EU Financial Transaction Tax. An Effective Means to Curb Speculation in Financial Markets?

Bachelor Thesis, 2017

56 Pages, Grade: 1.7


Table of contents

Acronyms and abbreviations

List of figures

List of tables

1 Introduction
1.1 Background
1.2 Research questions
1.3 Structure

2 Speculation in the financial markets
2.1 General definition
2.2 Implications of speculation on the real economy

3 Financial transaction taxes
3.1 History and developments
3.1.1 Stamp duty tax
3.1.2 Keynes’ financial transaction tax
3.1.3 Tobin Tax
3.1.4 Further developments until today
3.2 Typology of FTTs
3.2.1 Securities transaction tax
3.2.2 Currency transaction tax
3.2.3 Bank transaction tax
3.2.4 Registration tax
3.3 FTT objectives, effects and detriments

4 EU Financial Transaction Tax
4.1 Debate and developments
4.2 Form and scope
4.3 Objectives and effects
4.4 Problems, detriments and criticism

5 Practical FTT experiences
5.1 Sweden
5.2 France
5.3 Italy

6 Conclusion and outlook
6.1 Results
6.2 Outlook

Reference list

Acronyms and abbreviations

illustration not visible in this excerpt

List of figures

Figure 1: Survey on the introduction of a financial transaction tax

Figure 2: Taxation of financial transactions following the EU FTT proposal

List of tables

Table 1: Annual foreign currency interest rates required to match 4% 13 return in home currency

Table 2: EU FTT 2011 revenue estimations in billion €


The global financial crisis of 2007/08 revealed the necessity of improved stabilisation and regulation of the global as well as European financial markets. In this context, increased attention was given to financial transaction taxes and in 2011, the introduction of a European Union Financial Transaction Tax was first proposed. The objectives for this tax, set out by the European Commission, were tripartite: financial revenue generation, regulative strengthening and the improvement of the efficiency of financial markets.

The aim of this thesis is to examine whether the European Union Financial Transaction Tax would be an effective means to curb speculation in the European financial markets, and a suitable tax solution for the European Union. The thesis further analyses whether this tax could increase the financial markets efficiency, and contribute to a fair and substantial contribution of the financial sector to the participating countries’ public finances. In this regard, underlying theoretical concepts, potential positive effects of the transaction tax, as well as detriments and shortcomings are discussed. The conclusion of the thesis is that the European Union Financial Transaction Tax might be effective in curbing speculation, should it be implemented in a way that prevents tax evasion. In addition, it is very likely that the tax would raise a significant amount of revenue. However, despite the arguments in favour of the introduction of said tax, it is currently under great pressure with many issues left unanswered.

1 Introduction

1.1 Background

“It is time for the financial sector to make a contribution back to society” (Barroso, 2011 cited in Chaffin, 2011). This quote by José Manuel Barroso, former president of the European Commission (EC), refers to the proposal of the implementation of a so-called European Union Financial Transaction Tax (EU FTT) and is more topical and relevant today than it has ever been. The reason for this is that 2017 was supposed to be the year for this proposal to be formally introduced and become the official law. Thus, it is interesting to analyse why the EU FTT has not been implemented yet, as of August 2017.

Most commonly, a financial transaction tax (FTT) is a tax levied on a purchase or sale of a financial instrument at the time of the transaction of said instrument. The tax is usually applied in proportion to the size of the financial transaction. It can either be applied to all kinds of transactions and all actors in the financial markets or only to certain types, such as shares or derivatives, and specific actors. The main objectives of a FTT are regulating and stabilising the financial market as well as curbing speculation, without discouraging other investment activities. In addition to this, the revenue generated by this tax is expected to be significant for the relevant country or area (Keightley, 2012, p. 1).

The idea of financial transaction taxes is not a new one but can be traced back to the 17th century when the first ever financial transaction tax was introduced and implemented at the London Stock Exchange, in the form of a levy of 0.5 per cent on the purchase of a share paid by the buyer (Dieter, 2002, p. 13). The concept of a tax on certain financial transactions was revived and concretised in 1936 by John Maynard Keynes following the Great Depression, and in 1978 by James Tobin at the end of the Bretton Woods system, both of which will be explained in greater detail later on (Nerudová, 2010, p. 206f.; Sun, Kruse and Yu, 2014, p. 104).

