IMF rebuffs critics and poses questions for financial transaction tax fans

The recent IMF report on financial transaction taxes does not seek to endorse or dismiss the idea, but rather provide a categorical analysis and evaluation.

The IMF has finally released its long-awaited report into financial transaction taxes (FTT).  The report does not seek to endorse or dismiss the idea, but rather provide a categorical analysis and evaluation of the history and full workings of any possible international transaction tax(es).

It should be welcomed by proponents, as it challenges and rebuffs many of the criticisms that have been leveled against it. Critics of financial transaction taxes, ranging from Giles Wilkes, the former chief economist at Centre Forum, and now economic adviser to business secretary Vince Cable, to the freelance journalist Tim Worstall, have outlined their opposition to the idea on several fronts.

Firstly, they argue the cost of the tax will be borne largely by the public, not the financial industry and traders operating in the speculative markets. They hold that the tax incidence, or economic burden, will fall on ordinary investors, shareholders, pension-fund holders, travellers etc. Mr Worstall even goes so far to argue that the effects are “so strong that the government could raise revenue collected by abolishing stamp duty on shares”.

A further counter to the much-vaunted tax is that an FTT will destroy marginal profit-making speculative trading. Mr Wilkes posits it is a “virtual outright ban on any speculation that is not looking for very large average profits”. He holds this would severely constrain market liquidity, and thus damage normal market operations and the workings of an efficient financial sector.

Real firms and businesses, from insurance to industry to government finance, would face a massively higher cost. Mr Wilkes states:

“Instead of facing a 0.2 per cent spread for doing a gigantic FX transaction, the absence of millions of small other-speculators on the other side might blow this out – to 0.5 per cent, to 0.9 per cent, more. Who knows? But this translates into a giant cost of capital charge on everyone else.”

A third criticism is that advocates have no idea what impact the tax will have on trading volumes and consequently, on revenues accrued. Related to this point, is their objection on practicality grounds.

So what does the IMF report say to all these points? The report argues it is difficult to make a strong economic case for introducing a currency transaction tax (CTT), since it would raise much less revenue on a considerably more elastic base than a security transaction tax (STT). This piece largely focuses on securities transaction taxes (STT).

Mr Wilkes’s point that financial transaction taxes would considerably increase capital costs for very short-term trading is confirmed by the report. However, they define very short-holding periods as a day(s). An STT at even the very low rate of one basis point reduces securities value by almost half. But for very long holding periods (e.g., 10 years), the drop in value from even a 50 basis point STT is quite small (1.4 per cent).

The report found that, in 2009, the average holding period for stocks in the Standard and Poors 500 stock index was 0.4 years, or about 3.5 months – down sharply from the average holding period of 1.8 years in 1990. The table below illustrates the reduction in security valuation and increase in cost of capital for different applied transaction tax rates:

IMF-financial-transaction-tax-analysis

So for an asset which has a holding period of three months (below the current market average) a 0.01 per cent STT would only reduce asset valuation by 1.3 per cent and increase capital costs by 0.04 per cent, a modest transactional cost. Also, transactional taxes over time can get priced in. For instance, the United States’ Securities and Exchange Commission (SEC), its equity market regulator, imposes a 0.17 basis point non-tax charge on stock market transactions to fund its regulatory operations, which has done little to damage market liquidity.

To soothe opponents of an STT, one potential option would be to introduce variable rates in accordance with the length of holding for an asset, i.e. a lower STT would be applicable for very short-term trades. This would take into account the narrow bid-ask spreads of short-term trades. The downside to such a system would be the additional complexity introduced. This is an idea worth exploring though.

To protect savings and investment made by the wider public, any proposed STT could be conditional on the size of the trade. Earlier this summer, Pete Stark, a US Congressman, introduced the ‘Investing in Our Future Act of 2010’ – which would amend the US Internal Revenue Code to impose an excise tax on currency transactions exceeding $10,000, equal to 0.005 per cent of the value of the currency acquired in the transaction (currency transaction tax). The $10,000 threshold is designed to target only large trades, which are predominately made by big financial firms.

Financial transaction taxes, if designed correctly, can raise substantial revenues. The IMF report stated that any proposed STT should have the broadest tax base possible, to avoid evasionary opportunities. If the goal is to raise revenue from the financial sector, one option is to improve the application. Taxing both debt and equity products will also reduce distortion of investment and financing decisions. However, they warn to be careful of taxing public sector debt, i.e. sovereign debt which would push up the cost of government borrowing. Not to do this, though, would reduce liquidity in the private bond market and increase capitals costs. This is something proponents will need to address.

The report found that unilateral STTs can work, even if they are only levied on narrow bases. They catalogue the different nations ranging from the UK (0.5 per cent stamp duty on all secondary share trading since 1986), Switzerland, Hong Kong, Singapore, and South Africa who have levied some form of an STT. This indicates that such taxes do not automatically drive out financial activity, particularly in major financial hubs like the UK and Switzerland.

There is a highly progressive element to any proposed STT, as a large part of the burden of an STT would fall on owners of traded securities. High-income individuals possess a “disproportionate share of financial assets, and would be ones to initially suffer from a fall in taxed securities prices”. In terms of revenue, a low-rate STT on stocks, bonds, foreign exchange and their derivatives could raise substantial sums. An example is that “a one basis point STT on global stocks, bonds and derivatives is estimated to raise approximately 0.4 per cent of world GDP”.

