Financial Transaction Tax

Financial Transaction Tax Economic and fiscal effects of the implementation of a Financial Transaction Tax in Germany Extracts The following text is an extract of a report by the biggest German institute for economic research, DIW (Deutsches Institut für Wirtschaftsforschung), based in Berlin. The report was prepared by Prof. Dorothea Schäfer and Marlene Karl. Given the relevance of the report for the European process to implement the Financial Transaction Tax we herewith publish an extract of the report with important arguments. The full German version is available at: http://www.diw.de/documents/publikationen/73/diw_01.c.405812.de/diwkompakt _2012-064.pdf We thank Prof. Schäfer and the DIW for the friendly authorisation to publish this English extract. London/Berlin August 2012 David Hillman Stamp out Poverty, UK Adam Musgrave, Oxfam UK Peter Wahl, German Campaign Steuer gegen Armut

DIW foreword/summary With 9 European countries pledged to implement a Financial Transaction Tax by the end of 2012, this brief document sets out how they will capture the revenue, the amount of revenue we estimate they may accrue, and how an FTT can be most effectively designed to achieve both aims. The first two sections of our report include material available in English such as the various principles which an effective FTT would adopt. Similarly, later sections include reference to Unitaid material also available in English. We do of course have our own additions to make in both these areas, but feel the third section of our document which deals with potential revenues would be best served by a short English translation. Briefly then, this document argues that 9 European nations moving ahead with an FTT will accrue upwards of 32bn, and very possibly more. It includes data from all Eurozone members, and suggests a scenario involving 9 member states moving forward with the FTT. Removing individual financial instruments from any FTT would entail substantial tax losses, and should be avoided. Making an exception for one type of instrument from an FTT would provide an incentive for replicating such a type by encouraging financial innovation so as to enjoy similar tax exemption. FTT coverage must therefore be as broad as possible. A combination of residence, exchange of legal title (sometimes referred to as issuance ) and ownership (tieing payment of the tax to ownership of the share) principles makes for by far the most effective tax. 3.1 Combination of country of origin, issue and owner principles advisable In May 2012 the EU Parliament accepted the draft directive of the EU Commission on financial transaction tax with a series of amendments. 18 In line with the decision of the Parliament we assume when analysing the effects of restricting its area of application that the tax will be levied in accordance with three principles.

1. The validity of the contract/the transfer to the new owner is tied to the payment of tax (ownership principle in line with the decision of the European Parliament), The tax is levied 2. if a party to the contract is based in the taxation zone (country of origin principle in accordance with the strategy of the EU commission) or 3. the financial instrument is issued by a financial institution in the taxation zone (issue principle as is the case with British stamp duty), Calculating revenues Without independent effects of the geographical restriction of the taxation zone the question of tax payment in smaller tax zones than in EU 27 depends on the distribution model used to calculate total tax receipts. Two models of analysis are used below to distribute the total revenue to the states in the tax zone. Scenario 1: assets of the national financial institutions including foreign subsidiaries and Scenario 2: gross profits/gross fixed asset investments + salaries in the financial sector of a country. 121 It must be pointed out that these distribution models do not amount to proposals for the distribution of tax revenue but serve exclusively to approximate fiscal income in various countries in the taxation zone. 3.2 Substantial revenue possible in a taxation zone with nine Euro countries With nine countries including France and Germany this produces a tax revenue of a good 37 billion (Table 4). Scenario 2 produces 32 billion (Table 5). In both 1 EU Commission (2011), COMMISSION STAFF WORKING PAPER IMPACT ASSESSMENT, op. cit

