10/1/6: After the Flood Comes the Tax: European Road to Financial Transactions Tax

New paper, forthcoming as Chapter 10 in Lessons from the Great Recession: At the Crossroads of Sustainability and Recovery, edited by Constantin Gurdgiev, Liam Leonard & Alejandra Maria Gonzalez-Perez, Emerald, ASEJ, vol 18; ISBN: 978-1-78560-743-1, titled After the Flood Comes the Tax: European Road to Financial Transactions Tax is now available on my SSRN page: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2713332.

Abstract

This chapter presents the results of the comprehensive literature survey and supportive empirical assessment of the potential impacts of the Financial Transactions Tax recently adopted by the European Commission in response to the significant financial sector misallocations arising from the Global Financial Crisis. A survey of fifty academic articles relating to both Financial Transaction Taxes and Tobin Taxes shows that although a reduction in liquidity can be expected from such taxes, the impacts this will have on volatility and efficiency in a market is less obvious. A regression model quantifying what the possible effect of an introduction of a 0.1% tax on financial transactions would be on trading volumes and levels of volatility in the European equity market confirms the survey results in broader terms. These results can be used to infer that such a tax would likely increase volatility levels but may not have much effect on trading volumes. As a result the proposed tax can be viewed as an exercise in revenue generation but not as a macro-prudential tool for addressing potential future shocks and imbalances within the European financial system.

8/8/15: Transactions Costs v Quality of Banks' Collateral

In standard financial theory (and practice), presence of transactions costs has an impact on asset prices traded in the markets. A recent ECB Working Paper, titled "Collateral damage? micro-simulation of transaction cost shocks on the value of central bank collateral", by Rudolf Alvise Lennkh and Florian Walch (ECB Working Paper Series, No 1793 / May 2015: https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1793.en.pdf) "analyses how changes in transaction costs may affect the value of assets that banks use to collateralise borrowings in monetary policy operations."

The authors estimate the effect of a 10 basis point increase in transaction costs to be a decline of -0.30% in collateral value. Adjusting for the expected drop in the volume of trades for each asset (reduced liquidity), the decline in asset prices is shallower - at -0.07%. "We conclude that banks will on average suffer small collateral losses while selected institutions could face a considerably larger collateral decrease."

So far - benign?

The problem, of course, is in that second order effect. The authors look at 25% and 75% decreases in turnover of pledged collateral debt instruments (e.g. bonds pledged by the banks in repo operations). This second order effect reduces the loss of collateral value to -0.22% and -0.07%, for the two assumed turnover reductions scenarios, respectively. In other words, the lower the turnover rate of the pledged assets, the lesser is the impact of the transactions costs on collateral value.

Now, as the study notes, when collateral is held longer (turnover lower), liquidity in the markets is impacted. The longer the banks hold collateral assets off the markets and in the central banks' repo vaults, the lesser is market liquidity for traded collateral-eligible paper. Thus, the higher is the associated liquidity risk. Banks dump risk premium into the markets.

Cautiously, the ECB paper goes on: "The results underline that transaction costs in financial markets can be one among many factors contributing to the scarcity or decline of liquid, high quality collateral. …an upward transaction cost shock that occurs simultaneously with a market or regulation-induced shortage in collateral assets, and in particular high-quality collateral assets, could hamper the access of financial institutions to central bank liquidity. The central bank could [make] additional collateral eligible for monetary policy operations. As most of high-grade collateral is already central bank eligible, such a move could entail a shift to collateral assets with more inherent risk that would have to be compensated with appropriate haircuts. This in turn could increase asset encumbrance on banks’ balance sheets."

But there is another channel not considered in the paper: reduced turnover of collateral implies reduced supply of assets into securitisation pools, as well as into the OTC markets. Both effects are hard to estimate, but are likely to induce even higher risk premium into the markets for risky assets, pushing the above estimates of costs wider.

As an interesting aside, the table below summarises, by the end of 1Q 2014, one quarter of all collateral pledged into Eurosystem central banks repo operations was of low quality variety Non-marketable assets (in other words, assets with no immediate markets). This represents an increase in the share of low quality assets from 24.75% in 1Q 2012 to 24.96% in 1Q 2014. Medium-to-low quality stuff accounted for another 20 percent of the total.

