The United Kingdom and Proposed European Union Financial Transaction - Essay Example

?The United Kingdom and the proposed European Union Financial Transaction Tax Introduction The European Union financial transaction tax (EU FTT) is an official proposal put forward by the European Commission with intent to introduce a financial transaction tax system within the EU’s 27 member states by 2014. “The tax would impact financial transactions between financial institutions charging 0.1% against the exchange of shares and bonds and 0.01% across derivative contracts”1. However, the proposed tax system will not have an impact on citizens and businesses. This EU financial transaction tax is different from a bank levy. Regulators believe that the proposed policy has the potential to raise nearly 57 billion Euros per year. This proposal has been the topic of a hot debate across the European Union since its announcement in 2010 and it still remains controversial among the member states of the EU. This paper will critically appraise the statement that “The United Kingdom should drop its opposition to the proposed European Union Financial Transaction Tax. The benefits accrued from the introduction of such a tax far outweigh the drawbacks”. EU financial transaction tax The provision for creating a new financial transaction tax was proposed by the European Commission President Jose Barroso on 28th September 2011 with intent “to make the financial sector pay its fair share”2. He pointed out that the under-taxed financial segment generated 4.6 trillion Euros during the crisis. Ultimately, through this policy, the European Commission aims to raise direct revenues for the European Union. Ten of the EU member states already impose some forms of a financial transaction tax; and the proposal aims to harmonise different existing financial transaction tax rates. The proposed policy will be applicable if any party to the transaction is located in the EU. According to an initial study, the proposal may cover nearly 85% of the financial transactions between institutions like banks and insurance companies3. However, this proposal gives exception to transactions like house mortgages, loans to small scale enterprises, fund raising by enterprises, and spot currency exchange. This proposal requires institutions to pay proper tax rates to their country of residence irrespective of the location where actual trade has been taken place. In other words, no matter whether the transaction is taken place inside or outside the EU if any of the party to the transaction is a resident of EU. An official study conducted by the European Union reflects that a 0.01% tax would generate revenues between €16.4bn and €43.4bn per year and it respectively represents 0.13% to 0.35% of GDP. If the tax rate is raised to 0.1%, the revenues would be between €73.3bn and €433,9bn4. The European Commission claims that major portion of those revenues would directly go to the member states. With this policy, the Great Britain would earn approximately €10bn in additional taxes. The proposal allows the EU member states to increase their revenues by charging financial transaction taxes at a higher rate. Nations such as Germany, France, Spain, Finland, Belgium, and Australia support the EU FTT whereas countries like United Kingdom, Sweden, Bulgaria, and Czech Republic strongly oppose the proposal. Benefits of EU FTT The proposed financial transaction tax has a range of potential advantages. According to the European Parliament President, proposal would help EU cities and regions improve their revenues5. Economists point out that EU regions and cities cannot survive with the current levels of revenues. In addition, existing taxation models are assistable for corporate giants to escape from paying national taxes. In this situation, the proposed taxation policy would be beneficial for cities and other regions to find a new source of revenue and thereby improve their operational efficiency. Unilateral cuts in public spending would adversely affect the economic activities of the EU. Therefore, improving revenues is the only strategy to pull the EU out of the economic crisis. Regulators believe that the proposed taxation policy would discourage risky trading activities, which is considered to be the prime cause of the current economic crisis6. In addition, it would shift the costs of bailouts and thereby significantly contribute to the sustainability of financial sector. Since revenues generated from the financial transaction taxes are shared between EU member states, it may aid member states to trim down their contributions to the EU budget7 . Consequently, member states can invest more money in infrastructure development and other public services. Supporters of the proposal claim that the imposition of FTT on secondary financial products would protect the real economy as it (the proposal) does not affect transactions including salary payments and household loans. Algirdas Semeta, the European Commissioner for taxation, customs, audit, and anti-fraud illustrates that if the estimated revenues from the FTT (€57bn per year) are spent on consolidation of national budgets and public services and infrastructure, the proposal can have a positive impact on the growth and employment in EU8. In addition, many of the economists are of the view that the proposal may significantly contribute to an increase in the EU GDP. The European Commission thinks that these additional revenues can be