Thursday, 29 September 2011

Transaction Taxes and Transparency

The City of London is in a stir over the EU proposal of a financial transactions tax. The great and the good are uniformly arrayed against such a tax. I am not so sure that it wouldn't be a good thing.

Here in Britain we now pay 20 per cent Value Added Tax on virtually everything we buy, except food, medicines and children's clothing. Yet the financial sector is exempt of any similar tax on transactions. This is patently unfair since approximately 5 pence of the 20 is required to finance the state bailouts of the financial sector. As a regressive and unfair tax, that is hard to beat.

In addition to raising revenues from an investment banking sector which has decimated public finances for a generation to come, a transaction tax might be a very good thing from an accountability and transparency perspective.

Those opposing say it would be anti-markets and drive trading offshore. Markets clearly do not work properly anymore at price discovery, liquidity aggregation or trade transparency. I rather think markets would work better if those participating had an economic stake in the transaction longer than a nanosecond, and a trading objective more durable than front-running real investors with HFT gaming.

More than that, a transaction tax would recognise that the state adds value to the market and deserves to be recompensed for that value. A huge part of the operational value of developed markets is derived from the rule of law. Taxing transactions would be recognising that each transaction benefits from the legal system which makes such a transaction valid and enforceable.

In my view, the way to make the transaction tax workable and cost-effective is to incentivise the reporting of transactions and the payment of tax. The way to do this is to legislate that transactions themselves will only be legally enforceable if there is a record that the tax has been paid. Anyone might choose not to pay the tax, but if they want to enforce a trade or debt obligation they are on their own. If they want recourse to the courts, rights to exercise on margin/collateral or a valid claim in insolvency, then they pay the tax as their ticket to rely on the legal system.

In the United States we see that the MERS scandal boils down to the wholesale attempt by US banks to avoid paying the transaction taxes on land mortgage registrations with local counties and states. As a result, the very enforceability of millions of mortgages is being thrown into doubt as a matter of law.

Had originators, banks, investment banks and investors been forced to register interests in mortgages in compliance with the law, some of the great abuses of securitisation would have become much more difficult to sustain for so long. In that sense, transparency would have promoted greater accountability and helped curb abuse.

The public has an interest in the integrity of markets. That integrity has been undermined horribly over the past 25 years by demutualisation of exchanges and clearing houses, fragmentation of markets to off-exchange systems and derivatives, leveraged shadow banking, and information assymetries between highly concentrated market insiders and everyone else. We now don't know who owns what and who owes what, and that means that economies are operating with dangerous blind spots. Relaxed accounting rules and forbearance on capital mean that mis-pricing and mis-allocation of capital are endemic and worsening, making any recovery even more doubtful.

A transaction tax on trades, as a pre-condition to legal enforceability, might restore some integrity to markets. That would help restore more efficient functioning to economies with much greater promise than further bailouts to banks.


Anonymous said...

Financial transactions attract no VAT because they add no value!

Seriously, VAT is not a transaction tax but a consumption tax. If you had ever run a small business you would know that businesses can net off the VAT paid on their purchases against the VAT levied on their sales. It's consumers that pay the VAT.

A better example of a transaction tax is stamp duty. While we no longer need to attach a postage stamp to legal documents, stamp duty is still levied on property sales, leases and most share transactions. In the Republic of Ireland stamp duty is still levied on cheques and now on credit cards.

tv said...

Transaction tax is a dirty band-aid on a broken bone.

Flat Out Banking Fraud, The LACK OF CRIMINIAL PUNISHMENT and CIVIL PROFIT DISGORGEMENT for the guilty, constant "BAILOUTS", Excessive Massive Financial Leverage, a Structural Fiscal Euro Problem (no 'Treasury'), and a socio/cultural aberrant meme against "taking the loss" are CORE PROBLEMS.

But a band aid will solve the above problems that the people actively choose to ignore.

Talk about inefficiency at work to avoid the real problems.

Игры рынка said...

Financial transaction tax should be applied to those entities which are not supposed to do excessive financial transactions. E.g. banks. The business of banks is to analyze credit risk and banks failed in this task on a historical scale. So banks either do not deserve their banking licenses or they should get back to banking.

Mark said...

One exercise I did many years ago was to examine how much hedging might be required for a plain vanilla at or near the money option with daily rebalancing and a life of several months. You can easily rack up 30-50 times the nominal contract size in delta hedge trades. Multiply your Tobin Tax by 50, and suddenly you have removed sensible options hedges from viability.

We have the Swedish experience of failure of a Tobin tax. We don't need another one.

Now, if you are interested in more sensible measures, there has been some interesting research at the Santa Fe Institute. Try these:

Heterogeneity, Correlations and Financial Contagion

Bankruptcy Cascades in Interbank Markets

Gaming Performance Fees by Portfolio Managers (with a recommendation about transparency)

Studies of the Limit Order Book around Large Price Changes

Systemic Risks in Society and Economics

Richard said...


As always, a thought provoking post.