Now, for all the esoteric debates about the ECB supplying liquidity, not providing solvency supports, one wonders just how much of a haircut would all of this proverbial 'assetage' gather were it to be collateralised into the markets to raise the said liquidity… for you know: if a bank is solvent, its assets would cover its liabilities, inclusive of haircuts, which means they are repoable… in which case, of course, there is no liquidity shortage to cover, unless markets were misfiring. The latter simply can't be the case in 2014 when the financial markets were hardly oversold.

26/9/2013: Sunday Times 15/9/2013: What About Irish Competitiveness?

This is an unedited version of my Sunday Times column from September 15.


Recent experiments in psychology have shown that people routinely distort their interpretation of objective evidence to fit their subjective political beliefs. More ominously, our propensity to ideologically colour evidence appears to be greater the better we are with data analysis.

This ability of humankind to see data through the tinted glasses of our biases is present all around us, including in the interpretation of economic data.
Take two examples.

Recently, the relatively ideology-free World Economic Forum published its annual report on global economic competitiveness rankings for 2013-2014. According to the report, Ireland now ranks 28th in the world in terms of competitiveness, down one place on a year ago. Back in 2005-2006 – at the height of the boom, and amidst rampant business costs inflation, we ranked 21st. Overall, Ireland's global competitiveness has deteriorated by 7 places over the last ten years, with this year's performance just one notch better than the absolute nadir reached in 2011. A more ideologically-informed Heritage Foundation / WSJ Index of Economic Freedom continues to rank Ireland highly in the 13th place in the world in 2013. However, tinted lasses aside, our overall competitiveness score in the latter index declined from around 82-83 in 2006-2009 to below 76 this year.

Meanwhile, Irish political and business elites continue to brag about the remarkable gains in the country competitiveness, brought about by the policies enacted since the beginning of the crisis or at the very least, by the reforms that took place since the last elections. Almost 6 months ago, seemingly unburdened by evidence, Taoiseach Enda Kenny has declared that the government is "making this the best small country in the world to do business in…" Never mind that Ireland ranks outside the top 10 countries in the world in every reasonably comprehensive and objective rankings produced so far. And never mind that our rankings have deteriorated, rather than improved, since the onset of the crisis. The government will still spin the evidence.

The truth, of course, is somewhere in between the two extremes of the opinion.

One core measure of competitiveness is the labour-related cost of the unit of output in the economy, the so-called unit labour costs (ULCs). Based on the ECB data, we  achieved substantial gains in this measure, with ULCs falling 18 percent peak-to-trough. However, since the trough was reached in Q2 2012, Ireland’s performance has deteriorated. In 2009-2010, Irish unit labour costs fell by over 7 percent compared to 2008. The rate of cost deflation declined to 2.4 percent over 2011-2012. So far, since the start of 2013, the ULCs are rising. This exposes the underlying causes of changes in the ULCs over the crisis period. Much of the recent gains in labour competitiveness were driven by a dramatic rate of jobs destruction back in 2009-2011. As the jobs market stabilised, competitiveness gains vanished.  Exactly the same story is being told by the broader harmonised competitiveness indicators published by the Central Bank of Ireland.

However, the data also shows that the key driver for the deterioration in our cost competitiveness in more recent months is government policy.

As the result of our non-meritocratic approach to labour markets, lack of reforms in core areas relating to business development and entrepreneurship, the use of tax policies to fund wasteful bank crisis resolution measures and public spending, Ireland finds itself in an absurd situation where we rank 12th in the world in capacity to attract talent and 40th in capacity to retain the talent we attract. As our openness to FDI is bringing scores of talented workers into the country, our internal markets policies are pushing talent out of the country. Having had their fill of "the best small country in the world to do business in", globally skilled workers tend to get out of Ireland.

As the result of our inability to keep key skills and talent in the country, labour costs are starting to creep up, even before we see serious uptick in new employment. In 2009-2010, according to the OECD,  labour costs accounted for 74 percent of the total inputs costs in production in Ireland. In 2011, the latest for which we have data, this rose above 77 percent. Labour productivity growth, having peaked with unemployment increases in 2009 has fallen back by almost two thirds by 2012.