The IMF has provided no ringing endorsement for advocates of FTT (particularly for CTT), but they have provided clarity to the issue and a framework of how it can be successful. They believe an STT coordinated and implemented internationally will reduce market elasticity, and thus be able to raise larger amounts of revenue with a lower rate. If we can secure global agreement, even at a regional level (eurozone) then this dream may yet become a reality.

14 Responses to “IMF rebuffs critics and poses questions for financial transaction tax fans”

  1. Jen

    RT @leftfootfwd: IMF rebuffs critics and poses questions for financial transaction tax fans: //bit.ly/b3GmJY reports @rayhanhaque

  2. Liam McKee

    RT @leftfootfwd: IMF rebuffs critics and poses questions for financial transaction tax fans: //bit.ly/b3GmJY reports @rayhanhaque

  3. liammckee

    RT @leftfootfwd: IMF rebuffs critics and poses questions for financial transaction tax fans: //bit.ly/b3GmJY reports @rayhanhaque

  4. LadyRoisin

    IMF doesn't reject Robin Hood tax – details here from leftfoodfwd //bit.ly/d7sEXu

  5. Shamik Das

    @guidofawkes more on the financial transaction tax for your perusal: //bit.ly/b3GmJY @leftfootfwd

  6. LCID

    RT @leftfootfwd: IMF rebuffs critics and poses questions for financial transaction tax fans: //bit.ly/b3GmJY reports @rayhanhaque

  7. Evidence based.

    So the IMF is right here? Is it also right when its says the coalition’s deficit reduction plans are the correct way forward, or is that not how analysis works?

  8. Guido Fawkes

    I think you’ll find the IMF is in a long-winded and circumlocutory way saying “no”.

    Forget a Tobin tax.

    Incidentally, UK stamp duty on shares is not paid by investment banks who market make in shares, which represents a huge proportion of turnover and is avoided by many players using derivatives like CFDs. Which is hardly a ringing endorsement.

  9. Aaron Peters

    The IMF was using data from twenty years ago when Forex speculation was a whole different game. To my mind there is a certain amount of ‘selection bias’ in the data they chose to analyse.

  10. Tim Worstall

    It’s meretricious shit like this that gives you lefties a bad name you know.

    You say:

    “There is a highly progressive element to any proposed STT, as a large part of the burden of an STT would fall on owners of traded securities. High-income individuals possess a “disproportionate share of financial assets, and would be ones to initially suffer from a fall in taxed securities prices”.”

    The IMF does say something like that in its first paragraph on incidence. It says this:

    “A large part of the burden of an STT would fall on owners of traded securities, at the time the
    tax was introduced, as the value of stocks, bonds and derivatives subject to the STT fell by the
    present value of the expected future STT liabilities on those securities. Like any tax on capital
    income, the distribution of this effect would likely be highly progressive: High-income
    individuals possess a disproportionate share of financial assets, and so would suffer from the
    initial fall in taxed securities prices.”

    However, read the next two paras and see what else they say:

    “In the longer run, market forces would work to equalize the after-tax return to capital in the
    taxed and untaxed capital markets. The increase in the cost of capital to firms issuing taxed
    securities would reduce their demand for capital relative to firms whose finance was untaxed; or,
    firms would finance more of their investment from untaxed sources, such as bank loans. The
    lower supply of taxed securities and the increased demand for untaxed forms of capital would
    lower the yield (or raise the price) on taxed securities and raise the yield (or lower the price) on
    untaxed capital until their after-tax price equalized.171 This effect would, of course, be the same
    for any tax initially imposed on capital income.
    How much overall investment would fall as a result of the STT would depend on the relative
    elasticities of capital supply and demand. In a small, open economy, the after-tax return on
    capital is determined on the world market. In response to imposition of the STT, capital would
    flow out until its after-tax return was restored to the world market level. In the long run, capital
    owners would therefore not bear the burden of the STT; it would fall on workers, who as a
    result of the smaller capital stock would be less productive and receive lower wages. If, however,
    the capital supply is less than perfectly elastic, the STT will lower the return on capital, and
    capital owners will share the burden of the tax with workers.172”

    So, we’re right. It will be the public, the workers in the form of lower wages, who will pay this tax (after that oh so pleasurable initial jolt of progressivity).

    This is “rebuffing the criticism” offered by Tim Worstall (freelance journalist) is it?

    Jeebus, the IMF has just blown a great gaping hole in your entire argument: that it’ll be the rich bastards who pay this tax. It just won’t be, as Giles and I have been saying all along.

    Honesty on your part would have led you to quote that point from the IMF report: it’s obviously way too much to expect you to ever utter the words “You know, that Worstall bloke, he was right on this, wasn’t he?”

  11. Jordan Hall

    RT @leftfootfwd: IMF rebuffs critics and poses questions for financial transaction tax fans: //bit.ly/b3GmJY reports @rayhanhaque

  12. Susan Jones

    IMF rebuffs critics and poses questions for financial transaction …: The IMF has finally released its long-await… //bit.ly/cRJLNz

  13. Matthew Lloyd

    IMF rebuffs critics and poses questions for financial transaction … //bit.ly/9wrN9w

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