EU do it!
''Dear Ms. Merkel and Mr. Sarkozy,
While the US has embarked on a significant overhaul of its financial system and China has been growing at a blistering pace, the EU is lagging behind both on financial reform and on kick-starting growth. We have been too busy fighting fires partly of our own making.
Meanwhile our new-found enthusiasm for austerity measures is sure to stoke even more fires and has already sparked widespread social unrest across the Union.
The EU's citizens are mature enough to understand the need for some belt-tightening, but they resent the fact that the financial sector that is responsible for our misery is getting away scot-free.
Government guarantees and depressed interest rates have generated record profits which have once again been privatised in the form of soaring bonuses. More government injection of funds into the weaker parts of the financial sector that will need to accompany the stress tests later this month will lead to an even greater socialisation of losses.
Citizens are getting very restless about the ability, nay willingness, of their leaders to make the financial sector pay even a small amount towards the damage it has caused. The broader financial reform process also remains dangerously incomplete. It's time to press the reset button.
Immediate steps to implement a financial transaction tax (FTT) will not only send the right signals and pacify citizen anger, but will also generate revenue to soften austerity measures and be a significant step forward on the reform agenda. Here is what you need to do:
First, tell your colleagues, especially the US and Canada, that the EU is moving forward on this, with or without their support. As much as half of more than $200 billion that can be mobilised in the EU alone will fall on taxpayers outside the Union, so there is a first mover advantage to implementing FTTs.
Second, think of an FTT not as a flat rate blunt tax for raising revenue alone, but as a surgical tool that can be used flexibly to achieve multiple policy objectives. FTT rates should be variable across markets and over time. More complex, opaque markets such as those in over the counter derivatives should be penalised with higher rate to capture their contribution to systemic risk.
Furthermore, FTT rates can be increased to cool overheating financial markets, and slashed in the event of a market downturn. This would be a good 'leaning against the wind' market complement to planned counter-cyclical capital requirements for banks. It would reduce the build-up of excessive risk.
Third, use FTTs to reduce tax evasion. In the recent past, Brazil and India both used the information generated through the collection of transaction taxes to tackle tax evasion and a Chinese official recently suggested taxing foreign exchange markets to identify speculators.
This information generated by transaction-level electronic record-keeping will not only help fight tax evasion at this critical time of depressed tax revenues, but also help financial regulators keep better track of risk-taking. Transactions with secretive low-tax jurisdictions can also be penalised with high rates. This will generate further revenues to help soften the austerity blow.
Fourth, remember that an FTT will make some high-frequency trading uneconomic. By reducing the importance of computer-generated trend-chasing trades that helped trigger the market dislocations in August 2007 and May 2010, FTTs will reduce systemic risk and make the markets less short-term oriented.
The financial industry will undoubtedly squirm – let them. It will be seen as a sign by voters that you are finally doing something right. No matter what they say, the industry's opposition is based not on genuine doubts about feasibility or concern for market efficiency, but purely on self-interest in not wanting to pay more tax.
It's time for you to look beyond the 'finance is rocket science, you don't understand it, if you try change something the system would collapse... so leave us alone' rehearsed arguments of the financial industry.
We, the taxpayers, are still paying the price of having left finance to its own devices.
The industry will scream that small savers would end up paying. You should introduce an exemption and refund system for all savers with less than €50,000 in savings. Problem solved.
They will say high rates will damage the market. You just introduce the tax at very low rates and gradually ratchet it higher following regular impact assessments. Arguments silenced.
They claim the tax will be evaded. At low rates of tax, which will still generate significant revenues, the cost of trying to avoid FTTs exceeds the tax payable. Moreover, the increasingly electronic nature of transactions, new regulations on centralised clearing and record keeping for derivatives and stronger supervision all will make it much harder to avoid FTTs than it already is. Evasion foiled.
They will say that a bank levy is enough. It is not. The levy on bank balance sheets will fall primarily on commercial banks. Done right, it is a good idea, but it could end up pushing credit away from banks to the shadow banking system and financial markets.
FTTs, by falling mainly on hedge funds and asset managers, will counter this push and ensure a level-playing field between the banks and markets. Bank levies AND FTTs not bank levies OR FTTs.
Clearly the case for FTTs could not be stronger.
Even as a non-politician, I understand well your predicament that policy measures that are often popular are not right, and those that are right are often not popular. That is all the much more reason for you not to squander this opportunity to implement FTTs which are both popular and sound.
So dear Ms. Merkel and Mr. Sarkozy, please tell Mr. Schäuble and Ms. Lagarde – EU do it.