The latest data from CSO shows that average hourly earnings are now up in eight out of thirteen sub-sectors year on year through H1 2013. Crucially, in the areas under direct Government control, earnings are now rising once again and at speeds exceeding those recorded for the overall economy. Public sector average weekly earnings were up 1.3 percent year on year in Q2 2013 and non-commercial semi-state earnings are up 2.7 percent.

With every new report, the IMF reiterates its advice to the Irish authorities to continue focusing on labour markets reforms. Despite this, the Government staunchly refuses to address the main factors holding back our labour competitiveness. These are flexibility of wage determination (with Ireland ranked 103rd globally), flexibility in hiring and firing (we rank 43rd here) and linking pay to productivity, especially in the public sector (our rank is 38th worldwide). According to the WEF, Ireland ranks 90th in the world in terms of the effect of taxation on incentives to work.


So labour competitiveness improvements of the past are neither a credit to the Government reforms, nor appear to be sustainable over time. Now, lets take a look at other policies-linked metrics.

World Economic Forum report lists the top 5 factors acting to depress our global competitiveness scores. In order of decreasing importance these are: access to financing, inefficient government bureaucracy, inadequate supply of infrastructure, insufficient capacity to innovate, and tax rates. The first two come under direct remit of public reforms aimed at dealing with the crisis. The fourth one, capacity to innovate, is linked a myriad of incentives and subsidies crafted by Irish governments in an attempt to shift the economy away from bricks and mortar toward innovation and exports. The third and the last factors arise from the Government policies since 2008 that saw higher tax burdens and shrinking public capital investment become the drivers of the state response to the fiscal crisis. Thus, by WEF metrics, Irish Government is responsible for dragging down Irish economy's competitiveness, rather than pushing it up.

These findings are broadly in line with the Heritage/WSJ index readings, which shows that we score poorly on Government policies, fiscal performance, and public spending efficiency.
Despite years of austerity and alleged reforms in public sector management since 2008, the WEF report ranks us 55th in the world in terms of wastefulness of government spending, and 29th in terms of burden of government regulation. When it comes to the transparency of Government policymaking, Ireland ranks below 24 other countries around the globe. The latter is a metric directly targeted by the Troika-led reforms and the one where the Irish Government has, allegedly, done most work to-date. We have revamped banks regulation and reporting, significantly altered macroeconomic risk monitoring, fiscal policies oversight, economic policy development mechanisms and more. Yet for all our successes in this arena, we are not even in top 20 worldwide when it comes to policies transparency.

Another obvious flash point of the crisis was the lack of robust audit and oversight over the operations of our banks and some companies. One would expect that 5 years into dealing with the crisis, Ireland would have delivered some serious improvements in these areas. Alas, we still rank 58th in the world in terms of the strength of our audit and reporting standards. In a business oversight metric, the World Bank Doing Business report ranks Ireland 63rd in the world in terms of the  enforcement of contracts, with average time to resolve a dispute of 650 days in Ireland, against 510 days for the OECD average.  As a legacy of the protected sectors inefficiencies, our legal system imposes average costs of 26.9 percent of the total volume of dispute-related claims on contracted parties, against the OECD average of 20.1 percent.

The current Government came into office with a clear promise to reform domestic sectors to breath in more competition into protected markets. This has not happened to-date. State-controlled sectors, such as professional services, health insurance and health services, energy, transport, education, and so on, remain shielded from real competition. As the result, Ireland ranks 42nd in the world in intensity of local competition, and 24th in effectiveness of anti-monopoly policies, even though much of this effectiveness comes via Brussels. Property regulations, planning and permissions systems are as atavistic as they were before the bust, meaning that the World Bank ranks Ireland 106th in the world when it comes to dealing with construction permits.


Ireland’s performance on the competitiveness side is worrying. In the long-run competitiveness metrics and rankings – imperfect as they may be – help global investors allocate capital investment and productive activities of their companies around the world. Even more significantly, these metrics expose structural problems in the economy and governance systems that are holding back Irish domestic entrepreneurship and innovation.