distribution models Germany and France achieve by far the greatest national tax revenues. Germany can anticipate just over 11 or just under 10 billion per year. This is equivalent to about 30% of total tax revenue. For France the annual revenue estimate is just under 11 or a good 7 billion. By contrast with Germany s proportion, France's proportion of total tax revenue differs comparatively sharply if another distribution model is applied. If the distribution is based on the assets of the financial institutions the proportion is around 30% 2. The distribution key profits and salaries on the other hand lowers France s proportion to 22%. Table 3: Tax revenue of the four Euro countries with the highest revenues Four highest revenues Germany France Italy Spain Total Revenue distribution key assets Share of the four in the total revenue of 57.4 billion Revenue distribution key profits and salaries Share of the four in the total revenue of 57.4 billion 11.15 10.79 5.32 4.94 32.20 0.56 9.88 7.08 6.22 4.17 27.35 Germany and France are followed by Italy and Spain respectively (Diagrams 1 and 2). Combining the four Euro countries with the highest revenues produces the picture shown in Table 3. Overall the four countries with the highest revenues achieve tax incomes of 32.2 and 27.35 billion respectively. That is 56% (distribution key assets) or 48% (distribution key profit and salaries) of estimated revenue from levying tax throughout the EU. 0.48 2 Germany s share may have been underestimated, as account cannot be taken when distributions are carried out in accordance with the two keys that Deutsche Bank is one of the most important actors worldwide in derivatives trading. 4

Scenario 1 Tax rates: 0.1% per contract party for securities, 0.01% per contract party for derivatives Basis of calculation: 15% evasion in the securities trade, 75% evasion in the derivatives trade Table 4: Distribution code for revenues: Assets of financial institutions including foreign subsidiaries 23 EU27 Germany Austria France Italy Belgium Spain Finland Greece Portugal All 9 countries 37 080.60 7 241.7 1 025.7 7 009.8 3 455.5 1 067.8 3 205.8 370.7 451.90 486.90 24 315.80 Share of total tax revenue as per 0.20 0.03 0.19 0.09 0.03 0.09 0.01 0.01 0.01 0.66 distribution key Revenue in billion Shares/units 1.332.46 0.19 1.29 0.63 0.20 0.59 0.07 0.08 0.09 4.46 bonds 0.35 2.38 1.17 0.36 1.09 0.13 0.15 0.17 8.26 Total revenue securities 3.79 0.54 3.67 1.81 0.56 1.68 0.19 0.24 0.25 12.72 Equity derivatives 0.64 0.09 0.62 0.31 0.10 0.29 0.03 0.04 0.04 2.16 Interest rate derivatives 5.78 0.82 5.60 2.76 0.30 0.85 2.56 0.36 0.39 19.41 0.94 0.13 0.91 0.45 0.05 0.06 3.15 Currency derivatives 0.14 0.41 0.06 Total revenue derivatives 7.36 1.04 7.13 3.51 1.09 3.26 0.38 0.46 0.50 24.72 revenue insgesamt (Distribution keys Fi Total revenuescial institutions - Aktiva) 11.15 1.58 10.79 5.32 1.64 4.94 0.57 0.70 0.75 37.44 Share of the nine in tax revenue 0.30 0.04 0.29 0.14 0.04 0.13 0.02 0.02 0.02 1.00 23 The proportion of assets is taken from the impact study Impact Study EU Commission, EU Commission (2011), COMMISSION STAFF WORKING PAPER IMPACT ASSESSMENT, accompanying the document Proposal for a Council Directive on a common system of financial transaction tax and amending Directive 2008/7/EC, Bd. 12 http://ec.europa.eu/taxationcustoms/taxation/othertaxes/financialsector/indexen.htm

