European Union’s intentions to tax the financial sector already in 2011

Keeping in mind the European financial sector's needs to make a fair contribution to public finances, and the EU-27 governments' urgent needs for new sources of revenue in the current economic climate, the Commission has put forward a two-sided approach for financial sector's taxation.

1) At the global level, the Commission supports the idea of a Financial Transactions Tax (FTT), which could help fund international challenges such as development or climate change.

The FTT is expected to produce about € 60 bln revenues a year.

2) At the EU level, the Commission recommends that a Financial Activities Tax (FAT) would be the preferable option. The FAT is expected to produce about € 25 bln revenues a year.

The Commission argues that if carefully designed and implemented, an EU FAT could generate significant revenues and help to ensure greater stability of financial markets, without posing undue risk to EU competitiveness. The Commission will present these ideas to the European Council at the end of October and to the G-20 Summit in November 2010.

Commission's official opinion was expressed by Algirdas Šemeta, Commissioner for Taxation, Customs, Anti-fraud and Audit in Brussels on 7 October 2010: “there are good reasons for taxing the financial sector, and feasible ways to do so; the Commission's ideas are to ensure that the financial sector makes a fair contribution to the most pressing EU and global challenges”.

Taxing the banks: global and EU approach

• The Commission has supported the idea of a Financial Transaction Tax (FTT) at a global level; this ides will be discussed at the G-20 summit at the end of 2010.

If ambitious global objectives are to be achieved, in areas such as development aid and climate change, international partners will need to agree on global financing tools. A Financial Transactions Tax, FTT would tax every transaction based on its transaction value, resulting in substantial revenues. The Commission believes that a well-implemented, internationally applied financial transaction tax could be an attractive way of raising the necessary funds for important global policies.

• At the European level, the Communication suggests an introduction of a Financial Activities Tax (FAT), which would target the profits and remunerations of financial sector companies.

In this way, it would tax the corporations, rather than each actor involved in a financial transaction (as is the case with the FTT). Following in-depth analysis of possible options for taxing the financial sector, the Commission is of the opinion that the FAT would be the best instrument for an appropriate taxation of the financial sector and the need to raise new revenues in the EU-27.

A fair contribution from the financial sector

In order to assess whether a new financial sector tax could be fully justified, the Commission examined the current contribution of this sector to public budgets.

1. It concluded that there are good grounds for introducing the financial sector taxes: firstly, the financial sector was a major cause of the financial crisis and received substantial government support over the past few years. It should therefore properly contribute to the cost of re-building Europe's economies and bolstering public finances.

2. Secondly, a corrective bank tax could complement the essential regulatory measures (including the bank levy and resolution fund) designed to enhance the efficiency of financial markets and to reduce their volatility.

3. Third, given that the financial sector is exempt from value added tax (VAT) in the EU, such tax would ensure this sector is not under-taxed if compared to other economy sectors. In sort, a new tax could help to ensure that the financial sector makes a fairer and more substantial contribution to public finances; it would provide additional sources of revenue and would help create a stable and more efficient financial sector.

Further steps

The Commission will present its Communication to EU Finance Ministers at the ECOFIN Council on 19 October, and to EU Heads of State and Government at the European Council at the end of October.

Then, the EU position on financial sector taxation will be presented at the G-20 Summit in November, with a view to encourage major international partners to agree on a global approach. The Commission will also begin an in-depth impact assessment with a view of further examining the “taxation ideas”; the EU policy initiatives would be formulated in 2011.

The Commission's Communication, see:

http://ec.europa.eu/taxation_customs/index_en.htm

Historic background

It seems that no one will escape “tighter financial supervision in the European Union in the future”, warned the EU's Internal Market Commissioner, even as he attempted to reassure the industry to “remain calm” over the new regulatory regime in the beginning of September. Michel Barnier's comments were especially directed at the City of London, which has expressed concerns about the impact of more centralised decision-making in areas such as over-the-counter derivatives, securities markets and hedge fund regulation.

