European Financial Transaction Tax – the story of a broken dream

The G20 summit last week made significant advances in the introduction of a global financial transaction tax (FTT). Not only France, Spain and Germany but also Argentina, Brazil, Ethiopia and South Africa have declared themselves in favor of an FTT, or Robin Hood tax, which is set to take money from the traders and distribute it to the world’s poor. International NGOs like Oxfam, CIDSE and ActionAid build momentum around this tax that could for example be used to finance climate change mitigation in the global South. The European Parliament has long supported the introduction of an FTT. And even the European Commission has recently declared itself in favor of an FTT, albeit claiming its benefits for the European budget rather than for developing countries.

A pan-European financial transaction tax, however, always seemed unlikely because of the UK’s defiant veto in the Council of Ministers. The city, British politicians fear, would take a heavy blow if every transaction lost 0,05% of its value to the state. And this despite the fact that, according to Sony Kapoor, a trader who takes a 10-minute coffee break comes back to a far higher change in stock prices than just 0,05%.

If a European financial transaction tax cannot be established, German and French politicians recently suggested that the Eurozone should simply go ahead and introduce the tax on its own. Other parts of the world would certainly fall in line behind the biggest economy in the world once the tax had been introduced. However, not only does the EU's impact assessment show that the Eurozone would lose 80% of its financial transactions to London and other stock exchanges according to Dr. Bart Van Vooren, Assistant Professor of EU law at Copenhagen University. The introduction of a universally applicable FTT would also heavily conflict with the freedom of capital mobility enshrined in the European treaties: “(A)ll restrictions on the movement of capital between Member States and between Member States and third countries shall be prohibited” (Article 63 TFEU). Countries may discriminate between inner-European transactions and foreign direct investment, but within the common market, an FTT would not stand before the European Court of Justice, says Dr. Bart Van Vooren.

The only means of introducing a Financial Transaction Tax therefore seems to be a global agreement. But would elected governments ever trust an international organization to enforce the first global tax in history? Realism seems to win this battle in a second.

See below my video interview with Dr. Bart Van Vooren:



Update 08-11-2011: The Economic and Financial Affairs Council today debates the Commission's proposal for an FTT. But according to Sony Kapoor and Dr. Bart Van Vooren, the FTT is a welcome object of political talk. Public opinion is in favor of it, and its implementation reaches beyond the political life of most heads of government and ministers. Talk about a European FTT without the UK's consent is therefore not much more than cosmetics. 

EPP heads of govt retreat to Belgian castle to discuss European Council

It’s a busy weekend in Brussels. Yesterday’s Economic and Financial Affairs Council cleared the path for today’s European Council/Eurozone Summit, while the General Affairs yesterday discussed (PDF) economic policy and finalized the EU positions for the G20 summit in Cannes in November and the COP17 climate conference in Durban in December.

Angela Merkel's badge is waiting for her
Source Flickr CC BY-NC-SA mounteulympus

Somewhere in between, 13 heads of state and government belonging to the European People’s Party (EPP), reinforced by José Manuel Barroso, Herman van Rompuy and Jerzy Buzek, took a retreat to a beautiful castle outside of Brussels to save the Euro over a decent dinner.

Journalists were waiting in front of the castle nervously as the first shaded limousines pulled into the driveway. One by one, heads of state and government got out of their cars and walked past the journalists to the castle entrance. Angela Merkel, Finland’s Prime Minister Jyrki Katainen and Austria’s Foreign Minister Michael Spindelegger stopped to explain their expectancy of the summit, while Silvio Berlusconi put on a grin and ignored the journalists as his bodyguards walked him to the door. MEP Elmar Brok opened his passenger door alone and walked up to the castle by himself. By the time of his arrival, the journalists’ interest had waned and they were comparing their notes of the Merkel interview.