Scenario 2 Taxation rates: 0.1% per contract party for securities, 0.01% per contract party for derivatives Basis of calculation: 15% evasion in securities trading, 70% evasion in derivatives trading Table 5: Distribution keys for revenue: gross profits/gross fixed asset investments + salaries in the financial sector 24 Shares of total tax revenue as per distribution key Shares/units bonds Germany Austria France Italy Belgium Spain Finland Greece Portugal All 9 countries 0.17 0.02 0.12 0.11 0.03 0.07 0.01 0.02 0.02 0.57 1.182.18 0.15 0.28 0.84 1.56 0.74 1.37 Revenue in billion 0.19 0.50 0.35 0.92 Total revenue securities 3.36 0.43 2.41 2.11 0.54 1.42 0.14 0.37 0.31 11.08 0.05 0.09 0.13 0.24 0.11 0.20 3.88 7.19 Equity derivatives Interest rate derivatives Currency derivatives 0.57 5.12 0.83 0.07 0.65 0.11 0.41 3.67 0.60 Total revenue derivatives 6.52 0.83 4.67 4.11 1.06 2.75 0.26 0.72 0.60 21.53 Total revenue per nation 9.88 1.26 7.08 6.22 1.60 4.17 0.40 1.08 0.91 32.60 Share of the nine in tax revenue 0.30 0.04 0.22 0.19 0.05 0.13 0.01 0.03 0.03 1.00 24 The shares of the individual countries as a proportion of the total gross profits (-gross investment in fixed assets) and salariesn in the financial sector is taken from the EU Commission (2011), COMMISSION STAFF WORKING PAPER IMPACT ASSESSMENT, accompanying the document Proposal for a Council Directive on a common system of financial transaction tax and amending Directive 2008/7/EC, Vol. 12 http://ec.europa.eu/taxationcustoms/taxation/othertaxes/financialsector/indexen.htm 0.36 3.23 0.52 0.09 0.83 0.13 0.24 2.16 0.35 0.02 0.21 0.03 0.06 0.56 0.09 0.05 0.47 0.08 1.88 16.90 2.74

12,00 10,00 8,00 6,00 4,00 2,00 - Diagram 1: Revenue of the nine countries in the taxation zone Basis of calculation: 15% evasion in securities trading, 75% evasion in derivatives trading Taxation rates: 0.1% (securities), 0.01% (derivatives) Verteilungsschlüssel: Gewinne und Gehälter Verteilungsschlüssel Aktiva The above table illustrates the annual revenue in billions of euros amongst the 9 nations. For absolute clarity, they are listed in the following order. Germany, Austria, France, Italy, Belgium, Spain, Finland, Greece and Portugal. The green bars show results derived from the profits and salaries model, whilst the grey bar illustrates those derived from the assets model Revenue from derivatives is with both distribution models very nearly twice as high as that from securities. The highest tax revenues are achieved from interest rate derivatives in both cases. Diagram 2: Shares of the nine countries in the tax revenue in the taxation zone 19

Basis of calculation: 15% evasion in securities trading, 75% evasion in derivatives trading Taxation rates: 0.1% (securities), 0.01% (derivatives) The Verteilungsschlüssel: Gewinne und Gehälter Verteilungsschlüssel Aktivaabove graph illustrates the percentage share of each member states ranging from Germany, at around 30% of both scenario 1 (grey bar) and 2(green bar), to Greece and Portugal (at around 2-3% of each). Removing individual financial instruments from taxation would entail substantial tax losses in each case. At the same time, making an exception for one type of instrument would provide an incentive for replicating such a type by encouraging financial innovation so as to enjoy similar tax exemption. 3.3 Including all euro countries produces little growth in revenue The inclusion of all euro countries in the estimate produces the following total revenue: Scenario 1: 44 billion and Scenario 2: 39 billion. That is 77% and 68% of the taxation revenue estimated for EU27. Of the remaining Euro states the country with the greatest revenue is the Netherlands, followed by Ireland and Luxembourg (Tables 6 and 7 and Diagrams 3 and 4). Only in these three states does tax revenue lie above 1 billion in each instance. Diagram 3: Revenue in the other euro countries when the taxation zone is restricted to the 17 Euro states

Basis of calculation: 15% evasion in securities trading, 75% evasion in derivatives trading Taxation rates: 0.1% (securities), 0.01% (derivatives) 3,50 3,00 2,50 Revenue 2,00 from derivatives is with both distribution keys very nearly twice as high as that 1,50 from securities. The highest tax revenues are achieved from interest rate derivatives in both cases. 1,00 0,50 - Verteilungsschlüssel: Gewinne und Gehälter Verteilungsschlüssel Aktiva

