Extraordinary Delusions and the Madness of Crowds – The European Financial Transaction Tax
By Roberto Bilro Mendes,
Trainee Lawyer at the Departments of Tax and Financial Markets at
1. Tulip Mania
Do you know the connection between Tulips and the Euro Crisis?
I remember reading, a few years ago, the “Extraordinary Popular
Delusions and the Madness of Crowds” by Charles Mackay, a book that
offered, among many other things, an overview of historical economic
bubbles and their effects.
After reading this book, one word marked me forever: Speculation...
Which kind of thing has the power to drive men into a state of
near-insanity? Having some doubts... I’ll work it out for you: Money!
And how do men obtain large amounts of money in such a broken financial
world? The answer is simple: same way we have been doing that for
ages: speculating, buying and selling on the markets, but not just
that, avoiding regulation, evading the tax system, whar is also
important for traders looking to make some serious money!
But now people appear to be acting even more insane than before,
the ones who began all this... because now we have Structured Financial
products (or toxic, if you know what I mean), with names that would
be better applied into some fictional character in a cartoon, and
with mechanisms of application that almost everybody fails to understand.
Such financial products also have an enormous power...
But let’s not get ahead of ourselves:
Have you heard about the Dutch Tulip Mania?
Indubitably, as we were beginning to clarify, men like to speculate.
Better yet, man loves, longs, can not live without, and so on, just
to be able to speculate, sell, buy, make some money on the side,
buy sugar and magically sell it as if it were gold... that’s who
we are now!
And it all began with the Tulip Mania, the first financial bubble
of all times!
Can you imagine living in a time where simple tulip bulbs would
be traded or sold for more than 10 times the annual income of a
skilled craftsman? That time, a Tulip was worth the same as a house.
That happened... came like the wind, and went by like the wind:
it was in February 1637! When that bubble collapsed, it left financial
holocaust all over Europe. All because of speculation! And people
are still doing it, but now it is even worse. They do it not caring
about anything, much less about moral hazard, taxes or justice.
And that has to stop!
Here we stand in 2012 and we are doing it all over again! We are
turning the markets into a giant bubble that will (no doubt about
Speculation does not walk alone: tax evasion, double taxation and
distortions of competition within the Market’s are problems without
an apparent solution. No returning point! That’s where we are. Or
so it seemed...
The main reason behind my words is the speculation around the European
Country’s debts. I believe financial speculation nowadays to be
what the Tulip Mania was back then.
The world is holding breath, and everybody is thinking: can Greece
hold on? Can Ireland? Spain? Portugal? And people are betting on
it. Make no mistake: huge financial transactions are being held
on European soil, without a solid tax regulation to prevent evasion.
That’s why a tighter regulation is needed. And for a while, the
European Union appeared not willing to intervene!
Or so it seemed to us before a proposal for the introduction of
a Financial Transaction Tax (the “FTT”) in the 27 Member States
of the EU was made. An historical day: 28 September 2011!
Alongside with the emission of Eurobonds that we defended in our
latest article, we believe this to be a huge step towards a stronger
Euro-zone economy, and the end of the crisis.
Shall we have a look at the FTT?
Notwithstanding the difficulties that the European Commission (the
“Commission”) has encountered, and struggled with, to obtain the
approval for the FTT from all the 27 Member States of the European
Union (the “EU”), this FTT is really to be applied.
So it is important to analyse such proposal, granting an overview
of its bases, it’s possibilities of application, even if through
a mechanism of enhanced cooperation, such as its effects and next
steps until it’s conclusion and entering into force.
3. The Proposal
The proposal seeks to set up a harmonised tax at EU level to create
a solid internal market for financial services. This tax would prevent
tax evasion, avoid double taxation and minimise distortions of competition
within the EU’s Single Market.
The Commission has decided to propose this new FTT to (i) ensure
that the financial sector makes a fair contribution at a time of
fiscal consolidation in the Member States and (ii) to strengthen
the EU Single Market.
