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Sunday 11 December 2011

Europe, Taxed by Tobin

1808 and All That

The soap opera that is the Eurozone continues unabated, as the intransigence of the UK has caused a split that seems likely to cleave the European Union in two. Regardless of the rights or wrongs of the situation the British appear to have approached the negotiations over Europe’s finances with the finesse of a bulldozer and the subtlety of a sledgehammer.

The UK has calculated that agreeing to the latest half-baked plan to save the Euro, which they’re not part of, is not in their national interest. As this “national interest” appears to be that of the UK’s financial sector, which helped caused most of the problems in the first place, this looks a bit strange. What’s even more strange is the main issue is the imposition of a so-called Tobin tax on financial transactions: which is peculiar mainly because the British already have such a thing and have had it since 1808.


The split within the European Union is not a small matter: the British veto on an agreement should, at least in theory, prevent the other 26 members from using the institutions of the union to implement their financial stabilization treaty, which is needed to shore up the Euro and prevent a calamitous global market collapse. This agreement is a complex affair, with all manner of checks and balances backed up by threats of automatic punitive action should member states transgress. Whether it’s workable is anybody’s guess, but you could apply that argument to the whole ramshackle mess that is Europe at the moment.

The British have never been very keen on the European Union.  They refused to join when it was set up in 1952, were vetoed from joining by General de Gaulle in 1963 and 1967, finally agreed to join in 1973 and have stood at a distance from the single currency since the pain of being forced out from its predecessor, the European Exchange Rate Mechanism, in 1992. Since then the UK has seemed mainly interested in keeping the single market – the cross-border trading union that permits a free flow of goods and services within the union – while seeking opt-outs on anything they don’t particularly like: which appears to be Europe as whole, most of the time. Yet the importance of the Eurozone to the UK can’t be understated – British trade with poor beleaguered Ireland alone is greater than its trade with the entirety of the BRIC emerging country block.

Van Man

Ostensibly the reason for the British veto was the implied threat to the UK’s financial service industry through the imposition of a financial services tax, a so-called Tobin tax. Given that Britain’s non-financial sector allegedly consists of two men in a van with a spot-welding torch we perhaps shouldn’t be surprised at the resistance to such a levy. The UK is particularly exposed to this as financial services make up over 10% of GDP, more than that of any equivalent developed nation. Moreover financials are the only major sector that actually generated a trade surplus in 2010.

Britain has steadily moved its economy towards services since the bizarre, amusing and ultimately futile attempts  to maintain "virtuous" manufacturing in the 1960s that we recorded in Weightless Economies. Nonetheless, reports of the demise of the British manufacturing sector are somewhat exaggerated. Manufacturing makes up around 13% of GDP and is primarily centred on high technology – aerospace, pharmaceuticals, electronics and so on. The UK would be even better placed if the culture of government secrecy hadn’t ensured that British inventions such as the digital computer and public key cryptography were kept hidden until someone else in America discovered them, patented them and made a fortune. Still, rebalancing the UK's economy away from financial services is clearly not an overnight task, so anything that threatens these revenues is a serious concern for Britain.

Rampant Speculation

The Tobin tax at the centre of this debate was an idea from the American economist James Tobin whose Proposal for International Monetary Reform was originally intended as a way of reducing currency fluctuations by making short-term trading uneconomic. The idea is that speculators, who rely on small fluctuations in prices to make a turn, would be priced out of the market, which would reduce the volatility in markets. As Tobin stated:
“Speculation on exchange rates, whether its consequences are vast shifts of official assets and debts or large movements of exchange rates themselves, have serious and frequently painful real internal economic consequences.”
However, one of the points that Tobin made, was that for this to work it needed to be internationally agreed; and this is the sticking point for the British, who argue that applying such a tax to financial transactions more generally, in order to reduce financial speculation may be a good thing but can’t possibly work if Europe applies this unilaterally. As the UK accounts for 36% of the European Union’s financial service industry and over 60% of its exports in financial transactions any financial transaction tax is likely to disproportionately impact it. In fact the European Commission itself reckons over 60% of the income would come from Britain.

