An evaluation of the financial transaction tax

The tax will apply to almost all financial transactions carried out by financial institutions established in the Member States.

In this note we explore 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. We find 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.