Ever since the financial crisis of 2007/08, for which speculation in the financial sector is considered a major cause, the idea of a financial transaction tax has been re-examined globally in various forms. One of these post-crisis proposals has been made by the EC. The idea of introducing an EU FTT was first debated in 2010 and presented as a draft bill one year later. Barroso, president of the EC at the time, argued that the establishment of this tax was a matter of fairness and that the time had come for the financial industry to pay back its debts. The debts mentioned by Barroso refer to the amount of more than €4,000 billion that the EU governments had provided the banking sector with, to support them throughout and after the financial crisis. The repayment of this debt was to be financed by the expectation that the tax could generate an amount of more than €55 billion per year (Chaffin, 2011). Beside this goal of repayment, the proposed FTT’s objectives further included plans to reduce or abolish other important factors that contributed to the financial crisis, such as “regulatory arbitrage, flash trades, overactive portfolio management, excessive leverage and speculative transactions of financial institutions” (Schäfer et al., 2012, p. 76).

Despite the fact that the above mentioned specific plans and objectives have been debated since 2011, no implementation of the EU FTT has taken place yet, as there is no consensus between the member states participating in the implementation process. What’s more, the number of countries willing to participate has decreased over time. There have merely been singular efforts or implementations of national FTTs by a few European countries, two of which will be presented in greater detail later on. Although no unified FTT has been introduced yet, a new survey has demonstrated that there is still a great deal of public attention regarding this topic. The survey has recently been conducted by Civey, a German opinion research institute cosponsored by the European Regional Development Fund (ERDF). The poll asked about 23,000 participants in Germany over the duration of almost one month whether they believed that the trading of financial products should be taxed in the future, by means of a financial transaction tax (Civey, 2017).

illustration not visible in this excerpt

Figure 1: Survey on the introduction of a financial transaction tax (Based on Civey, 2017)

The results, which can be seen in figure 1, show that almost half of all participants are in definite favour of the implementation of a financial transaction tax and a total of 75 per cent of poll takers believe that financial products should be taxed with a FTT in the future. Only a combined percentage of 15 is in strong or light opposition to the taxation of financial products (Civey, 2017). In light of these results, it is interesting to analyse the EU FTT and the relevant background information, with the aim of answering the following research questions.

1.2 Research questions

This bachelor’s thesis aims to answer two research questions.

1. What do financial transaction taxes look like and what are their objectives? To answer this question, the history of FTTs will be depicted, including the most important developments over time. Additionally, the four most common types of FTTs will be presented as well as general FTT objectives, effects and potential detriments.
2. Would the introduction of the European Union Financial Transaction Tax fulfil its goals and succeed in curbing financial speculation? To answer this second question, the thesis will first analyse the term speculation. Further on, the main achievements as well as the challenges so far will be reviewed. Moreover, the form and scope of the EU FTT proposal will be analysed to find out what a joint financial transaction tax in the EU would look like. Subsequently, its objectives, benefits and detriments will be examined and the likelihood of success will be evaluated, for example by examining FTTs which have already been implemented.

1.3 Structure

To answer these research questions in a structured manner, this bachelor`s thesis is divided into six sections. After the topic’s background, the thesis’ research questions and its structure have been presented in this introduction, the second section will define the term speculation and present its effects on both financial markets and the real economy. The subsequent section will explain the relevant theoretical concepts of financial transaction taxes. First, the history of FTTs and important developments will be examined, including imperative FTT concepts by Keynes and Tobin. This is followed by a typology of financial transaction taxes, before general FTT objectives, effects and detriments are discussed. In the fourth section, an overview of the proposal for the EU Financial Transaction Tax will be given. To do so, the most important developments in the period between its first mention and today will be identified, the objectives and form of this FTT concept will be depicted, and challenges arising from the introduction process as well as criticism of the establishment will be analysed. The fifth section reviews practical FTT experiences in Sweden, France and Italy, serving as potential positive or negative examples for the EU level. In the sixth and final section, a conclusion will be drawn and an outlook will be given.

2 Speculation in the financial markets

2.1 General definition

In order to answer the title question of this thesis and to find out if the introduction of an EU FTT would indeed curb speculation in the financial markets, it is imperative to establish a precise definition of the term speculation, and its associated risks, first. Financial speculation is quickly and commonly associated in conjunction with high risks as well as negative and destabilising developments, both for the financial markets and the real economy. This is, however, not always the case. This section will therefore analyse the term speculation and demonstrate the distinction between financial speculation with positive and negative effects. This thesis focuses on the latter as the goal of the EU FTT is to curb this kind of high-risk speculation with negative effects on the real economy.

