April 03, 2017
The Hankyoreh, April 3, 2017
The efforts to implement a financial transactions tax (FTT) within the European Union (EU) seem to be finally coming to a head. While the EU is far from unanimous in support of a FTT, an effort to implement a joint FTT has been moving forward for the last six years under a provision that allows ten or more countries to act collectively. The ten countries include the four biggest economies in the euro zone, which ensures that it will be a meaningful bloc, if they succeed.
At this point there are serious questions as to whether the ten countries can come to an agreement. The biggest remaining stumbling block is an effort by Belgium to include special carve outs, most importantly for pension funds.
The government of Belgium is arguing that trades by these funds should not be subject to the tax. This objection makes little sense if the goal of the Belgium government is actually to protect the pension funds. Of course it is a great line of argument if the point is to sabotage the FTT while appearing to be supportive.
The reason why the objection makes little sense is that Belgium’s pension funds are likely to incur very little cost as a result of the tax. At 0.1 percent on stock trades, with scaled rates on other financial transactions, the tax is already low. But the bigger issue is that trading volume will fall in response to the tax. In other words, because the tax increases the cost of trading, pension funds like other investors will trade their stock less frequently.
The pension funds don’t care about how much money they spend on the tax alone, they care about how much money they spend in total trading costs, including the tax. Insofar as they save money from a reduction in other trading costs, they will see less of a burden from the tax due to less trading.
While there are a range of estimates as to how much trading will change in response to an increase in costs, the center of these estimates would make the change roughly proportional.
In other words, if the tax raised trading costs by 50 percent, then trading volume would fall back by one-third, leaving total trading cost pretty much constant. (Pensions would do 67 percent as much trading as before the tax was put in place, but pay 1.5 times as much on each trade.)
If the decline in trading volume is proportionate to the increase in cost due to the tax, then pension funds will see little change in their total trading costs as a result of the tax. In this case, the burden of the tax is entirely on the financial industry, since it will see its revenue from trading fall by an amount roughly equal to the size of the tax.
(A recent study by the Tax Policy Center of the Brookings Institution and the Urban Institute assumed that the decline in trading volume would actually be 25 percent greater than the size of the tax, which would mean that total trading costs would fall by even more than the amount of revenue raised through the tax.)
When the decline in trading volume is factored into the calculation, it is very difficult to see why the Belgium government would be concerned about the impact of the tax on its pension funds.
Their total trading costs will not be affected in any big way by the tax, they will just be paying more to the government and less money to the financial industry.
There is one implication to this story that will bother many people. It implies that pension funds and other investors are not getting anything from their current level of trading. This is likely true. Every trade has a winner and a loser. If I am fortunate and sell my stock near its high, then I have profited by the trade, but the person who bought over-priced shares from me is a loser. When we take all the trades in the economy as a whole, they even out so that on average investors neither gain nor lose from trades. While every investment adviser will like to claim that they beat the market, on average they don’t. This means that their trades are just a waste of money.
There is an argument that better operating financial markets can direct capital to its best uses. This would increase productivity for the economy as a whole, thereby creating a situation in which everyone could be better off. However there is little reason that the massive volume of turnover that we now see in financial markets is actually necessary to allocate capital to its best uses.
Certainly that did not appear to be the outcome in the years of the internet bubble, when ill-conceived start-ups could quickly raise billions of dollars with an initial public offering, or in the last decade when trillions of dollars were funneled into mortgages on overpriced houses.
We need liquid capital markets to facilitate the flow of capital from savers to investors, but we likely hit the necessary levels of liquidity long ago, with trading volume that was far lower than it is today.
In short, Belgium’s pension funds really have nothing to worry about from the FTT. On the other hand, Belgium’s financial industry and the financial industry of other participating countries have a great deal to worry about. The FTT would make the economy more efficient at their expense.
Of course it’s difficult for Belgium’s government to argue that it is opposed to the tax because it wants to protect the income of the banks. So, we hear that they are concerned about pension funds.