x Abu Dhabi, UAEWednesday 17 January 2018

France will find new levy galls investors

Paris has imposed a financial transaction tax but, instead of it being a fair way to raise vital revenue, it is a populist "sin tax" fantasy that will fail on all counts.

France is imposing a tax on all transactions involving French companies with market values exceeding €1 billion. Balint Porneczi / Bloomberg News
France is imposing a tax on all transactions involving French companies with market values exceeding €1 billion. Balint Porneczi / Bloomberg News

Facing resistance to finding increased funds from traditional tax sources, governments are looking at ways that invite less political resistance.

And so it is that the French government imposed from this month a financial transaction tax (FTT) that is portrayed as a levy supposed to be paid only by the "1 per cent".

The FTT would be collected on all transactions involving French companies with market values exceeding €1 billion (Dh4.51bn). The levy will fall on "transfers of property" of companies with shares trading in Paris and incurred regardless of the domicile of the buyer or seller.

And to add inanity to insult, France's new president François Hollande doubled the levy to 0.2 per cent from the 0.1 per cent tax initially proposed by the former president Nicolas Sarkozy.

Various rationalisations were offered for imposing the FTT on share purchases, including high-frequency trading and credit default swaps.

On the one hand, it was said the aim is to curb market speculation. On the other hand, it was depicted as a way to provide the government with more funds to engage in growth-enhancing spending. And there were suggestions some of the money raised would be used to fund research into Aids.

In the end, the FTT should be seen as a desperate grab for more tax revenues. And that is a generous interpretation. As it is, raising tax rates or imposing new taxes during an economic downturn, especially during a prolonged struggle with recovery, is a recipe for disaster since it will dampen economic activity. But the issue is that representative democracy creates incentives for elected officials to do the wrong thing in responding to short-term political impulses.

It might be useful to think of the FTT in the context of "sin taxes" targeting behaviour that incites widespread moral indignation. In as much as financial investors and bankers have been demonised for engaging in real or imagined excesses, there will be widespread assent to offering them up as sacrificial lambs to the exchequer.

But since sin taxes are all about "nudging" people away from activities that are taxed, an FTT can be expected to curtail all manner of share trades, not merely speculative ones. It is hard to imagine a coherent theory suggesting how this promotes economic growth.

For their part, politicians look for ways to continue conferring benefits on the voting blocs and special interest groups that support them even if doing so leads to long-term economic costs. In the end, a heavier burden on the private-sector economy reduces its growth potential while the public sector grows in both absolute and relative terms.

In short, this is the woeful tale of an unrestrained welfare state that leads to economic underperformance and perpetual fiscal crises such as in Greece. (A European Commission report concluded with 1.5 per cent average annual growth and a 0.1 per cent FTT on shares and 0.01 per cent on derivatives, GDP of its member states would be 0.53 per cent lower by 2050.)

Further evidence of the wilful ignorance of economic logic behind the FTT is that revenue projections are unrealistically rosy: €170 million this year; and €500m next year. Reality usually interferes with the fulfilment of government estimates that tend to assume taxpayer behaviour is unchanged when new taxes are imposed or rates are raised.

Yet history and theory shows new levies always induce avoidance behaviour.

And if set too high, they will inspire evasive behaviour. If the financial transaction tax is successful in reducing the number of transactions - as is almost certain - the revenue yield will be lower than expected.

Another problem with the FTT is it adds injustice to potential injury since it threatens to be a regressive tax falling on smaller investors.

As it is, institutional investors can use "contracts for difference" that allow bets on a stock's gain or loss without owning the shares.

This tactic is currently used to evade stamp duties imposed in the United Kingdom on share purchases and is usually available only to prime customers.

In all events, a selective imposition of an FTT makes it easy to avoid such that it will yield few additional revenues.

Sweden's unilateral imposition of levies on trading in shares, bonds and derivatives in the 1980s ended in 1991 when trading volumes fell sharply as local investors placed trades elsewhere.

In sum, France's flirtation with an FTT is likely to fail on all counts except one.

It may succeed in promoting populist fantasies about taxing the "rich" in support of certain political ambitions fulfilled at the expense of long-term economic growth.

Christopher Lingle is a research scholar at the centre for civil society in New Delhi and visiting professor of economics at Universidad Francisco Marroquin in Guatemala