Generally, speculation can be defined as the process of buying or selling something to make a profit, taking advantage of the temporal price arbitrage. This means that the business process does not have the intention of an actual delivery of purchased or sold goods but instead focuses solely on the gains realised from the difference between the purchase price and the selling price. In the context of stock exchange transactions, these business processes are carried out on very short terms and in two ways, either speculating on rising prices (bull market speculation) or on falling prices (bear market speculation). These anticipations of future price developments of both kinds of speculation can have a regulating effect on the financial markets, smoothing out price and risk fluctuations, increasing overall tradability of securities, and, thus, ensuring the markets’ future viability. The potential positive effects on the financial markets and ultimately also on the real economy are countered by negative opposing effects, namely severe price movements which may lead to erratic developments, uncertainty in the financial markets and potentially even a stock market crash (Oxford University Press, 2014; Springer Gabler Verlag, 2017).

Said negative implications on the real economy are exactly what a financial transaction tax attempts to prevent from occurring. It is, therefore, imperative to find out how the speculation process works in detail, in what way it influences the real economy, and in what way these implications can be curbed successfully.

2.2 Implications of speculation on the real economy

As mentioned before, speculation does not have to have negative implications per se. What is, however, harmful to stable financial markets and a well- functioning real economy is a certain kind of speculation which will be characterised in this section. One of the most well-known definitions of this type of speculation, which is still widely used today, was given by John Maynard Keynes in the 12th chapter of his famous 1936 book The General Theory of Employment, Interest and Money. He characterises a speculator as someone who is not concerned with the stable long-term development of an investment but instead primarily focuses on the forecast of short-term changes of a financial instrument’s valuation and current market trends. Thus, the emphasis of the speculator is not on the real value of an investment but on the market value it will reach in the short term, influenced by the - oftentimes irrational - behaviour of the public and therefore the psychology of the masses. Consequently, investment decisions are primarily made on the basis of other market participants, ignoring the underlying fundamental data of the investment opportunities (Keynes, 1936, p. 99ff.). This fundamental value of an investment depicts its intrinsic value, based on a high volume of internal data of a company, neglecting perceived external assessments. It can be determined by internal financial ratios, such as the price-to-earnings ratio or the free cash flow, as well as multiple complex valuation methods, such as the Dividend Discount Model or the Residual Income Model, and usually differs from the investment’s market price (Björkegren, 2011, p. 8f.).

In the previously referenced book, Keynes compares the above described short-term orientation to a newspaper beauty contest, in which all participants are asked to select the six most beautiful faces out of a selection of 100 photographs. The competition’s price is awarded to the participant “whose choice most nearly correspondents to the average preferences of the competitors as a whole” (Keynes, 1936, p. 100). Hence, each participant must not pick the faces which he himself finds most beautiful but instead choose the ones he anticipates to be chosen by the average participant’s opinion. Keynes then applies this concept to the stock market’s behaviour. In this case, the prices of shares are not based on the speculator’s own belief of the investment’s fundamental value but rather on his beliefs about what the other market players’ beliefs are, and how they value the relevant investment. As a result, the market price of a financial investment deviates from its ‘true’ intrinsic value. The latter would only correspond to the market price under the assumption of the existence of efficient markets, under which the prices of assets entirely reflect all existing information (Keynes, 1936, p. 100f.).

Trading on the premise of predicting the price movements based on something other than information about the investment’s fundamental values, namely the reasoning of other investors, is what Stiglitz as well as Summers and Summers call “noise trading” (Stiglitz, 1989, p. 105; Summers and Summers, 1989, p. 268). One reason for this phenomenon could be the fact that it is very expensive and it involves making a large effort to collect all necessary information about the fundamentals and then analyse the obtained data. This is particularly difficult for small private investors. They are, therefore, reliant upon the assessment of other investors, which ultimately forces them to concentrate on the short-term developments, too. This process is called noise trading because the noise of the mass seems to drown out the - perhaps differing - fundamentals and, in consequence, impedes an accurate price formation. In consequence, markets react to small events, such as new information about a company or financial instrument, in a highly volatile way. Reinforced and accelerated through the domino effect of noise trading, this also leads to a shift of the whole market towards the short-term orientation. The high price volatility itself already has negative implications on the real economy, as it has prices fluctuating very strongly and it complicates long-term planning and stability. Even more grave, however, is the wrong price valuation as a result of speculative capital movements which has the price of an investment deviating from its fundamental value. Instead of fulfilling their vital social function of effectively allocating resources, the markets contrarily enforce a distortion of said resource allocation. Thus, a destabilisation of the real economy which can, in the worst case, lead to economic and financial crises can occur (Summers and Summers, 1989, p. 262).