See: Sanderson R., Blitz J. No escape from tighter EU financial supervision . – Financial Times, 5 September, 2010.

Under the proposals, three new EU-level watchdogs – for the banking, insurance and securities markets sectors – will draw up common technical rules and standards, while not supervising companies directly. However, there are concerns among some finance executives, especially in the UK, that the new watchdogs will permit Brussels to pursue greater centralised control of controversial activities such as derivatives and short selling.

There will also be tighter requirements on financial institutions to register derivatives. Mr Barnier denied that the introduction of tighter financial supervision could put Europe at a competitive disadvantage: “the Americans are doing the same reforms in parallel that we are proposing. We don't have enough supervision at the moment. People must adapt,” said Mr. Barnier and added that the UK was still a centre of strength for Europe but that was in the interests of Europe and the City to be an example of supervision”.

See: Tait N., Wiesmann G., Hall B. Push for common approach on bank tax in EU – Financial Times, 6 September 2010.

Among the suggestions, however, were broader view of the Commission's tax officials on the merits of taxes on financial transactions or on financial activity. The latter could be levied on profit and remuneration at financial firms, or on returns from risky activities.

Suggestions did describe in precise way the desirability of such taxes, which could raise billions of euros annually, or their relative merits. But officials acknowledged that the impact and feasibility of a transaction tax “remained largely uncertain in many cases” and tax avoidance and unintended consequences could be problematic.

See: Tait N., Wiesmann G., Hall B. Push for common approach on bank tax in EU . –Financial Times, 6 September 2010.

A financial activity tax would make financial services more expensive and cut the size of the financial services sector, the paper says. Nevertheless, commission officials say they want to get a better sense of the policy goals that member states believe such taxes could advance – ranging from helping to bolster national budgets to damping excessive risk-taking.

France, Germany and the UK are already committed to introducing bank levies based on bank assets, but only Germany is willing to dedicate funds raised to future bank resolutions. The UK is adamant that proceeds should go towards general budgetary needs.

Technical differences are already causing some friction. For example, the British government's plan to include the balance sheets of foreign bank subsidiaries operating in the UK has caused disquiet in Germany. The French tax is likely to be focused more narrowly and raise substantially less than the UK levy.

Germany and France are also pushing for international agreement on a financial transaction tax while the UK is less enthusiastic.

See: Financial Times. Editorial: EU go-ahead for regulatory shake-up – 7 September 2010.

Already in September, the EU finance ministers have given the green light to the proposed overhaul of the EU's patchy system of financial supervision – meaning that four new pan-European bodies to bolster national supervisory structures are set to start operating in January 2011.

The pact – which creates three EU-wide supervisory authorities for banking, insurance and securities market, as well as a European Systemic Risk Board to warn about threats to financial stability – was approved by the European Parliament at the end of September.

At the September meeting in Brussels, finance ministers also agreed to submit national budget plans to the European Commission and other EU governments for vetting – a move aimed at strengthening governance across the EU-27 in the wake of the Greek crisis.

But they failed to reach any consensus on whether new taxes should be levied on Europe's banks or financial services sector, an issue that creates sharp divisions among European governments.

For example, Olli Rehn, the EU economic and monetary affairs commissioner, mentioned that the budget-vetting initiative was a major improvement in the EU's economic governance architecture. He also promised to toughen actions against member states that ran excessively lax budgetary policies saying that the same level of commitment from all member states is expected on moving to a more rules-based enforcement of the growth and stability pact, including more and more effective incentives and sanctions, which will kick in at an earlier stage.

There had been concerns in the UK that the vetting process might mean Brussels would see budgetary plans before they were presented to the House of Commons, the UK's lower house of parliament. But George Osborne, UK chancellor of the exchequer, said Britain's timetable had been recognised and that submissions to Brussels would follow the spring Budget.

Lack of agreement on the bank tax was not surprising, given the splintered views on what kind of levy might be desirable and how any proceeds should be used.

