Why the Tobin Tax is a Bad Idea; Sweden's Experience With the Tax; Details of Sarkozy's Proposed Tax; Sarkozy Wants to "Provoke a Shock"
There is massive theoretical as well as actual real life evidence that financial transaction taxes will backfire, but that never stops politicians hell-bent on plowing ahead with "it's different this time" horrendous ideas.
Via Google Translate from Les Echos, please consider Sarkozy's stock exchange tax as of August 1
The 0.1% tax on financial transactions will apply from 1 August. In addition to equities, derivatives and high frequency trading are also covered.Sarkozy Wants to "Provoke a Shock"
Drawn up in haste, the tax on financial transactions is still the subject of intense discussions with the banking sector. A meeting has yet to take place on Monday to clarify the exact scope of covered products.
Many things are acquired, however: the tax will be paid by the people who buy a financial product, not by those who sell it. As reported Sunday, by the head of state, it will amount to 0.1% regardless of the nature of the product purchased (equities, derivatives) and will apply from 1 August, leaving a few months to Germany to eventually join the movement.
Three types of products involved
The law affects three different types of products: stocks, derivatives (including the famous' credit default swaps ", CDS) and high frequency trading-that is to say execution in microseconds of financial transactions by the only way of computing. This activity represents a huge chunk of transactions (about one-third). But most of the computers being located in London, the government will struggle to reach this activity. Still: he wants to show that tackles the most speculative operations.
Bloomberg provides more details in Sarkozy Says France to Tax Financial Transactions From August
France plans to unilaterally impose a 0.1 percent tax on financial transactions starting in August, President Nicolas Sarkozy said, brushing aside opposition from the nation’s banks.Sweden’s Experience with the Tobin Tax
“What we want to do is provoke a shock, to set an example,” Sarkozy said late yesterday on French television from Paris. “There’s no reason why deregulated finance, which brought us to the current situation, can’t participate in the restoration of our accounts.”
“CDSs, which are speculative instruments against sovereign debt, will be taxed and online speculative purchases will be taxed,” he said.
Ernst & Young, an accounting company, has said in a report that while an EU transaction tax itself may raise as much as 37 billion euros, its net effect could be negative by between 2 billion euros and 116 billion euros by decreasing economic activity and reducing revenue from other taxes.
Socialist candidate Francois Hollande leads in the French presidential election polls. He has the support of 31 percent of voters in the first round, 6 points more than Sarkozy, and his second-round lead has risen to 20 points at 60 percent, according to a CSA poll published last week. Hollande, too, has pledged to impose a tax of financial transactions, if he’s elected.
The Peterson Institute for International Economics presents Sweden’s Experience with the Tobin Tax
The Swedish Social Democratic government enacted a transaction tax on stocks, bonds, options, and some other securities in 1983. The tax, named after the economist James Tobin, was abolished by the new nonsocialist government in 1991.Sarkozy's Pledge of Going it Alone
The tax rates varied from 0.1 percent on ordinary stock trade to 0.15 percent on treasuries and 1 percent on options.
The Tobin tax in Sweden was a devastating failure that nobody would like to revive.
1. The expectation had been that the tax revenues would be 1.5 billion Swedish krona (SEK), but they stopped at SEK80 million.
2. Most Swedish trade in securities disappeared and went abroad, mainly to Oslo and London, and never returned. Soon after, the previously tiny Oslo stock exchange overtook the Stockholm stock exchange, and it is still the larger of the two stock exchanges.
There is no way that the current non-socialist Swedish government would accept a Tobin tax, as they know the security trade would leave the European Union.
In general, the Nordic and Baltic governments are amazed by what they view as a combination of arrogance, incompetence, madness, and slowness in Brussels, Paris, Berlin, and London. These sentiments are rather stronger in this region than in Washington. These countries are run by people who know how to handle crises, but they are effectively excluded from EU decision making.
That discussion is all one should need to read to determine France would be acting very foolishly to implement such a tax.
Sarkozy thinks Germany would "soon" follow. As we have seen in the Eurozone, political decisions seldom if ever happen soon. Moreover, why would Germany act instead of watching France for a while?
Ironically, as soon as Germany saw the results in France (which likely would be soon), there is little chance they would implement such a foolish thing ever.
But what if all the European countries agreed to do it? We already know the UK opted out, but for the sake of argument, let's assume even the UK agreed.
