How does the financial transaction tax work?

The financial transaction tax (FTT) is intended to counter speculation, harmonise regulations in the EU and force the sector to contribute to the costs of the financial crisis. It remains to be seen whether these objectives are achieved with the proposal laid on the table by the European Commission in February 2013.

Firstly, the FTT proposal of February 2013 does not distinguish between high-risk and healthy financial transactions. For example, the FTT also applies to repurchase agreements (repos). Repos form the basis of secured financing (financing with collateral), which has become the norm in the financial world in the quest for greater financial stability at the request of the regulator. In its current form, the FTT proposal would therefore encourage financial institutions to return to unsecured financing, which could have an impact on the stability of the financial system and the cost of financing a financial institution.

Repo transactions are therefore essential to the healthy balance sheet management of a financial institution. They are also crucial in the services provided to customers (mainly export-oriented businesses). As a consequence, both export-oriented businesses and financial institutions are involved. There is therefore a real risk that the FTT will make financing the economy more expensive, since the appraisal will more than likely reduce the number of transactions and affect liquidity.  It will also become less attractive for businesses to issue shares to strengthen their equity, for example. Nevertheless, strengthening companies’ equity should be a priority point for attention given the current economic context.

Secondly, the FTT as it stands in the proposal of February 2013 hinders the harmonisation of rules within the EU. The introduction of a tax in 11 of the 27 countries of the European Union may encourage the delocalisation of activities, not only to countries outside the European Union, but even to the other 16 EU Member States.

The European Commission has been severely criticized, not just by the banking sector, but by the world of business and some public authorities too. Central bankers seem reluctant too, and the magazine The Economist called the FTT 'a masterpiece of flawed design'.