utilized towards fighting climate changes or reducing greenhouse gas emissions also9. Since the EU is struggling to raise funds for fighting issues like increased CO2 emissions and drastic climate changes, the financial transaction taxes have of a considerable significance in the EU economy. Another potential advantage of the FTT is that, it is very easy to operate and is the most workable strategy to raise a new source of funds. Regulators argue that this proposal contains provisions for giving money back to taxpayers and thereby improve their banks savings; this situation in turn would promote sustainability of banking institutions. Steinhauser and Olsen point out that the EU economy is striving to recoup the money that was spent by national governments for saving banks during the global financial crisis. Hence, the proposed taxation policy would contribute to the efforts of the EU. Policy makers argue that this proposal would never hurt the financial interests of its audience since the rate of FTT is negligible. To, illustrate, if somebody is able to purchase stock worth €10,000, he/she may not experience any difficulty to pay an additional tax of 10 Euros for that transaction10. Public opinion also supports the implementation of the proposed taxation system. According to a Eurobarometer poll of over 27,000 people, Europeans strongly support the FTT proposal by a margin of 61:26 percent. Among the participants, 80% opined that implementation of FTT in Europe would be beneficial to achieve global agreement of the policy. In addition, 65% of the participants held the view that UK must support the proposal11. The proposal is likely to increase the efficiency of the EU financial sector as the FTT would put a check on risky financial trading activities. Economists argue that if the financial sector can effectively carry out its functions as an intermediary with fewer workers and less capital, the FTT can have a positive impact on the overall EU economy. The proposal would persuade financial institutions to be more thoughtful and proactive in designing and implementing operational strategies. This practice may assist EU member states to avoid uncertain or high risky trading activities to a great extent. In other words, the proposal may persuade the EU financial sector to engage in more responsible financial activities and thereby promote establishment of a real economy. Although the FTT may increase the trading costs and thereby affect liquidity of assets, its effect would be smaller on less liquid assets. Currently, the EU financial sector is exempted from value added taxation because it is technically difficult to properly measure the value added in financial sector products and services. Hence, private households’ use of financial services is also exempted from value added taxation. In this context, distortive nature of FTT is very useful to appropriately improve the taxation of the EU financial sector industry. In addition, FTT is the best method to collect insurance fees (if it requires) as this strategy results in least distortion12. Demerits of EU FTT The proposed financial transaction tax has some drawbacks too. Critics argue that this policy may persuade traders to take their business outside the EU so as to escape from the FTT13. Naturally, this situation would lead to job losses, lack of trading activities, and ultimately to an overall economic downturn across the EU. Since employment rate is a major factor influencing the economic growth of a country, job losses would negatively contribute to the EU’s economic development. This transplantation of trading activities may also cause troubles to other dependent industries. Economists point out that the proposal has some adverse effects on financial markets and the real economy. To illustrate, Swedish experience reflects that the financial transaction taxation causes decline in derivates transactions up to 90%14. Economists predict that the proposed taxation policy would result in a long term decline in GDP in the EU by 0.53%. Opponents argue that the proposal was formed of political interest rather than economic interests. They add that the Europe already taxes everything heavily and hence the proposed FTT would impose additional financial burden on its target audience. Moreover, taxation of financial transactions rather than financial activities on the basis of wages and profits in the financial sector may have a negative impact on the GDP. A potential argument against the proposal is that ordinary people and enterprises may be forced to shoulder the burden of the FTT indirectly. Although regulators cut this argument by stating that citizens and business are exempted from the tax, banks and other financial institution may try to spread the burden of the tax among its clients. It is still uncertain whether the proposal would cause an increase in the interest rates on government loans15. It is widely argued that the proposed taxation policy would adversely affect pension funds and this situation will certainly cause troubles to pensioners. Since transfer of pension funds comes under the jurisdiction of the proposed policy, pensioners will be paid a less amount than what they would have actually paid in the absence of such taxation. In short, this provision would hurt ultimate aims of the pension funds. Likewise, it is expected that the EU FTT may increase the capital costs to some extent. Obviously, an increase in capital costs would directly lead to a