As economies and fiscal positions of governments around the world improve over time, the competition for FDI and new markets for goods and services exports will heat up, once again. Downward pressure on taxes – Ireland’s core competitive advantage to-date – will re-accelerate too. At the same time, capital investment will remain scarce and costly, while skills shortages worldwide will once again start driving up cost of doing business, including here. This means that global investment flows will tend to be concentrated on the markets with the greatest demand growth potential, and where the profit margins are the highest. The only way Ireland will be able to compete is by becoming a competitiveness haven for product innovation and development, advanced specialist manufacturing, distribution, marketing and sales. Being just a tax haven will not be enough.

Box-out:

A financial transaction tax (FTT) on derivatives trades came into power in Italy this week, as a follow on to March 2013 introduction of the FTT on equity transactions. Per new law, derivatives will be taxed at rates that vary with the volume and the type of the contracts traded. Equities transactions are taxed at 0.12% for shares traded on a regulated exchange or 0.22% for over the counter trades. Six months in, the FTT is having an effect. As a number of analysts, including myself have warned prior to the introduction of the tax, Italian trading volumes for equities are down significantly, compared to the rest of Europe. Since March, Italian equity market turnover dropped to EUR50 billion from EUR101 billion a year ago. French equity markets experienced exactly the same effect post FTT introduction. At the peak in 2011, French equity market accounted for 23 percent of the European equity markets turnover. Today, it is at around 13 percent. There is also some evidence that wealthier investors are moving their transactions out of FTT-impacted equity markets. Which means that more burden of the levy – popularly mislabeled as 'Robin Hood' tax – is falling onto the shoulders of smaller investors. Falling trading volumes are now expected to undercut significantly Italian and French estimates for the Government revenues that FTT was expected to raise. With projected funding already allocated in the budgets, any shortfall will have to be compensated for via other taxes or cuts elsewhere. Yet, undeterred by the evidence, the EU continues to press on for a cross-border FTT. John Maynard Keynes once said: "When my information changes, I alter my conclusions." Sadly, his otherwise enthusiastic students in Brussels have missed that lesson.

20/6/2013: FTT: Extra-territoriality and Stamp Duty Comparative

An important piece of analysis of the European Financial Transactions Tax (FTT or 'Robin Hood' Tax) by Clifford Chance from January this year.

The importance here is in detailed note on application of the FTT as contrasted with existent stamp duties (see page 3) and the extra-territorial nature of the FTT (see page 2).

Link: http://www.cliffordchance.com/publicationviews/publications/2013/01/the_new_eu_financialtransactiontaxwhyi.html

Link to the previous post on FTT: http://trueeconomics.blogspot.ie/2013/06/1462013-eus-ftt-one-tax-multiple.html

14/6/2013: EU's FTT: One Tax, Multiple Problems

FTT - Financial Transactions Tax - has been the pet project of pure love for Eurocrats and Socialistas in the Member States, hungry for revenue. It has been labelled a 'Robin Hood Tax' because the politicians attempted to sell it as a tax on filthy-rich financial services to redistribute to starving unemployed, presumably, despite the simple fact that in the un-competitive and fragmented market for financial services that is Europe, such a tax - any tax - will be fully passed onto ordinary savers, investors, depositors and in general onto the users of financial services.

The EU Commission published volumes of commissioned - made-to-order - research that shows just how brilliant an idea the FTT really is: it will raise loads of revenues, harm no one and will not reduce financial markets efficiency. Stopping just short of declaring the FTT to be a panacea to common cold, the EU enthusiastically propagandized the idea despite the simple fact that vast majority of academic research on the topic of transactions taxes finds that they are either ineffective as means for revenue raising or costly in terms of economic efficiency.

I wrote about this (see link at the bottom of this post below) and will continue to write, not because I long for an easy life for the bankers or financial investors, but because I recognise the fact that investment markets are necessary to the functioning of the society and the economy, and because I also recognise that more open, less restricted, but well-regulated and strictly enforced financial services are better than anything that Brussels et al can conceive in their technocratic dreams.

