Eleven member countries of the European Commission are planning to introduce a financial transactions tax in 2016. If it takes effect as planned, the tax could cost pension funds, not only in Europe but also in North America, billions of dollars every year.
Based on previous experience with such taxes, the proposal likely would produce neither the expected revenue, nor the elimination of trading abuses it is designed to do.
Rather, it is likely to disrupt investment strategies by institutional investors within and outside the 11 countries.
Because of this disruption alone, executives at pension funds and other institutional investors, especially the U.S. and the United Kingdom, should press the European Commission to abandon the tax by pointing out it will deter investment in or through their markets.
The 11 countries developing the tax would impose charges on financial activity, including a 0.1% levy on stock and bond transactions and a 0.01% levy on derivatives trades. The tax would be imposed on every part of an equity, bond or derivative trade that touches one of the participating countries.
The financial transactions tax could impose costs of more than $7 billion a year on U.S. money market funds alone if they continued to trade European securities at the 2012 level, according to an estimate by the Investment Company Institute. But it is unlikely money market funds would continue to trade in such a way with such a tax.
The FTT, as it is known, represents the latest iteration of an idea that is in effect in Italy and France. It has been tried previously, with ineffectual results, in several other countries, including Sweden, which found the revenue generated disappointing and completely offset by the loss of capital gains tax revenue as equity investing plunged.
At the very least, executives at pension funds, endowments and foundations should campaign strongly for an exemption for tax-exempt investors, and even many sovereign wealth funds, because of their social purpose and observance of high standards of fiduciary responsibility.
With their long-term investment horizons, pension funds and other institutional asset owners bring stability to the markets and serve to temper trading and investment strategies that add to market volatility.
Pension funds and other institutional investors, especially in the U.S. and other markets outside Europe, should point out to the European Commission that such a tax would reduce the return from investments that touch their markets, making such investments and their markets less competitive.
But the European transaction tax isn't the only one looming for investors.
In the U.S., pension funds and other investors face the Wall Street Trading and Speculators Tax Act. It was introduced Feb. 28, 2013, as S.B. 410 and H.B. 880 by, respectively, Sen. Tom Harkin, D-Iowa, and Rep. Peter DeFazio, D-Ore. In addition, S.B. 277 was introduced Feb. 11 that same year by Sen. Sheldon Whitehouse, D-R.I. All three versions would impose a 0.03% tax on trading in equities, fixed income and derivatives, including futures, forwards, options and swaps, as well as derivatives in currencies and commodities.
The low tax rate, coupled with a high volume of transactions that occurs in trading, makes the tax attractive to proponents who believe few investors will feel the pinch paying a relatively tiny amount.
Showing his ignorance as to how markets work, Mr. Harkin declared, while introducing his transactions tax proposal: “There is no question that Wall Street can easily bear this modest tax.” But investors, not Wall Street or the equivalent in the 11 European countries, will bear the tax.
The Chicago Teachers Union has embraced the concept, calling for a transactions tax on financial trading at the Chicago exchanges to shore up the gap in funding for the Chicago Public School Teachers' Pension & Retirement Fund and other public pension plans in the state. Such a tax could raise $12 billion a year, according to a CTU quoted estimate. Casting aside any impact of such a tax, Karen Lewis, CTU president, was quoted as saying “You and I pay more on takeout orders at McDonald's.”
National Nurses United, a nurses union, calls for a global financial transactions tax to promote sustainable development and strengthen public services. In the U.S., it proposes a 50-cent tax on every $100 in Wall Street trades, estimating it would raise $350 billion a year.
Even exempting pension funds and other asset owners would still lead to the imposition of indirect costs on them for transaction taxes paid directly by other investors.
In fact, an exemption would create costly administrative complexity as investment management firms with, say, commingled funds have to sort out transactions to comply with the tax and any exceptions to it. This administrative task adds to investment management firms' costs.
In addition, the tax likely will drive European and U.S. trading outside the domestic markets to more favorable markets. In turn, non-European and non-U.S. investors would be reluctant to trade in the transaction tax markets because of the additional costs.
The proposed U.S. transaction tax is still in committee. Depending on the outcome of the congressional elections in November, a new Congress bent on raising further revenue could pass such a tax.
U.S. institutional investors should begin right now to campaign against the proposed U.S. transactions tax, and the coming European tax.
They should fight this tax as costly to market participants and a misguided way to raise revenue or to deter trading abuses.
U.K. officials took the right course. They rejected the FTT. And realizing the impact on U.K. investors, they challenged it in court. The European Court of Justice denied the challenge.
”The FTT is not the best way to reduce excess risks or tackle bad behavior in the markets,” James Walsh, policy lead, EU and international, for the U.K.'s National Association of Pension Funds, was quoted as saying in P&I after the April 30 European court ruling.
“In addition, the cost of this tax would undoubtedly be passed on to the millions of private savers and pension scheme members in the U.K. by the financial institutions and banks that manage their investments.”
The NAPF has estimated the tax could cost European pension funds e4 trillion a year.
The toll — whether by the European pension fund or the U.S. money market estimate — would be considerable. To put it in perspective, total contributions to defined benefit pension plans of companies in the Standard & Poor's 1500 was an estimated $70 billion in 2012.
The impact on the losses from the tax would force corporate pension plan sponsors to raise contributions, funding them through a combination of means that could include wage cuts and price increases, and public plan sponsors to do so through some combination that includes tax increases.
They should fight this tax as costly to market participants and a misguided way to raise revenue or to deter trading abuses.