See: Tait N. EU go-ahead for regulatory shake-up. – Financial Times, 7 September, 2010.

But ministers and officials differed in their assessment of how wide the gulfs were. Although several EU finance ministers supported the UK's argument that it was up to national governments to decide how proceeds from any bank levy were deployed. The EU Commissioner, Michel Barnier, would like to see at least some of the proceeds go to mandated national “bank resolution funds”. He was encouraged by the discussion and that there had been progress from “just talks” earlier in 2010.

 

Clearing up the idea

Together with the mentioned communication, the European Commission published a set of clarification points concerning the perspective issue of financial sector taxation (Brussels, 7 October 2010); the deliberations on the proposal went the following way:

• The essence of the financial transactions tax, FTT

A financial transaction tax (FTT) is a tax applied to financial transactions, usually at a very low rate. Financial transaction means any exchange of financial instrument between two or more parties. The financial transaction tax would apply only to stocks and bonds, working as a currency transaction levy; these are two examples of a “arrow base FTT”. At the opposite end of the spectrum a very broad base financial transaction tax would be introduced, which applies to all financial instruments including derivatives and structured instruments.

• The essence of the financial activities tax, FAT

A financial activities tax (FAT) is a tax on profit and remuneration, which applies to all activities of a financial sector company (e.g. bank or insurance company). It can tax all profit and wages; it can be specifically view economic rents (rent-taxing FAT) and/or profits gained through riskier activities (risk-taxing FAT).

In contrast to an FTT, where each financial market actor is taxed according to transactions, the FAT targets financial corporations. This decision was presented to the G-20 meeting in the IMF's report on financial sector taxation in June 2010.

See: http://www.imf.org/external/np/g20/pdf/062710b.pdf

• The options in taxing the financial sector

Already at the European Council in June 2010, it was agreed that the EU should “lead efforts to set a global approach for introducing systems for levies and taxes on financial institutions with a view to maintaining a world-wide level playing field".

The European Parliament and some member states have also called for the idea of financial sector taxation in Europe and around the world. After a wide public debate on the various possibilities for taxing banks in Europe and at global level, as well as in-depth analysis of the issues, the Commission intends to arrange discussions on financial sector taxation in order to come up with the best approach.

By putting forward options for a European approach, the Commission aims to avoid new obstacles to the “internal market”, which could be created through a patchwork of different national bank taxes.

The Commission has always supported the idea of a global financial transactions tax to fund global challenges. The initial Communication would serve as a basis for further discussion within the EU-27 in order to consolidate the EU position prior to the G-20 meeting in Seoul in November. The Commission intends to pursue the idea of a global financial transactions tax with its G-20 partners.

• Reasons for a new tax

Among the numerous reasons behind the introduction of a new tax on the financial sector, the following were considered most appropriate.

• First, the banks played a central role in creating the recent economic crisis, and it is generally agreed that they now need to make a fair and substantial contribution to the costs of recovery.

• Second, a new tax on the financial sector would raise important and much-needed revenue. The Commission has concluded that the financial sector is probably under-taxed compared to other sectors. Therefore, it would be justifiable to introduce a new financial sector tax which could help meet current revenue needs.

• Third, some taxes with their “corrective” characteristics could help positively influence market behaviors and help prevent future crises. The Commission will, however, take into consideration the cumulative impact of taxes and regulation in order to ensure their complementarities and to allow the financial sector to fulfill its role in the "real" economy.

The financial services have been constantly treated preferentially: e.g. they are generally exempt from VAT due to difficulties in measuring the taxable base. A number of studies suggested that this situation could lead to the under-taxation of financial services.

See, for example:

- Genser and Winker (1997) "Measuring the Fiscal Revenue Loss of VAT. Exemption in Commercial Banking",

- Huizinga (2002) "A European VAT on financial services? Economic Policy",

- De la Feria and Lockwood (2009) "Opting for Opting-In? An Evaluation of the European Commission's Proposals for Reforming VAT on Financial Services".

