How did France's Robin Hood Tax work out?
Back in 2011 and 2012 I wrote quite a bit about the financial transaction tax (FTT) that was being proposed by the EU, and which is now being proposed by Labour. We have a FTT on shares in Britain in the form of stamp duty, but now Labour want to impose it on other financial assets too.
An FTT is a tax, usually a fraction of a percent, on trades of financial assets. It’s sometimes referred to as a Tobin Tax and is intended by its advocates to reduce high-frequency trading which, they claim, adds random noise to market prices and increases volatility.
In this sense the tax may be efficiency-raising in that it shifts costs these traders impose on others onto those traders themselves. However, if high-frequency trading is not mostly based on randomness, as Sam Dumitriu argues here, then curbing it will slow down the incorporation of new information to market prices, increasing market volatility and making markets less efficient.
FTTs are also sometimes referred to as ‘Robin Hood Taxes’ by people who think they will raise lots of money. Some of these people look at the total volume of a market and presume that taking 0.5% of that will not reduce the volume of trading very much. This is somewhat at odds with the other case for the tax – if it changes behaviour it won’t raise much money, if it raises much money it won’t reduce the supposed negative externalities that high-frequency trading creates.
The EU still has not implemented a Eurozone-wide one. France, however, did introduce a 0.2% tax on purchases of shares in any publicly traded company with a market cap above €1bn (£789m), on “naked” short sales of sovereign credit default swaps, and on some high-frequency trading. It included several provisions that made it less restrictive than a true FTT, including a rebate scheme for trades of the most liquid shares and for intraday trading. Still, we can look at this to see what the impact of stamp duty on shares might be in Britain, and what extending this to other assets might be.
At the time I pointed to the empirical evidence and warned that France’s tax could reduce market liquidity and raise volatility, and not raise very much money either. Sweden introduced a financial transaction tax in the 1980s which ended up raising one-fortieth of what its backers had promised, drove many exchanges to London, and was abandoned after less than ten years. I reckoned that France would see many similar results.
Five years on, what have been the consequences of France’s transaction tax? A recent European Central Bank paper looked at the impacts on French equity markets, and for the most part it concludes that the outcomes of the tax were quite bad.
Market liquidity fell a lot, by 20% for affected stocks. Revenues were much lower than anticipated – an estimated €475m instead of the €1.6bn that had been predicted – “which once again points at an underestimation of the impact on revenue-generating market activity”.
Importantly, volatility rose and price efficiency fell, even though the tax exempted intraday trading (allowing “short-term arbitrageurs to continue eliminating price inefficiencies quickly”). Though the overall effect was small (but statistically significant), the rebate scheme masked a large effect on volatility in shares that were exempt.
The paper’s authors conclude that the French FTT had an overall negative impact on market quality, where reducing market liquidity led to less efficient pricing of assets and more volatile price movements, and effectively priced high-frequency trading out of existence altogether in affected shares. “The decrease in volume associated with the FTT hurt liquidity and crowded out “useful” trades.”
In order words, as I said in 2012:
“High-frequency trading allows markets to be highly sensitive to new information and to intermediate between buyers and sellers who may not be in the market at the same time. Stopping high-frequency trading would have the effect of making price shifts more sudden, unpredictable and large.”
More volatile markets are riskier ones, so the cost of investing is higher and you get less of it. We don’t want that. All of this should make us treat a British FTT with extreme caution, and indeed make us consider abolishing stamp duty on shares instead of extending it to other parts of the market.
PS: I can’t resist pointing out my other prediction, about a man whose approval ratings eventually fell to 4% and whose party now seems to be on its deathbed: “Along with policies like the 75 per cent upper tax rate Hollande proposed during the election, the French may soon regret electing their blundering new President.”