Unpromising Speculation

The evidence of previous attempts to unilaterally curb speculation using Tobin taxes isn’t encouraging. Sweden introduced a financial services transaction tax in 1984 but abandoned it in 1991:
“The Swedish system of taxes also played a very profound role in causing trades to migrate to non-taxed or lower-taxed jurisdictions. With the 1986 announcement that the equity tax would double, 60% of the trading volume of the 11 most actively traded Swedish share classes, accounting for one-half of all Swedish equity trading, moved to London; thus 30% of all Swedish equity trading moved offshore. By 1990, more than 50% of all Swedish trading had moved to London. Foreign investors reacted to the tax by moving their trading offshore while domestic investors reacted by reducing the number of their equity trades”.
It’s perhaps not surprising that the British government regards this as an unacceptable imposition. The other members of the Eurozone see the freedom of the UK’s financial sector as a prime cause of the current bout of global economic unrest – what the French President Nicolas Sarkozy has called “Anglo-Saxon capitalism”; the relatively unrestrained free market approach of the US and UK financial sector. Indeed this comes on the back of the European Central Bank requiring euro-denominated clearing houses to be located in the Eurozone and therefore outside of London – a clear breach of the European single market, but evidence perhaps of the way the winds are blowing.

Stamp Duty

What is a bit odd, though, is that Britain already has a Tobin tax, and has had one since the beginning of the nineteenth century, a century before James Tobin was born. This is the so-called “stamp duty” on share transactions on publicly listed companies. This rate of tax has been steadily reduced over the years, which has provided a natural experiment for researchers into financial transaction taxes and the results certainly imply that the tax reduces the number of transactions, but research has also shown that it:
“Clearly depresses share prices, particularly for firms with more frequently traded shares. This may increase the cost of capital faced by firms, which in turn could have negative repercussions on investment. Stamp duty also distorts the signals that share prices send about the profitability of firms, as share prices are also affected by expectations of future turnover volumes and stamp duty rates.”
When researchers looked theoretically at investor behavior if one market unilaterally imposed Tobin style taxes while others didn't they showed that speculators did indeed move away from that market – just as the British suspect. They also showed that the market became more stable – just as the Europeans suspect. This was at the cost of destabilizing other markets, as speculation moved to where it was most cost effective, leading to some hopeful theorizing that this would cause these other markets to also introduce such taxes.

Sovereignty Lost

This is the problem that the British and the Europeans have with each other. It’s not just a question of financial transaction taxes, but more fundamental – it’s about what they’re trying to achieve. The British approach is more open, more conducive to freedom but brings with it a whole host of potential calamities.

Europe meanwhile is busily moving sovereignty away from democratically elected governments to an unelected centralised bureaucracy in order to ensure control and order can be maintained. So far two elected Prime Ministers in Greece and Italy have been unceremoniously removed and replaced under pressure from the European centre; the question for the remaining leaders is just how much they’re prepared to give up to maintain unity. The British were never likely to go far down this route, it’s just ironic that the split has come over something they were doing long before the Euro was ever thought of.


  1. Just an excellent synthesis. Many thanks

  2. Your comment "the UK’s financial sector, which helped caused most of the problems in the first place" is contrary to most of the analysis I have seen. Is the UK to blame for the real estate bubbles and sovereign debt overloads of the Euro-zone? I think not. It looks to me like they are just steering wide from a slow motion train wreck of an unsustainable economic experiment.

    -- Vance

  3. Serious high volume traders in London never pay the stamp tax. It's really not much of a factor, except in recent discussions of the transaction tax, where people cite the fact that "England has one". Market makers are exempt, and traders use contracts for difference with them to avoid the tax. The transaction tax is a political smokescreen, the easiest populist gimmick to make it appear that "something is being done about banks". It would be very effective in reducing trading volumes, but of course, that means that most of the estimates of its revenue generation are off by a factor of 3 or 4, maybe more. Thank goodness the British are in a position where they must act in alignment with reality, it's the only thing standing between a functioning financial system and the fantasies of the Eurocrats. The conflation of 40-1 leveraged CDO speculation with ordinary liquidity and price discovery operations on ordinary markets is the biggest and most prosperity-threatening regulatory concept out there. But it's easier to score political points by publicizing that false meme than to really do something about Europe's debt predicament.

  4. I'd agree with both of the previous comments.

    Firstly, the structure of the Eurozone, currency union without political union, was an accident waiting to happen. Nonetheless it took the profligacy of the banks to create the conditions under which it happened. Something else would have caused it eventually.

    It's also correct that the UK's Stamp Duty isn't really an issue for London based traders. If it was then they'd have migrated offshore, of course. The possibility of really effective Tobin Tax raises exactly that possibility: which is why the British government is so determined to fight it. I just rather like the historical quirk that there's any kind of Tobin Tax in the one regime that's determined to reject it.