One option to counter the problem of noise trading and strengthen the social function of financial markets is the introduction of regulatory measures. Many economists and financial experts, such as Keynes (1936), Stiglitz (1989) as well as Summers and Summers (1989), encourage and believe in the merit of financial market regulations. They all agree that the societal benefits of these measures, for example a stronger orientation of market prices on the investment’s fundamentals, by far outweigh their respective costs. Nonetheless, the economists do not agree on the type of regulation and their precise impacts. One of the multiple regulatory proposals is the implementation of a financial transaction tax, which will be introduced in the following section. Due to the scope of this thesis, this will be the only regulatory measure curbing speculation addressed.

3 Financial transaction taxes

In the following section, the concept of financial transaction taxes will be introduced and explained in detail. The first section reviews the history and the developments of FTTs throughout the years, introducing the most important historic FTT proposals, which serve as a base for the discussion of today’s EU FTT. This is followed by an analysis of the different types of financial transaction taxes applied today and their respective characteristics, with special attention to how they aim to curb the above analysed kind of speculation.

3.1 History and developments

3.1.1 Stamp duty tax

The very first financial transaction tax is the oldest tax collected in England and the United Kingdom today. It is called “stamp duty” and collected on every share purchase at the London Stock Exchange (LSE) (Dieter, 2002, p. 13). The tax, which has been in place since 1694, is to be paid by the buyer of the share and amounts to 0.5 per cent of the total value of the transaction. Today, it applies to electronic share purchases as well as share purchases using a stock transfer form, which are greater than £1,000 (United Kingdom Government, 2017; London Stock Exchange, 2014; Dieter, 2002, p. 13). For the contemporary understanding of financial transaction taxes, however, this stamp duty tax is not of great importance.

The focus in the following sections will be on two other FTT proposals, explicitly John Maynard Keynes’ financial transaction tax and especially the Tobin Tax, named after James Tobin. This selection has been made because these two FTT considerations are most relevant as underlying frameworks for the introduction of the EU FTT.

3.1.2 Keynes’ financial transaction tax

The first relevant idea of a financial transaction tax dates back to John Maynard Keynes’ 1936 book The General Theory of Employment, Interest and Money. In his work, the British economist advocated the utilisation of transaction taxes in order to stabilise the financial markets, using the United States of America (USA) as an example. This stabilisation was strongly sought after during this time of the Great Depression which had been caused by a major stock market crash in October 1929. It was characterised by enormous declines in areas such as personal income, trade, gross domestic product (GDP), corporate profits and tax revenue, as well as an exceptionally high unemployment rate (Frank and Bernake, 2007, p. 98).

In Keynes’ opinion, “the introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation” (Keynes, 1936, p. 102). He argued that there is a need for a FTT because the financial markets, and the stock exchange, had become too liquid and, in consequence, too accessible and affordable for the average person. He also compared the stock exchange to a casino and reasoned that since casinos are restricted in terms of accessibility and are also very expensive, the same should be applied to stock exchanges. That would prevent the participation of the average person who then trades on the markets as a speculator in the sense that was analysed in section 2. Neither having all relevant information nor the funds or expertise to analyse the investment’s fundamentals, these speculators invest with the principle of noise trading, relying on other investors’ assessment. Hence, in Keynes opinion, diminishing the markets’ liquidity would lead to a reduced presence of the noise trading phenomenon and, consequently, to a gradual and sustainable movement, away from the short-term view, which is solely focused on quick capital gains.

In his work, the economist also praised the stamp duty tax system of the LSE in England and believed that the establishment of a FTT, in the USA and in other countries, would not only stabilise financial markets by reducing the markets’ liquidity, but ultimately curb high-risk speculation. This would be achieved through a shift from the short-term orientation to a more sustainable long-term investment strategy, with a stronger focus on fundamental data, therefore depicting an investments true valuation (Keynes, 1936, p. 101f.).