The first that that would happen would be a mad scramble to execute transactions in the US, Switzerland, or Hong Kong. Nonetheless, let's assume the long arm of the law still managed to tax those transactions. What then?
Expect Increased Volatility, Decreased Trading Volumes, Lower Share Prices
The Adam Smith Institute offers a Comparative Study of the Potential Effects of a UK Tobin Tax. Here are some snips.
Sweden’s Experience with the Tobin taxCapital Flight
The rise and fall of the only case of a “pure” Tobin tax began in Sweden, when a 0.5% tax on the purchase of all equity securities (and stock options) was introduced on 1st January 1984. The tax applied to both domestic and foreign customers, and was levied directly on registered Swedish brokerage services.
Until 1987, inter-broker trades were considered intermediate (and hence exempt). ‘Round trip’ taxation effectively made the net taxation 1%, or 100 basis points. This was doubled in 1986, and later to include fixed income. Furthermore, a tax on stock options of 2% was introduced (1% relating to the premium, 1% upon exercise).
Understandably, investors devalued their assets to reflect the present value of future tax payments on the marginal share. The 2.2% average decrease in share prices on the announcement day added to the -5.35% index return over the 30 day period including the announcement. A further 1% share price reduction was seen in 1988 in reaction to the rate doubling.
Decreased Trading Volumes
Decreasing trading volumes led to secondary effects such as a reduction in capital gains taxes, almost entirely netting the (exceptionally low) tax revenue being generated.
Despite the tax being higher on equities, it was the fixed income market that suffered most. Despite the ‘low’ 0.003% tax levied on 5-year bonds, trading volumes dropped by 85% alone in the first week after implementation. Futures trading fell by 98%, and the options market was virtually non-existent.
All market participants would be subject to the tax; a Tobin tax is unable to discriminate between de-stabilising trades and those which provide liquidity, information and tradefinancing. With short-term trading providing invaluable liquidity to the market, an incapability to segregate individual trader motivations will therefore lead to a reduction in both liquidity and welfare-enhancing trade, in addition to increasing market susceptibility to individual shocks.
Whilst the Tobin tax’s roots lie in economic theory, its current appeal is evidently political. The Robin Hood imagery drives the tax’s public support. It is its ‘stealing from the rich to give to the poor’ appeal that attracts many of its advocates, not the belief in its realistic economic capability. Understandably, some people are more-easily influenced by a well publicised, celebrity-endorsed Robin Hood Tax marketing campaign than by econometrical analysis or time series data.
The experience of Sweden is one of capital flight. Odds are it would happen again.
The ATM Effect
The Adam Smith article contained an interesting analogy regarding ATM usage. When fees were zero, people would think nothing of doing an ATM transaction for $20. With fees of $2, you have to be pretty desperate to do an ATM transaction for $20. Instead, you would do one for your maximum limit. Some only use an ATM in an emergency and keep a pile of cash in their house instead.
In a falling market short-term traders provide liquidity (so do those shorting). Yet, Robin Hood proponents will drive those short-term traders away.
"In thinner markets, each trade would have a larger impact on price; resulting in less fluidity within the currency inventories of broker-dealers, the ‘liquidity providers’ of the market."
I fail to see how reduced liquidity and increased volatility will not be the result.
Four Reasons Tobin Tax is a Bad Idea
- It would encourage capital flight (I know hedge funds that have contingency plans to move their entire operations to the Caribbean if such a tax is passed)
- It would drive out short-term traders who provide much needed liquidity
- Reduced liquidity would lead to increased volatility at the worst times
- Pension plans and mutual funds would bear much of the brunt of the tax. Rest assured market makers will find a way to pass their costs on.
The results in Sweden are conclusive. A ‘low’ 0.003% tax levied on 5-year bonds caused trading volumes dropped by 85% in the first week after implementation.
Five-year US treasuries now yield .74%. Three-month treasuries yield .05%. Corporate bond yields are pathetic. How much of that do you want to take away?
Excluding bonds is not the answer. Liquidity and capital flight arguments suggests this idea should never get off the ground for any transactions.
By the way, buyers of CDS are often hedgers. Tax them heavily and there will be less interest in the underlying bonds. I would also point out that the speculators Sarkozy want to drive out of the market just happen to provide liquidity. Short sellers eventually cover, and provide fuel for rallies. Day traders will step into falling markets when others won't.
Sarkozy will "provoke a shock" alright, and it may crash the markets when he does.
Mike "Mish" Shedlock
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