Tax rates: 0.1% per contract party for securities, 0.01% per contract party for derivatives Basis of calculation: 15% evasion in securities trading, 75% evasion in derivatives trading Table 6: Distribution key for revenue: assets of financial institutions without branches abroad but with foreign subsidiaries EU27 Estonia Ireland Luxembourg Malta Netherlands Slovakia Slovenia Zypern Alle Weiteren 37080.6 15.8 1198.3 681.2 41.2 2153.2 50.7 52.9 133 4326.3 Revenue in billion Shares of total tax revenue as per distribution key 0.000 0.032 0.018 0.001 0.058 0.001 0.001 0.004 0.117 Steueraufkommen gemäß Shares/units 0.003 0.220 0.125 0.008 0.395 0.009 0.010 0.024 0.793 Bonds 0.005 0.407 0.231 0.014 0.732 0.017 0.018 0.045 1.470 Revenue total securities 0.008 0.627 0.356 0.022 1.127 0.027 0.028 0.070 2.263 Equity derivatives 0.001 0.107 0.061 0.004 0.192 0.005 0.005 0.012 0.385 Interest rate derivatives 0.013 0.957 0.544 0.033 1.719 0.040 0.042 0.106 3.454 Currency derivatives 0.002 0.155 0.088 0.005 0.279 0.007 0.007 0.017 0.560 Total revenue derivatives 0.016 1.218 0.693 0.042 2.189 0.052 0.054 0.135 4.399 derivativesgesamt Revenue pro Land 0.024 1.845 1.049 0.063 3.316 0.078 0.081 0.205 6.662 Share of the nine in tax Revenue 0.004 0.277 0.157 0.010 0.498 0.012 0.012 0.031 1.000 25 The proportion of assets is taken from the EU Commission (2011), COMMISSION STAFF WORKING PAPER IMPACT ASSESSMENT, accompanying the document Proposal for a C o u n c i l D i r e c t i v e o n a c o m m o n s y s t e m o f f i n a n c i a l t r a n s a c t i o n t a x a n d a m e n d i n g D i r e c t i v e 2 0 0 8 / 7 / E C, V o l 1 2 http://ec.europa.eu/taxationcustoms/taxation/othertaxes/financialsector/indexen.htm

Scenario 2 Tax rates: 0.1% per contract party for securities, 0.01% per contract party f derivatives Basis of calculation: 15% evasion in securities trading, 75% evasion in derivatives trading Taxation rates: 0.1% (securities), 0.01% (derivatives) Table 7: Distribution keys: gross profits-gross fixed asset investments + salaries in the financial sector 26 Other Euro countries Estonia Ireland Luxembourg Malta Netherlands Slovakia Slovenia Cyprus All others All Euro countries Shares of total tax revenue As per distribution key 0.001 0.029 0.018-0.056 0.005 0.003 0.001 0.113 0.684 Revenue in billion Shares/units 0.007 0.197 0.122-0.381 0.034 0.020 0.007 0.768 4.651 Bonds 0.013 0.365 0.227-0.706 0.063 0.038 0.013 1.424 8.618 Revenue total securities 0.019 0.563 0.349-1.086 0.097 0.058 0.019 2.192 13.270 Equity derivatives 0.00 0.10 0.06-0.18 0.02 0.01 0.00 0.37 2.257 Interest rate derivatives 0.03 0.86 0.53-1.66 0.15 0.09 0.03 3.34 20.246 Currency derivatives 0.00 0.14 0.09-0.27 0.02 0.01 0.00 0.54 3.283 Total revenue derivatives 0.04 1.09 0.68-2.11 0.19 0.11 0.04 4.26 25.787 Revenue pro Land (Distribution keys: profits und salaries) 0.06 1.66 1.03-3.20 0.29 0.17 0.06 6.45 39.056 Shares of the remaining Euro countries in (distribution keys profits + salaries) 0.009 0.257 0.159 0.000 0.496 0.044 0.027 0.009 1.000 The share of the individual countries as a proportion of the total gross profits (-gross investment in fixed assets) and salariesn in the financial sector is taken from the EU Commission (2011), COMMISSION STAFF WORKING PAPER IMPACT ASSESSMENT, ibid.