In addition, the Commission has taken into account the privileged position that the financial sector enjoys in the economy compared to other sectors, the fact that it has benefited from economic rents and the implicit protection it has received from governments. These factors also need to be considered when weighing up what would constitute a fair contribution by the financial sector to public finances.

Therefore, the Commission supported a global financial transactions tax too. The recent economic crisis was global in its causes and its effects: responding to it, and recovering, requires global solutions. If ambitious global objectives are to be achieved, in areas such as development aid and climate change, international partners will need to agree on the global financing tools. Given the potentially high revenues a global FTT could generate, it is an attractive funding solution for such global objectives. Economic analysis also shows that a financial transaction tax, in addition to the revenue it could raise, may prevent certain market behaviors (such as high speed trading) if implemented globally. Therefore, it would offer a “double dividend” in that it could help to raise important revenues while also contributing to more stable and efficient financial markets.

Some possible revenues raised from a global FTT were estimated: if applied at global level, and at a rate of 0,1%, tax revenues from a financial transaction tax are predicted to be around € 60 bln (without derivatives). Some even say that values of more than ten times this amount are expected if derivatives are included. Although for various reasons, these figures are not considered to be highly reliable.

• Global and European “financial taxation”: FTT vs. FAT

The Commission considers that the FAT is more preferable option for Europe than the FTT; the Financial Transactions Tax is a tax more suited to global application – there are considerable risks (particularly of relocation) in its unilateral introduction. Therefore, the risks are considerably lower with the FAT, because profits and wages are less mobile than trading. The FAT appears to offer the advantages of being able to raise revenue and ensure a fair contribution from the banks, without the high risks associated with the FTT.

The Commission's analysis suggests that the FAT is more suited for the European rather than for the global level, as it would fit better with the specificities of European economic and taxation situation. The FAT is not really a tax that could uniformly apply in every region of the world, given the different approaches to taxation internationally. Hence, a financial transactions tax would, by its nature, be much easier to apply globally.

See: European Commission (2010), Staff Working Document on the Taxation of the Financial Sector (available at: http://ec.europa.eu/taxation_customs/index_en.htm).

• Expected revenues

The Commission estimated preliminary amount of revenue that could be raised from an EU FAT. However, the FAT would depend on its design: in its most extensive form, as a tax on total remuneration and profit, the revenues for the EU-27 could be € 25 bln with a tax rate of 5 per cent, i.e. one-fifth of the present EU budget.

The Commission believes that it is important first of all to agree on whether a financial sector tax shall be introduced, as well as how it should be designed and implemented in order to maximise its benefits. Then, after that, the EU-27 can start discussions as to the appropriate use of revenues received. At the same time, the Commission will design an impact assessment procedures, which would provide an opportunity to examine in detail the economic, political and technical implications of the different options put forward for taxing the financial sector. The impact assessment procedures intend to help ensure that any subsequent tax introduced would minimise possible risks and maximise potential benefits.

Critical remarks

The European Commission has thrown its weight behind the introduction of a financial activities tax in Europe, which would tax profits and remuneration at banks and other financial services companies, as it considers ways to raise money from the financial sector.

In October 2010, officials in Brussels said that the alternative idea – a financial transaction tax – was less suitable because of a “high” risk that business would simply move to other regions in the world.

See: Tait N. Brussels backs financial activities tax. – Financial Times, 7 October, 2010.

The Commission argues that at this stage, there is greater potential for a financial activities tax at the EU-level. For example, tax officials in Brussels argue that the financial sector has received large amounts of public through “financial crisis injections” and yet it is taxed relatively light. However, tax officials expect to present their views to the EU leaders' summit in late October with an in-depth impact assessment for policy initiatives in 2011.

See: Financial Times, Editorial Comment: The moving target of bankers' bonuses – 7 October, 2010.

Eugene ETERIS, European correspondent (14.x.2010)

№10(48), 2010