decline in investments because every investor tries to acquire maximum returns with minimum investment. When the capita costs rise, investors may be forced to raise more amount of capital to establish their planned ventures. In short, the FTT may persuade investors to abstain from investment activities. Eventually, decline in investments may lead to reduction in real wages and GDP of the EU. In addition, institutions would hesitate to raise additional capital during the course of the business so as to escape from the transaction taxes. This situation would adversely affect organisations’ economic as well as territorial expansion. In sum, the proposed FTT has some long term negative implications on the EU economy. Another notable argument against the proposal is that it would cause to reduce liquidity as the proposed taxation is likely to reduce trading activities. This situation would reduce member states’ potential to meet unforeseen contingencies. Furthermore, the proposal raises another controversy. The EU has been finding ways to recapitalise its banks with public money for the last year. In contrast to this policy, the proposal contains provisions for taxing banks more. Hence, critics opine that this taxation policy would negatively impact the EU banking sector, which is still struggling to recover from the global economic recession 2009. More precisely, this proposal would result in a series of bank collapses in the EU like what happened in the United States in 2009. Conclusions and recommendations Admittedly, the benefits of the EU FTT overweigh its drawbacks. The major argument against the proposal is that it may discourage financial traders to continue their operations in the EU and hence they may take their business outside the EU. Critics argue that such a practice would dreadfully affect the economic interests of the EU. In fact, this argument is not reasonable. The provisions of the EU FTT precisely indicate that if any of the parties to the financial transaction is a resident of the EU, the taxation will be applicable regardless of whether the transaction takes place inside or outside the EU. Therefore, if the financial actors need to escape from this financial transaction, they have to completely abandon their European clients. Since it is most unlikely to happen, traders would not relocate their businesses outside the EU to avoid the FTT. Moreover, the proposed taxation rate is affordable to all traders. Experts opine that currently the EU does not have any other alternative to raise revenues for restructuring the broken economy. Even though some member states argue that this proposal would impede the GDP growth, none of them could clearly justify their argument with potential evidences. In contrast, the proposed model is more likely to result in an improved GDP growth of the EU. The proposal clearly states that the FTT would not be applicable to citizens and business; and therefore, the proposed taxation will neither impose burden on the public nor will impede the market growth. Although the proposal may lead to an increase in capital costs, the resulted fund raising issues in the market would be resolved by the revenues generated from the FTT. In addition, the implementation of FTT in the EU may influence other global countries to think about such taxation policies. The global acceptance of the FTT would promote the growth of the overall global economy. Hence, it is recommendable for the United Kingdom to withdraw its opposition to the proposed EU FTT. Bibliography ABBL, ‘Financial transaction tax’, (n.d), , Accessed 19 April 2012. European Commission., ‘Economic governance in the European Union’, Eurobarometer, (2011) , Accessed 19 April 2012. European Parliament., ‘Parliament weighs up cost and benefits of taxing financial transactions’, (2012) , Accessed 19 April 2012. European Commission, ‘Commission working paper: Executive summary of the impact assessment’, (2011), 1-11 , Accessed 19 April 2012. European Parliament. Directorate General for Internal Policies. Financial Transaction Tax: Small is Beautiful. (2010). Accessed 19 April 2012. KPMG., ‘KPMG reviews levels of government support in member states for the European Commission’s proposal for a financial transactions tax’, United Kingdom, (2012) , Accessed 19 April 2012. Morrison & Foester, ‘EU proposed financial transaction tax- Fortune or fully’, Attorney Advertisement, (2011), 1-4 , Accessed 19 April 2012. Mahony, Honor, ‘Schulz: 1 million EU signatures could spur finance tax’, Euobserver.com, (2012). Accessed 19 April 2012. Parliament.uk., ‘CHAPTER 3: assessing the commission's proposal’, (2012) , Accessed 19 April 2012. Ralitsa Kovacheva, Sofia., ‘Pros and cons of a European tax on financial sector’, Eu Inside, (2011) , Accessed 19 April 2012. Sadakova, Yaldaz, ‘Debate on transaction tax heats up in Europe: EU-wide tax seen unlikely, but euro zone levy has backing of Germany, France’, Market Watch, (12 March 2012), , Accessed 19 April 2012. Sofia. Pros and Cons of a European Tax on Financial Sector. (2011). Euinside. Accessed 19 April 2012. The Telegraph., ‘Rebalancing the financial transactions tax debate’, (09 February 2012) , Accessed 19 April 2012. Wahl, Peter., ‘When an EU commissioner takes over the arguments of a social movement’, Global Social Justice, (2012) , Accessed 19 April 2012. Whyte, Philip., ‘Why an EU financial transactions tax is a red herring’, Center for European Reform, (2012) Accessed 1 April 2012. Read More