Diagram 4: Shares of the remaining Euro countries in tax revenue with taxation zone restricted to the 17 Euro states Basis of calculation: 15% evasion in securities trading, 75% evasion in derivatives trading Taxation rates: 0.1% (securities), 0.01% (derivatives) 0,60 0,50 0,40 0,30 0,20 0,10 0,00 Verteilungsschlüssel Gewinne und Gehälter Verteilungsschlüssel Aktiva The above diagram illustrates the percentage shares of the nine countries listed above. The countries are, namely, Estonia, Ireland, Luxebourg, Malta, the Netherlands, Slovakia, Slovenia, and Cyprus. The green bars indicate the results of the profit and salaries model, whilst the grey indicates the results of the asset model. 3.4 Tendency to underestimate revenue It must be pointed out that the procedure for calculation and distribution to the individual states tends to entail underestimating tax revenue. Essentially there are three reasons for this. As already mentioned above, one reason for a possible underestimate is the way in which account is taken in the calculation formula of the two sides to a contract of tax. Unless joint and several liability comes into effect it would be justified to apply the taxation rate to one contracting party first of all and then to double the revenue calculated therefrom. The route taken here of using the doubled tax rate in the calculation formula yields a lower tax revenue. Tax revenue calculated in this fashion can only be expected if the joint and several liability of one contract party is triggered. The second reason for an underestimate is likewise due to the fact that both parties to the transaction are taxed and are jointly and severally liable for one another. The selected classification keys chosen only register the effect of

double taxation to a disproportionately small extent, which can easily be demonstrated by a simple example. 23

Let us assume that the maximum possible taxation zone consists of two countries. If both countries introduced the tax the first country would receive 70% of the revenue and the second country 30%. The distribution of the assets to the financial institutions of both countries would be in perfect correlation with the transaction volumes. Let us now assume that country 2 waives the introduction of the tax. Application of the assets key of the financial institutions results in a reduction of 30% in tax revenue. As however one party to the contract is jointly and severally liable for the other party, all cross-border transactions remain in the basis of calculation and are taxed at the same rate as before. However, the indigenous financial institutions of country 1 are now liable for the same debt for cross-border transactions. The cross-border tax revenue overall therefore remains constant, but its distribution changes in favour of the residual taxation zone. Although the tax revenue is reduced, as the transactions within country 2 are no longer taxed, the reduction falls to a disproportionately low extent because of the joint and several liability. The distribution of total revenues in accordance with the assets of the financial institutions cannot reflect this effect and tends therefore to underestimate tax revenue in the remaining taxation zone. Finally the manner in which the total revenue is distributed does not take account of trade with financial instruments of the taxation zone with foreign banks. The latter is nevertheless subject to taxation from a combination of the country of origin and the country of issue principles (see also transaction examples 10 and 11 in Box 3). The United Kingdom achieved tax revenues of a good $4 billion in 2009 by applying the issuer principle to trade in shares of domestic companies. For a rough estimate of the anticipated revenue from taxing trade outside the taxation zone with financial instruments issued in the taxation zone, let us resort to information provided by the World Federation of Exchanges. The latter provides information on trading volumes for the most important exchanges. If we consider the marketing centres represented in the World Federation of Exchanges, an average of 7% of share transactions is for foreign securities (more at the large trading arenas). Of this foreign proportion about 10% can be ascribed to the nine countries taxation zone outlined above, if the foreign proportion is distributed on 24

average to worldwide trade volumes. The resultant volume of trade in domestic shares of the nine countries only came to about 0.25 billion in 2010. Clearly only small additional income can be anticipated for the nine countries in foreign trading. So we shall not provide precise information. The significance of the estimate is essentially reduced by the poor data reliability of Asiatic stock exchanges in particular and the fact that in the case of transnational stock exchange groups, such as the NYSE Euronext for example, it is not clear what proportion of trade activities can be assigned to the taxation zone with the nine countries. In spite of the presumably rather small additional income from combining the country of origin and the issuing principles, this comprehensive taxation of the securities and derivative trade is important as it is the best way to avoid evasive trends.