It introduces the important idea that an industry should pay for its supporting infrastructure (contract enforceability, bailouts for losses,...). This is a very reasonable proposition. The previous posts simply object to 'how' the industry pays, not 'that' the industry pays.

I appreciate that you too see the need to bring transparency back to the capital markets (for price discovery, for determining who owns or owes what, for knowing who is solvent and who is insolvent,...).

My preference is that all trades are disclosed, not just those where a VAT payment is made - it avoids any problems if a big institution needs to be wound down.

Mark said...

@ Richard:

Industry never pays taxes and fines: their customers and shareholders do, as they do for the banks' legal bills and contributions to financing regulators. I doubt you read the SFI papers I referred to, but they have several important messages for those who need to regulate the markets. I note that Messrs. Haldane and Fisher at the BoE do appear to have recognised the value of this work.

Whilst I criticised the tax, I do not criticise the need for much greater transparency. A bank should not be "an undertaking for great advantage, nobody to know what it is". It is plain that modern accounting makes them just that. Of course, there are elements of regulatory arbitrage just as with tax arbitrage. I wasn't greatly encouraged by these words of Donald Kohn:

"We do need to balance the benefits of gathering and releasing information against the costs incurred by institutions and market structures. One such potential cost would be the loss of legitimate competitive advantage from revealing proprietary business strategies. The public should have access to enough information to evaluate risks and prospects for a firm without compromising its competitive position or reducing growth-enhancing innovation or expansion of market share. This may not be an easy balance to strike, and in doing so we do need to keep in mind the costs for financial stability of inadequate market discipline."

The one big advantage of having a transparent regime is trust. When we can see and understand what is happening, we can trust the institution more. When we can't, we can't evaluate their trustworthiness, and moral hazard looms large.

I do not share LB's enthusiasm for centralised clearing: of itself it disguises the positions of individual market participants from each other, where a statistical analysis of bilateral deals may offer some important clues. Some of the best regulation is from competitors: if they can assess a strategy of a counterparty is becoming dangerous they will moderate their trading accordingly. Central clearing places all the burden on the clearer/regulator, who may use margining to slant the game towards certain parties: it centralises the risk when failure occurs, and makes it likely that the guilty will be rewarded and the innocent punished.

It's starting to become a little clearer that we're dealing as much in the financial bailouts of the state as in the state bailouts of the financial sector. The state willingly harnessed and legalised the tools of the financial sector such as PFI financing, off market rate currency swaps, ratings agencies and other institutionalised artificial measurements of risk (e.g. Basel). Governments have been the chief racketeers in the Ponzi schemes. The Faustian pact was expressed by Mandelson: "We don't mind people getting filthy rich so long as they pay their taxes" (and he might have mentioned, help finance the Labour Party). Another prawn cocktail?

Richard said...


First, I have probably been the leading voice for transparency since before the financial crisis began in 2007 - or at least that is what Bloomberg, the WSJ, Fortune and a few other mainstream media types would have you believe. You can read what I have to say on this topic at

Having provided that background, I would like to thank you very much for your very perceptive comments on transparency. (I wrote something very similar about Mr. Kohn's speech.)

Second, I do not disagree that taxes are likely to get passed through to customers and shareholders. Like Michael Porter in his book on Competitive Strategy, I include customers and shareholders in my definition of 'industry'.

Thanks again for your comments on transparency!

Thomas Barker said...

I had some similar thoughts years ago.

Although I can't see how you would go about pinning down the taxable "end point" for a lot of financial transactions, I do think you could sensibly start giving a lot of speculation a similar legal status to gambling.

Mark said...


You mean going back to the Gaming Act, 1845 which had the following provision:
All contracts or agreements, whether by parole or in writing, by way of gaming or wagering, shall be null and void; and no suit shall be brought or maintained in any court of law and equity for recovering any sum of money or valuable thing alleged to be won upon any wager, or which shall have been deposited in the hands of any person to abide the event on which any wager shall have been made: Provided always, that this enactment shall not be deemed to apply to any subscription or contribution, or agreement to subscribe or contribute, for or towards any plate, prize, or sum of money to be awarded to the winner or winners of any lawful game, sport, pastime, or exercise.

That was only repealed for approved business by the Financial Services Act, 1986, which legalised cash settled contracts for differences and other cash settled derivatives. The US followed soon after via no-action letters from the CFTC.

Certainly cash settled contracts favour those who can magic up extra cash to tilt the market their way. Consider what might happen to the gold price if only physical futures were permitted, and why that market appears to be dominated by JPM and HSBC. Then again we have some interesting new laws:

Jesse said...

The benefit of a very nominal transaction tax on financials is that it would tend to dampen some of the enthusiasm for gaming the system via High Frequency Trading.

I would propose a very nominal flat fee of say 1 pound to be added to every trade on any exchange. The fee would be used to support financial regulation activity, similar to the gasoline tax in the states which promotes the interstate highway system.

Keith said...

The possibility that some hedging or other trades might become uneconomic is presumably one point of such a levy? How much such activity is useful for the economy?