A comprehensive tax on financial transactions once seemed like a pipe dream but is now only a few months and a general election away.
When asked at an event last week if he would support a new plan that would raise an estimated £7bn a year for the exchequer, the shadow chancellor, John McDonnell, had a one-word answer: yes. The proposals were unchallengeable, he said.
That’s not true, obviously. Labour’s plans for a financial transaction tax (FTT) were being challenged even as McDonnell spoke. The City has enormous lobbying power and the machine was quickly cranked into gear. The financial sector employs a million people, paid £75bn in tax last year and provides essential products such as pensions, mortgages and insurance, said Stephen Jones, the chief executive of UK Finance, the trade body for the financial sector.
“This proposed FTT is a tax on growth that will ultimately hit savers, homeowners and SMEs.”
However, McDonnell’s support for an FTT is longstanding. He used to urge Gordon Brown to introduce one in his days as chancellor, to no avail. The plan now being supported is a more ambitious version of the FTT proposal included in the 2017 manifesto. In the event of Labour winning the election, this will be one occasion when City lobbying falls on deaf ears.
Britain already has a financial transaction tax: the stamp duty paid when shares listed on the London Stock Exchange are traded. It is a nice little earner for the government, raking in £3.5bn in 2017-18, and one of the hardest of all taxes to avoid paying. The FTT McDonnell is supporting would cover a wider range of assets.
Opposition to the FTT is based on the principle that it would make markets less efficient. When in the 1970s the economist James Tobin came up with the idea of a tax on foreign exchange dealing, he talked about throwing sand in the wheels of the financial system. To market fundamentalists, this has to be a bad idea.
However, the real test of markets is not whether they are pure and efficient but whether they are effective. Financial markets have a pretty basic function: to take savings and turn them into productive investment in a way that keeps costs to consumers low and makes the economy safer and more sustainable. As currently constituted, the UK financial system does the opposite of all that.
Over recent decades there has been an explosion of short-term trading, some of which – the hedging of foreign currency risk, for example – can be beneficial but most of which falls into the category of shuffling bits of paper around. The churning of assets has made plenty of people in the City extremely rich but has not led to any discernible benefits for the non-financial sector of the economy.
More churn has meant more short-termism
The cost of raising finance is the same as it was in the late 19th century; all the gains from technology and economies of scale have been grabbed by producers rather than consumers. As the crash of 2008 showed, the arrival of “fast finance”, with all the herd-like behaviour that involved, did not make the financial system safer; it made it more vulnerable. And the UK has the lowest investment rate of any country in the G7 group of industrial nations. McDonnell nailed it when he asked: “Why is it that we have such a large finance sector and yet are starved of long-term finance?”
Well, one reason is that transactions by long-term investors such as pension funds and insurance companies once represented more than 70% of turnover on the London Stock Exchange. Now it is 40%. More churn has meant more short-termism.
FTTs are a modest antidote to that because they are fees – levied at a fraction of 1% – on each and every transaction. In the plan McDonnell is proposing, a financial firm would pay 0.01% for each interest-rate derivatives transaction. The idea is to raise the cost of short-term churning relative to holding assets for longer.
But wouldn’t an FTT be avoided? Wouldn’t all those hedge funds merely do their business in New York or Zurich?
It seems unlikely because Labour’s FTT plan includes a residence principle. Tax liability depends on the beneficial owner of an asset following purchase being a UK resident. So moving the transactions offshore would not allow individuals to avoid the tax. To do so, they would have to stop residing in the UK and the proposed tax rates are almost certainly too low to provide an incentive to do that. What’s more, some of the transactions that would be covered by McDonnell’s plan are already subject to an FTT in other jurisdictions, including Switzerland and the US.
The City is also suffering from cognitive dissonance. Memories of the financial crisis are long and bitter. According to opinion polls, a majority for every party thinks the City does not contribute sufficiently to the wider UK economy. Fewer than one in six voters think the financial sector could not afford to pay more tax.
Jean-Baptiste Colbert, the finance minister to Louis XIV, once said: “The art of taxation consists in so plucking the goose as to procure the largest quantity of feathers with the least possible amount of hissing” – a comment that sums up McDonnell’s approach to an FTT.
The shadow chancellor mentioned last week some of the things that Labour could do with the £35bn that an FTT could raise in the course of a five-year parliament: putting it towards retrofitting homes, so that they are carbon neutral, or on a major expansion of wind and solar power. The public will like that. Outside of the City, there won’t be a lot of hissing.