Friday, 15 April 2011

I am sorry about the F in Tax

By Neil McCulloch

On Monday I spent an intriguing day in Brussels at the European Tax Policy Forum’s meeting at the Centre for Economic Policy Studies (CEPS). The topic was taxation of the financial sector. 

Now, I do appreciate that taxation policy is not everyone’s idea of an exciting subject, but taxation of the financial sector has become something of a hot topic of late. This is principally because the vast majority of citizens of rich countries think that banks should pay back the huge sums they were given to bail them out, and should stop paying billions of pounds of bonuses to the already extremely rich people whose actions helped to get us in the mess in the first place (see Oxfam’s recent poll on this).

Governments have responded to this sentiment by introducing a raft of new regulations (most notably the new Basel III rules which increase the amounts of capital banks must have) and by considering a range of new taxes. Three in particular are under discussion:  the Financial Stability Contribution (FSC), the Financial Activities Tax (FAT), and the Financial Transactions Tax (FTT), and it was the relative merits of these three taxes that was the topic of discussion in Brussels (driven in part by the European Commission’s current consultation on the topic). 

  • The FSC is IMF-speak for Bank Levies. The idea is that you tax a Bank’s liabilities, after taking out Tier 1 capital (mostly equity). The effect of this tax therefore is to discourage Banks from taking on lots of debt – banks’ high ‘leverage’ was seen as one of the reasons they got into trouble in the crisis, so this is a good thing.
  • FAT taxes basically try to apply VAT to financial services. Currently they don’t pay it, principally because it is technically very difficult to apply. The FAT tries to get around this by saying just tax profits and pay. Since profits and pay is the value-added of a firm, the FAT effectively achieves VAT in a different way. But some argue that the FAT should be thinner i.e. that it shouldn’t tax all profits and pay, but just ‘excess’ profits and ‘excess’ pay. And others argue that financial services are intermediate goods anyway and so good economic theory would suggest that they shouldn’t be taxed at all.
  • Finally FTTs, which would charge a tiny percentage of every financial transaction, have been proposed by development NGOs, churches and unions through the Robin Hood Tax campaign, as a way of funding efforts to combat climate change, and poverty in both rich and poor countries. I’ve recently completed a Systematic Review of the evidence both for and against FTTs – you can read the policy briefing on this, and the final Research Report will be out shortly.

In Brussels, Prof. Michael Devereux, the Director of the Oxford Centre for Business Taxation, laid into the FTT saying that it would do nothing to solve the problems that caused the crisis and that it wasn’t at all clear that it would rob from the rich to help the poor. As I pointed out, he is right on both counts, but neither are good reasons to be against the FTT. The FTT isn’t intended (and wouldn’t) solve the structural problems that caused the crisis – the FSC and better regulation is a much better tool for that – but it is a reasonably efficient way of raising a large sum of revenue. 

That leaves the issue of who would pay it and here, alas, we have very little evidence.  But it would seem highly unlikely that a tax on transactions of assets which are predominantly owned by the better off, would ultimately be paid by the poor (or at least it seems improbable that it would be any worse than, for example, VAT).

So which F tax should governments go for?  A nice presentation by Emrah Arbak from CEPS showed the pros and cons of each of these taxes. But personally I think this is the wrong question  – we should do all three. The FSC discourages excessive leverage; the FAT ensures banks pay VAT; and the FTT raises considerable sums at a time of fiscal tightening.  Of course, doing all three raises the possibility that the banks will be taxed too much. That, ironically, is a real risk – but I suspect it is one that most citizens are prepared to take.

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