EU Financial Transaction Tax would wipe out derivatives markets and cost UK £25.5bn

4 Nov 2011 11:55 AM

· An EU Financial Transaction Tax (FTT), or Robin Hood Tax, would impact Britain more than any other EU member state

· The FTT would eliminate derivatives trading in the City of London

· The tax would not raise any significant revenue and would increase market volatility

In a report released today (Friday) the Adam Smith Institute warns that an EU-wide Financial Transaction Tax would cripple the British economy. Its research reveals that, based on European Commission impact assessments, an FTT would cost the UK economy £25.5bn, and hit EU member state economies by £185bn in the long term.(1) This figure is likely to be even higher once Britain’s disproportionate share of financial trading in the EU is factored in. The tax would also lead to increased market volatility, reduced market liquidity, higher unemployment, greater tax avoidance and reduced tax revenues.

The impact on derivatives trading will be particularly damaging to the UK. The City of London currently accounts for 74.4% of interest rate derivatives turnover within the EU (its next biggest rival is France with just 11.7%). An EC impact assessment projected that the FTT would lead to a decline in derivatives trading activity by up to 90%. Therefore a Financial Transaction Tax would nearly eliminate derivatives trading in the UK. This would hit tax revenue and other parts of the City by preventing traders from hedging against real-world risks. As a result of this, ordinary consumers would find it harder to find fixed rate mortgages.

Advocates of an FTT argue that it will reduce volatility, but the ASI report shows there is no clear, consistent evidence that the tax would reduce volatility. However, empirical studies do show a positive relationship between increasing transaction costs and higher levels of volatility. This increase in volatility with rising transaction costs would be accompanied by significant declines in turnover, stock prices and a migration of trading activity.

An introduction of a Financial Transaction Tax would also lead to a reduction in the market volume of transactions. This would shrink the tax base considerably, off-setting the apparent revenue gained from an FTT. It would also lead to a decline in investment, which combined with the elimination of derivatives trading, would lead to job losses and an exodus of companies from the City. Our financial services sector is the UK’s flagship national industry and employs over 1.9million people (6% of the UK total) and as such must be protected from such an economically damaging tax.

Commenting on the report, Sam Bowman, Head of Research at the Adam Smith Institute, adds:

“This report reveals the huge damage that a Financial Transaction Tax would cause to the UK. It would wipe out London’s derivatives sector, destroying jobs and driving other traders overseas. By destroying a critical part of Britain’s most lucrative industry, an EU Financial Transaction Tax would be killing the goose that lays the golden eggs.

“The EU is proposing this tax to distract from the real culprits for Europe’s troubles – spendthrift governments who cannot balance their books. Using markets as a scapegoat might buy Eurozone leaders some political credibility, but it would ruin the City of London.”

(1). The figure of £25.5bn comes from applying EU impact assessment to UK GDP 2010 figures