Nowadays 10 Member States already possess a FTT similar to the
one the Commission has proposed. However, this proposal seeks to
impose minimum tax rates and to harmonize the different taxes over
financial transactions that already exist in the Member States.
4. Definition of FTT
A FTT is a tax applied to financial transactions, usually at a
very low rate. A financial transaction applies for the exchange
of financial instruments ((securities, bonds, shares and derivatives)
between banks or other financial institutions.
The European Parliament (the “EP”) voted in favour of the Commission
proposal on 23 May 2012, and issued an opinion defending the need
to better design the FTT in order to capture more traders and make
evasion unprofitable. The EP, although presenting a series of amendments
to the proposal, considers that such proposal should be adopted,
even if it fails to be adopted by all Member States.
The Commission proposed minimum tax rates for the trading of the
bonds and shares of 0.1% and 0.01% for derivative products. The
EP considered such tax rates to be sufficient.
Based on the original proposal, the FTT was only based on a “residence
principle”. The transactions will be subjected to the FTT if at
least one party to the transaction is established in a Member State.
The EP imposed an “issuance principle” whereby financial institutions
located outside the EU would also be obliged to pay the FTT if they
traded securities originally issued within the EU.
5. Tax base
One of the major goals of the Commission and of EP is to prevent
the evasion to FTT, turning such an evasion more unprofitable than
to pay it, trough minimum tax rates. As such, the tax base proposed
by the Commission is very broad, aiming to reduce the risks of tax
evasion and dislocation of the markets. The tax rate above mentioned
is the minimum rate, although, all Member States will be free to
apply higher tax rates.
6. Benefits of the FTT
The Commission aims for the FTT to be applied in all 27 Member
States, with the purpose to contribute, like any other tax does,
to the public finances. As for the FTT, part of the revenue will
go to the EU budget and another part will help finance the budgets
of Member States. The Commission estimates that, at a rate of 0.1%
to bonds and shares and 0.01% for derivatives, the tax could raise
€ 57 Billion per year.
It is intended to benefit the companies and the citizens with the
FTT, through the increase in the public accounts, that can be utilised
to create economic growth and bring prosperity to the EU.
7. How will the FTT be charged?
The tax burden will fall on the financial institutions (banks,
investment companies, insurance companies, collective investments
undertakings and their managers, alternative investment funds such
as hedge funds and others). The FTT will be applied to all transactions
if at least one party to the transaction is established in a Member
State and to all financial institutions that trade securities originally
based within the EU.
The FTT will be paid immediately by financial institutions to Member
States on the basis of the transactions undertaken, before netting
8. Mitigation of the risk of the tax being passed on to
To prevent such an indirect risk, the Commission has proposed that
the FTT should cover only transactions where financial institutions
are involved, taxing only the financial sector, not their clients.
However, in case private households and enterprises were to purchase
or sell financial products, financial institutions could pass on
the tax, charging an amount for each transaction.
The Commission will be looking for excessive amounts charged by
financial institutions and will intervene if it happens.
Of an extreme importance is the fact that the transactions made
on the primary market are exempt from the FTT. This will prevent
investments that contribute to the real economy from being subject
to the tax.
9. Next steps
The EP has issued an opinion on the proposal and such amended proposal
was discussed by all Member States in the EU’s Council of Ministers
on 22 June 2012. The Commission will present it to the G20 Summit
in November 2012.
Even though some of the Member States are against the application
of a FTT, the Commission and the EU intend it to enter into force,
even if failing to do so in all Member States, envisaging an enhanced
It was proposed by the Commission and adopted by the EP that the
FTT will be adopted until 31 December 2013, entering in force on
1 January 2014.
Will the FTT solve speculation problems? Probably not, but it will
help and show to the meanest traders out there that regulation is
really possible, even to financial transactions.
Like the stories reported by Charles Mackay at the “Extraordinary
Popular Delusions and the Madness of Crowds” have shown us, men’s
social psychology and psychopathology is even more toxic than economics
and financial markets!
You have read it here: go on, run and tell the world!
Published - September 2012