Furthermore, individuals would not see the value of their transactions being eaten away by the imposition of a tax each time they act to manage their portfolios. This too may be illusory because investors use intermediary brokers with pooled accounts for discretionary management. Given that discretionary portfolio management of pooled accounts is very common and saves money for clients, we could see a move away from this market practice which is not necessarily a good thing because it would again increase costs.
Ordinary bank transactions
Banks, as lenders, are exposed to the default risk of their principal counterparts: borrowers. To mitigate this risk, banks embark on investment and hedging strategies. Furthermore banks are required to hold certain assets of various forms in order to reduce the risk of their failure and use them to manage liquidity. These assets have to be managed through ordinary investment transactions. Put simply, if a tax is applied each time the bank acts to manage its exposures or regulatory assets, it will suffer a tax and this may undermine the very exercise itself. Banks will therefore reduce, or abstain from, these trades. Banks alone, not to mention pension funds, funds and insurance companies among others, can make thousands of such transactions a day. This tax only adds unnecessary friction in the banking system.
We are currently increasing the banks’ required capital ratios while simultaneously creating costs for them to manage this capital.
Suffocates activity
A financial transaction tax is a damaging proposal because it will suffocate and then gradually kill several types of financial activity not all of which are negative. The Commission estimates 1.5 per cent of European GDP growth will be throttled if the plans go through. As much as half a million jobs could be lost! Only ten to 20 per cent of financial activity would survive. This is not us saying this, but the Commission, and one asks: has it been established that over 85 per cent of all financial transactions are toxic and have damaging effects or have otherwise contributed to the financial crisis? If so, will their toxic effects disappear if they are consciously pushed outside the EU, possibly to other systems which will either not regulate them or regulate them inadequately or in any case not tax them? Have we not learned that this is one globalised and highly interconnected world of risk?
The Commission’s prediction that this tax will decimate the EU’s securities trading volume is no surprise. History confirms the destructive effects of any financial transaction tax. When a similar tax was implemented in Sweden, capital stopped flowing through the Scandinavian country. So negative was its impact that the tax was removed a decade later but the reputation of Stockholm as a centre for securities trading never recovered. Malta already has its own FTT in the form of duty on non-listed bonds and shares. The effect is that we do not see the use of bonds which are not listed in our economy. Not having commercial loans documented as bonds, or notes as commonly named, is highly detrimental to Malta’s economic development because it is a clear obstacle to economic activity, corporate finance, secondary market liquidity, fast enforcement of debt claims on defaults and ability to diversify risk exposures. And all this just because we have a two per cent duty on transfers of non-listed bonds!
Moreover, assuming that financial institutions have a predisposition to survival and the laws of democratic states cannot hinder free movement of capital, banks, insurance companies and funds among others would simply move their transactions elsewhere. The offshore centres, where tax is virtually inexistent, stand to gain, as the rest of the major finance centres outside Europe, including the USA, unless the tax is imposed globally – a remote prospect if there is one. That the most evident outcome of this tax will be a flight to untaxed and less regulated jurisdictions (many of which have inadequate anti-money laundering regimes) will largely nullify the EU’s efforts to raise revenue, rein in tax evasion, discourage the use of offshore centres and strengthen anti-money laundering processes.
The last point to emphasise is that Malta and its institutions have not been part of the problem but we are already paying dearly for it. We are now expected to apply a tax to solve a problem we don’t have. Can someone please explain to us why, after prudently managing its affairs, Malta can ever be forced to implement measures the other countries, which did not control their banks, consider necessary to do to solve their problems? Furthermore if Malta is not systemically relevant, we should not need an FTT. Of course we should adopt several other important measures which will be effective in strengthening the domestic financial services sector and will do so because they are effective measures to address the real problems.
Since joining the European Union in 2004, Malta witnessed significant growth in its financial sector. International players now opt for Malta as a place for doing business of many reasons. Investment funds, insurance companies and even some banks have based some operations locally because of a favourable business environment. This has been crafted over the years and supported by a serious regulatory framework consistent with EU norms. Sheer hard work on the part of many, boosting employment and economic benefits, not just in the financial services sector, but in Malta generally has produced these results.
Plans to introduce a financial transaction tax which is not global would damage any country where it is introduced. Plans to introduce such a tax in the eurozone only will seriously jeopardise Malta’s achievements to date.
(Dr Ganado would like to thank Christopher Cachia, Christopher Mallia and Matthew Mizzi for their contribution.)
The author is managing partner of Ganado & Associates, Advocates.