Your blogger had access to the advisors’ chamber, so over dinner I plugged into some interesting conversations. The advisors themselves were not fully aware of what was going on behind the closed doors of the meeting room, either. “Sometimes, very important progress is made in between the negotiations, in bilateral conversations in the hallway,” said German government spokesman Steffen Seibert. And after heads of government have negotiated a compromise among themselves, each of them returns home to win the approval of their Parliaments. “For those governments with a narrow majority, that can be quite a struggle,” Seibert said. Indeed, one reason for the postponement of the European Council to Wednesday is that Angela Merkel has not secured the approval of the German budget committee yet.

Throughout the dinner, buzz was high about the tête-à-tête between Sarkozy and Merkel after the EPP summit. Sarkozy did not participate in the summit but was due to arrive in Brussels later in the evening. According to media reports, however, the meeting only achieved little progress.

It seems that a lot of work remains as heads of government meet for the European Council today. And if the leaked conclusions prove to be true, there will not be an agreement on the recapitalization of the banks today.

Finally - a debate about the future of the European Union in Germany

For one and a half years, debates on the European Union in Germany could be largely summed up as "we always pay, we never get anything back". Not only is this wrong, the pure limitation to financial aspects also obstructed the view upon a more important question: In a world where the European Union "will account for only 18% of world GDP in 2020, signifying a decline of 28%" compared with 2000 levels, are citizens prepared to give the EU strong multilateral institutions? This question has long been left unanswered in Germany. The Lisbon treaty was nodded off without debate.

Thanks to finance minister Schäuble, the debate now seems to take a new turn. Schäuble has always been one of the most fervent supporters of more European integration. After his initiatives for a European Monetary Fund (more or less granted), a European rating agency (still negotiated) and an economic government for the Eurozone (granted), the German finance minister yesterday pursued that the answer to the European debt crisis can only be more Europe. For once, I've got the feeling that the debate is not directed against fellow European countries but towards the degree of competence to be given to Brussels.

Chancellor Angela Merkel gave a one-hour televised live interview last week in which she explained the reasons behind the EFSF. This doesn't happen very often, and it may have given many people a new view upon the EU and Germany's role in. People begin to understand that the country profits a lot from European integration and stronger institutions do not necessarily mean less democracy.

The time is right to pursue this debate and to wonder what Europe will look like in the future. Bavaria's CSU, in dire need of voter support, warns against a "European superstate", but it was apparent from the EFSF vote last week that there is room for more Europe in large parts of CDU, Social Democrats and Greens.

Unnoticed by many, chief German constitutional lawyer Andreas Voßkuhle recently gave an interview in which he predicted (14min30) that Germany may pave the way for stronger European institutions (within the next 10-20 years, roundabout), and give itself a new constitution to accommodate these changes. The time hasn't come for such a quantum leap, but I've got the feeling politicians start laying out the cobble stones to get there.

I hope that there will be an honest debate about the future of the EU, not only in the Parliament but also in the public sphere. After Schäuble started the debate, the next few days will show if other parties are prepared to exchange some serious arguments on this.

Kiyosaki's promise: Quit your job, let your money work for you

Don't work for money, let your money work for you. That is the essence of an interesting book by Robert T. Kiyosaki called "Rich Dad, Poor Dad". Employment in a company with a fixed work contract, Kiyosaki says, will lead most people into a hamster's wheel. Looking to earn money to support their growing expenses (children, house, car etc.), most people tend to work harder to receive more pay. They promptly hand over a larger share of their income to the State as they enter a higher tax category. In 2010 for example, an average German citizen employed in a private firm was working for the government until July 4th, after which he started producing value for himself. If he decided to work harder, it might push Tax Freedom Day even farther away.

Let your money work for you/adapted from
Flickr CC BY esbjorn2

Kiyosaki therefore proposes to a) cut spending and b) invest the money thus saved. His book can be criticized for many reasons, but the idea of "making money work for you" sounded appealing. I'm all in favor of investment with a moral backbone, so I scrapped speculation on oil, currencies, pension funds and food commodities in favor of stock options. I invested a fictional 7740 EUR into a portfolio of big stable European companies on May 7th (if I wanted to do that annually, it would require me 645 EUR per month in real life). Commission fees etc. of approx. 2% would put it down to 7585 EUR.