So in line with the past record, here's another study (http://www.cpb.nl/en/publication/an-evaluation-of-the-financial-transaction-tax) that explores "...whether the FTT is likely to correct the market failures that have contributed to the financial crisis, how well the FTT is likely to succeed in raising revenues, and how the FTT compares to alternative taxes in terms of efficiency."

The study finds (emphasis is mine) "... little evidence that the FTT will be effective in correcting

market failures. Taxing of transactions is not well targeted at behaviour that leads to excessive risk and

systemic risk creation. The empirical evidence does not suggest that the introduction of an FTT reduces

volatility or asset price bubbles. Transaction taxes will likely reduce investment in trading activity and

information acquisition, but also raise the costs of insurance against currency and interest risks by

companies, insurers and pension funds. The welfare effect of that is unclear."

"The FTT will likely raise significant revenues, in spite of the fact that the tax base is highly elastic. In the short term, the incidence of the tax will be chiefly on the current holders of securities. Ultimately, the tax will be borne in part by end users, and we estimate the likely effects on economic growth."

"When compared to alternative forms of taxation of the financial sector, the FTT is likely less efficient given the amount of revenues. In particular, taxes that more directly address existing distortions (such as the current VAT exemption for banks, and the bias towards debt financing) provide more efficient alternatives."

And here's a report from the Open Europe think-tank on the FTT, assessing the EU Commission response to the concerns of the eleven - that right, eleven - member states: (http://openeuropeblog.blogspot.co.uk/2013/05/if-you-had-kept-quiet-you-would-have.html)

Quote: "The Commission's response ranges from weak to capricious to outright ridiculous. For example, when it says that "we're not aware of any credit crunch" in Europe."

What else is new?

Note: I wrote about the concerns around the issues of repos and hedging here: http://trueeconomics.blogspot.ie/2013/05/3052013-ftt-up-down-down-again-climbing.html


Links to past articles on FTT: http://trueeconomics.blogspot.ie/search?q=FTT&max-results=20&by-date=true
You can search this blog for key words and sort the posts by relevance or date.

30/5/2013: FTT: Up, Down, Down again: Climbing Political Hillocks in Europe

Looks like the EU is now climbing down another over-hyped policy hillock. After scrapping plans to ban / regulate olive oil in restaurants, the EU is now moving in the direction of drastically undercutting original plans for the Financial Transactions Tax (FTT).

I outlined on a number of occasions numerous reasons why FTT was a bad idea for the EU (see set of posts here: http://trueeconomics.blogspot.ie/search?q=FTT&max-results=20&by-date=true). The latest changes in the EU seem to be related primarily to the rate of tax (see http://www.ifre.com/brussels-plans-major-scaling-back-of-financial-trading-tax/21088491.article).

However, also per article: "Rather than levying trade in stocks, bonds and some derivatives from 2014, it may now apply to shares only next year and to bonds up to two years later." Again, sadly, the new changes are way off, as argued here: http://trueeconomics.blogspot.ie/2013/05/2652013-ftt-v-sovereigns-addiction-to.html .

The real problem is that there is no way to structure a reasonably efficient FTT. None at all. Any FTT proposal will strike either one or some of the outcomes below:

1. Raise too much revenue, chocking off market efficiency and damaging liquidity
2. Raise too little revenue, making no real differences in any direction
3. Push high volume (liquidity-enhancing) and low margin (information-disclosing) transactions out of open markets platforms into dark pools and off-shore
4. Incentivise even more debt over equity

At some point in time, we must realise that any defence of FTT is at this stage is nothing but political face-saving.

26/5/2013: FTT v Sovereigns' Addiction to Debt

FT.com reports (http://www.ft.com/intl/cms/s/0/c3121802-c480-11e2-9ac0-00144feab7de.html?ftcamp=published_links%2Frss%2Fhome_us%2Ffeed%2F%2Fproduct#axzz2UQE68h14) that 

"The European Central Bank has offered to help the EU redesign its financial transactions tax to avoid any ‘negative impact’ on market stability, highlighting official fears about the implementation of the levy."

So far so good, as FTT indeed is likely to cut liquidity in the markets, reducing markets efficiency, and potentially increasing volatility, rather thane educing it.

