Taxation of the financial sector

The 2008 financial crisis revealed the instability of the financial sector. It now appears crucial to consolidate the sector and to generate revenue which could be used for climate change financing or to provide aid to developing countries. In this context, the European Union (EU) is assessing two tax instruments which could generate revenue if implemented on a large scale.

ACT

Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions of 7 October 2010 – Taxation of the Financial Sector [COM(2010) 549 final – Not published in the Official Journal].

SUMMARY

This Communication proposes further exploration of two tax instruments which could be applied to the financial sector:

• Financial Transactions Tax (FTT);
• Financial Activities Tax (FAT).

Why are new taxes on the financial sector required?

The financial sector is regarded as one of the main sectors responsible for the 2008 crisis, particularly for the considerable growth in government debt in the world. As a result, the European Commission believes that the application of specific taxes to this sector could have the following positive effects:

• these taxes could complement the essential regulatory measures which aim at enhancing the efficiency and stability of financial markets and reducing their volatility;
• these taxes would enable the financial sector to contribute to national budgets in return for the support they received during the crisis;
• these taxes could enable the financial sector to contribute more to public finances given that the majority of financial services are exempt from Value Added Tax (VAT) in the European Union (EU).

What is the Financial Transations Tax (FTT)?

The FTT would tax the value of each transaction relating to:

• equities;
• bonds;
• currencies;
• derivatives.

According to an estimate based on 2006 figures, if this tax had been implemented in that year, the tax revenues would have been around EUR 60 billion, with a rate of 0.1 % on stocks and bonds transactions.

The advantage of such a tax might lie in the application of the ‘polluter pays’ principle. This tax could reduce ‘undesirable’ operations by penalising short-term transactions. However, it would need to be applied by several financial centres in the world in order to achieve market stability and prevent relocations. For these reasons, the Commission believes that a global FTT would be the most appropriate.

What is the Financial Activities Tax (FAT)?

The FAT is an instrument which has been proposed by the International Monetary Fund (IMF). It has the following elements:

• in principle it falls on total profit and wages;
• it can be designed to specifically target economic rents and/or risk;
• it taxes corporations.

The implementation of this tax, with a rate of 5 %, by the 22 ‘developed economies’ identified in the IMF report to the G-20, could generate the equivalent of 0.28 % of their GDP. At EU level, the tax revenues could be EUR 25 billion.

In principle, the FAT does not change the prices of financial instruments and does not affect the market structure. However, it could encourage profit shifting via relocating income and remuneration outside the EU. Certain technical aspects of this tax still need to be examined further in order to avoid such practices. The Commission believes that the implementation of the FAT would be more relevant at EU level.

Context

In its Resolution on financial transaction taxes of 10 March 2010, the European Parliament asked the Commission and Council to look at how a financial transaction tax could be used to finance development cooperation, help developing countries to combat climate change and contribute to the EU budget. In June 2010, the European Council insisted on the leading role that the EU should take in this area as part of a global strategy. However, there is currently no global consensus on additional tax instruments in the financial sector.

Last updated: 13.01.2011