Now, the DAX which reunites 30 of the strongest enterprises in Europe's economic locomotive, Germany, grew by roughly 26% in 2009 and 17% in 2010 (my calculations). If I was lucky and my European company portfolio outdid the DAX by a third, I'd be between 23% and 35%. After a year of foregoing spending, I'd have gained 1745-2654 EUR (again subject to taxes).

Let your money work for you? I couldn't quit my job and live on 2654 EUR per year. Nor could I do so after ten or 20 years. Investment, I guess, cannot replace a work contract. It can give you a bit of spending money, but it won't make you rich unless you put your money into high-risk endeavors like startups or low-priced stocks.

Besides, for the last month all of my big European company stocks have only seen one direction: down.

What does the financial crisis have to do with Three Mile Island?

A lot, if one believes the Financial Times columnist and book author Tim Harford. For his book Adapt, he researched the parallels between security in engineering and security in financial markets. Harford singles out three main issues which put the stability of the financial markets in danger: complex structures of financial institutions, interconnectedness of financial institutions and a lack of control through regulators.

The more complex a financial institution, the more likely it is that risks will not be recognized until it is to late. Harford compares the meltdown of Lehman Brothers with the failing reactor at Three Mile Island in the United States. The reactor, he says, started overheating at 4 a.m. when knowledgeable personnel was absent, the control room was difficult to understand due to its impractical design and security systems reinforced the catastrophe rather than attenuating it.

Controlled explosion of a bank/CC BY-NC
total_incompletion

In the financial meltdown of Lehman Brothers, Harford sees the same process. Pricewaterhouse & Coopers was asked to organize Lehman Brothers Europe's orderly insolvency but when its consultants arrived, they had no idea how to understand the complexity of the institution with its numbers of divisions, assets and real estate. They ended up following Lehman Brother employees around to understand what there job actually was.

Likewise, politicians were not given adequate information permitting them to handle the financial crisis responsibly. Harford cites an example of Tim Geither, the head of New York FED at the time of the Lehman Brother collapse, who received the information about AIG's imminent breakdown at 4 a.m. after a transatlantic flight on a handwritten DIN A4 paper with a lot of numbers.

Finally, security systems reinforced the financial meltdown. According to Harford, even small banks that didn't engage in risky speculation often took out an insurance with a re-insurer like AIG. The goal: if for whatever reason customers should withdraw more money than the bank had in cash, the remainder would be covered by the re-insurer. Given that most re-insurers were rated AAA, this also gave the small bank an AAA rating (as it was now absolutely certain that the bank could service its debt). However, in practice re-insurer A also had a re-insurance contract with re-insurer B, who had a contract with re-insurer C, who had a contract with re-insurer - A! At the moment where A's panicking clients withdrew money, it not only pulled B and C into the abyss, but also the small commercial bank. Its portfolio was suddenly no longer insured and became rated C; it did not obtain any more loans from other financial actors except for skyrocketing interest rates.

The example shows two things. Not only was there a latent error lurking in the equation: The security system would fail exactly at the moment when everybody sold stocks and rushed to the banks to withdraw their money. But the security system also put players in danger that it was supposed to protect. Besides, it gave an incentive to insured banks to take a greater risk, certain that they would be covered if their speculation backfired.

Harford draws four conclusions from his findings: it is crucial to

• understand the structure of a financial institution to reduce risks and latent errors, 
• not only understand but reduce complexity of this institution, 
• decouple regular bank activities from risky activities so that they cannot be endangered by the collapse of the speculative sector and 
• encourage whistleblowers within the institution to uncover risks and to communicate them. 

I encourage you to listen to the entire talk Tim Harford recently gave at the LSE. You can find it here.