Of course, the original idea the EU came up involved levying tax on trading in bonds, equities and derivatives. So one would expect the following prioritisation from the ECB concerned with markets impacts:
1) Not to distinguish between bonds and equities in tax application and rates, as the two instruments are de facto long-only instruments in either corporate (real) economy, banks (financial economy) and sovereigns (for bonds - which somewhat qualifies as a real economy as well).
2) Levy tax primarily on derivative instruments (although here, tax can be avoided much easier)
3) Recognise that in the restricted competition environment and with legacy subsidies from the crisis period still in place for incumbent financial institutions, any FTT will be at least in part passed onto retail investors and savers, and in more extreme cases - e.g. duopoly model of banking in Ireland - onto all retail users of banking services)
4) Real economy - incomes, investment, entrepreneurship, unemployment, etc - will be most impacted by the FTT levied on real assets - equities and some (not all) bonds and this effect will be stronger the stronger is the banking and investment banking sector concentration in the economy.

Alas, as is clear from the FT.com article, the ECB is not concerned with (3) and (4) whatsoever, and it is unconcerned with (1) either. It also seems to be aware of (2) pitfalls. Aside from that, ECB is concerned with the perennial task faced by all European Government - the obsession of raising as much tax revenue as possible while incentivising more debt pumped into sovereign bond markets.


Per FT.com: "The ECB believes markets should efficiently “transmit” changes in interest rates to the real economy." You might think that this means transmitting higher (lower) ECB rates into higher (lower) (a) Government bond yields and (b) higher/lower cost of private credit. Err… you would be wrong.

Per FT.com there are rumours that "…the ECB would prefer to have a limited UK-style stamp duty on equities". What can possibly go wrong, then?

ECB concern is clearly to grease the wheels of sovereign bond markets. The fact that FTT will reduce markets liquidity in real instruments & will cost retail investors in the end - well, that is hardly ECB's concern at all. ECB like the EU Governments is only worried about own coffers & give no attention to the economy.  

Equity markets volatility (FTT original raison d'être is to reduce volatility) had NOTHING to do with the current crises. The ECB focus on 'UK-styled stamp duty on equities', if confirmed, thus exposes FTT as a pure scam to raise more tax revenues, not a measure to deal with 'markets instability'. 

As FT.com quotes one of the market participants: "bond markets were a “phenomenally attractive” way of channelling savings into investment." Alas, it is not - corporate bonds are debt. Shoving more debt while disincentivising equity investment is not a great idea for long term sustainable funding.

In Europe, lending money to Governments, including to fund dodgy unfunded pensions and white elephant projects, is tax-wise deemed to be more laudable than to invest in equity of real enterprises. By corollary, lending to companies is also deemed to be more preferential than funding them via equity. One of the outcomes of this decades-long preferential treatment of debt is the current crisis: over-bloated and under-funded public spending coupled with too much private debt (including banking debt) against too little equity (the latter imbalance drove the bailouts of banks in euro area periphery).

With this in mind, talking about 'Robin Hood' taxes on Financial Services in EU is equivalent to believing in Santa's Magic raindeer as a viable alternative for public transport.

16/11/2012: FTT - two bits of new evidence

Financial Transactions Tax news:

First we have new research from the Bank of Canada (link here) stating:
"Little evidence is found to suggest that an FTT would reduce speculative trading or volatility. In fact, several studies conclude that an FTT increases volatility and bid-ask spreads and decreases trading volume. Furthermore, a number of challenges associated with the design and effectiveness of an FTT could limit the revenues that FTTs are intended to raise. For these reasons, countries considering the
imposition of FTTs should be aware of their negative consequences and the challenges involved in implementation."

And next we have early stage evidence from just a few months of FTT operations in France: here.

I wrote on the topic of FTT for a number of years now. Here's an article from 2010. Here's more from 2010. And more on the blog. I am also working with two co-authors on a comprehensive literature review of the FTT, which so far is not going well for supporting the idea of FTT.

Stay tuned.

Updated: and here's a SoberLook take on the French experience with FTT. Paragraph below the quote explains the little French problem... oh, well, it's a War on Speculators, then.