One of the strengths of Keynes’ proposal is the fact, that he did not limit his theory to the positive effects a FTT would create, but also mentioned the key arguments opposing the tax. They included, for instance, the argument, that a FTT might restrict the financing of corporations and enterprises, as the reduced market liquidity makes raising capital or diversifying risks harder for entrepreneurs. In addition, FTT opponents argued that the diminished liquidity would further limit the possibilities for increased returns for private investors and raise their risks. Both of these arguments might lead to an overall reduction of the capacity of society to carry out extensive investments (Matheson, 2011, p. 12). Having depicted these arguments, however, Keynes highlighted the key arguments in favour of the introduction of a FTT which have been mentioned before. He was not just a proponent of a financial transaction tax in itself but also advocated for the tax to be of a substantial amount. This expression was, at the same time, one of the weaknesses of his FTT theory because he did not give any more details about the size of this tax rate.

3.1.3 Tobin Tax

The American economist James Tobin is the second major proponent of FTTs throughout history and the most important for today’s understanding of financial transaction taxes as well as for the establishment of the EU FTT. He was strongly influenced by Keynes’ ideas and first advocated a financial transaction tax on foreign exchange transactions in his Princeton lectures in the year 1972.

This recommendation became famous as the so-called Tobin Tax (Matheson, 2011, p. 12). His proposal followed as a reaction to the suspension of the Bretton Woods system of monetary management in the previous year. Tobin was a critic of this suspended system, which obligated the participating countries to follow the monetary policy of fixed exchange rates. This meant that the exchange rates of the countries’ currencies had a certain fixed value against gold, fluctuating with a maximum of one per cent. When this system ended in August 1971, as a result of the overvaluation of the US dollar, the world’s major currencies started floating either freely or pegged against another currency (IMF, 2017).

In this context, Tobin proposed a reformed system for international currency stability which included a tax on all foreign exchange transactions. The underlying reason for his suggestion was that he saw a problem in “excessive internal - or better, inter-currency - mobility of private financial capital” (Tobin, 1978, p. 153). Like Keynes, he believed that financial markets were too liquid. He concluded that financial institutions as well as large international companies should be taxed because, in his eyes, they were the ones who had to be held responsible for the “current troublesome perfection of these markets” (Tobin, 1978, p. 159). He also argued that the national governments were not able to cope with the large amounts of cross-border capital flows without making sacrifices with regards to employment, production and inflation policies. Additionally, he stated that the governments’ domestic policies did not have the strength to counterbalance the economic consequences of speculation on foreign exchange rates. In his paper A Proposal for International Monetary Reform, Tobin further announced that the purpose of his tax proposal was to “throw some sand in the wheels of […] excessively efficient international money markets” (Tobin, 1978, p. 154). He intended to achieve that objective by having governments around the world implement a multilateral transaction tax, amounting to somewhere between 0.05 per cent and 1 per cent of the overall foreign exchange transaction value, to stabilise exchange rates.

This tax can be categorised as a currency transaction tax, one of the four FTT types which will be specified further in section 3.3.2, and often serves as a pecuniary exchange regulator. According to Tobin, it should apply to all acquisitions of foreign currency financial instruments and each participating government should administer the transaction tax in its own jurisdiction (Tobin, 1978, p. 158f.;, 2017).

In Tobin’s opinion, the suggested tax would make many short-term cross-border transactions either virtually or completely unprofitable and, in consequence, lead to a reduction of foreign capital flows across borders, enabling national governments to better regulate aggregate demand (Tobin, 1978, p. 155; Spahn, 1995, p. 3; Matheson, 2011, p. 12). This theory of the tax, making short-term foreign investment unprofitable while barely impacting long-term cross-border transactions, was confirmed by Paul Bernd Spahn in 1995. In his work International Financial Flows and Transaction Taxes: Survey and Options, he calculated the annual interest rates of a foreign currency required to match a return of four per cent in the home currency. To do so, he used two different possible Tobin Tax rates, 0.5 per cent and 1 per cent, and various short-term maturities ranging from one day to one year, as well as one longer-term maturity of five years, as a comparison. The results of the calculations are depicted in table 1 below.

Table 1: Annual foreign currency interest rates required to match 4% return in home currency (Spahn, 1995, p. 4)

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EU Financial Transaction Tax. An Effective Means to Curb Speculation in Financial Markets?
Berlin School of Economics and Law
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Finance, Finanz, Finanzen, EU, Europäische Union, European Union, Finanztransaktionssteuer, Financial Transaction Tax, Speculation, Spekulation, Finanzmärkte, Financial markets, European markets, Europa, Europe, VWL, Steuer, Tax
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Sabrina Schleimer (Author), 2017, EU Financial Transaction Tax. An Effective Means to Curb Speculation in Financial Markets?, Munich, GRIN Verlag,


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