By Shaan Devnani, Senior Economist, London Economics
The revised EC proposal for a financial transactions tax (FTT) landed on the desks of policymakers a year ago this month. However, the potential introduction of the tax in 11 Member States is a subject that is keenly debated today because, among other reasons, its effects are still not very well understood. To add to our understanding of the effects of the tax, we, London Economics, recently researched what its expected effects would be on household financial savings.
Financial assets are an important instrument for saving for European households, providing them with access to emergency funds and allowing them to build future retirement income.
Households save through various types of financial assets. In the UK for instance, life insurance and pension funds are important instruments for savings, making up over half of financial savings. Meanwhile, in Italy, 40% of household savings is invested directly in financial markets.
The EU proposal for a FTT covers secondary market transactions in a broad range of financial instruments. If introduced, the tax would affect the returns to financial savings households could achieve to the extent that the financial assets they trade (or are traded on their behalf by insurers or pension fund managers) attract the tax.
Specifically, we study the 'instantaneous price adjustment' of financial assets resulting from the tax: Part of the value of financial assets arises due to low transaction costs. With the introduction of a tax on transactions, this aspect of the value of financial assets would fall and be reflected in the price of financial assets. There exists a significant body of empirical evidence supporting the existence of instantaneous price adjustments. [1,2,3,4,5]
We capture the size of the instantaneous price adjustment on equity and debt securities by calculating the tax incidence on household portfolios of financial savings given current trading patterns. This is achieved by identifying the assets held in household portfolios using Eurostat and IMF data; and trading data from, among others, the Federation of European Securities Exchanges (FESE).
The results of the analysis show that the impact of the FTT on household savings is expected to be large in some Member States. In countries that plan to introduce the tax for example, among the countries studied, the impact is in the order of €80bn (Spain) to €200bn (Italy), representing a loss of as much as 15% of the value of the assets being taxed.
This is a multiple of annual household savings in some Member States. If the tax were introduced in Spain for example, households would have to save for an entire year in order to restore the value of their savings to their level prior to the introduction of the tax; in Italy, they would have to save for eighteen months.
The key results from our research are shown in table below for a selection of EU Member States. [6]
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Total impact of the FTT on household savings in equity and debt holdings
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Reduction in the value of equity and debt holdings |
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€bn |
Percentage of equity and debt holdings |
Percentage of GDP1 |
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Participating Member States |
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|
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Germany |
-150.6 |
-14.1% |
-5.8% |
|
Italy |
-204.9 |
-12.3% |
-13.0% |
|
Spain |
-79.6 |
-16.0% |
-7.6% |
|
Slovakia |
-0.1 |
-2.3% |
-0.1% |
|
Non-participating Member States |
|
|
|
|
United Kingdom |
-4.4 |
-0.6% |
-0.2% |
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Luxembourg |
-0.4 |
-2.2% |
-0.9% |
It is important to observe that this study considers the immediate effect of the introduction of the tax on savings. In the long-term, or, on an ongoing basis, savings may also be affected through other channels; for example, due to the effect the tax is expected to have on the cost of capital and in turn GDP, as discussed in previous research. [7]
The research is available to download for free from the City of London's research website.
[1] Jackson, P.D. and O’Donnell, A.T. (1985). The effects of stamp duty on equity transactions and prices in the UK stock exchange, Bank of England Discussion Paper, No. 25.
[2] Umlauf, S. (1993). Transaction taxes and the behaviour of the Swedish stock market, Journal of Financial Economics, 33, pp. 227-40.
[3] Saporta, V. and Kan, K. (1997). The effects of stamp duty on the level of volatility of UK equity prices, Bank of England Working Paper No. 74.
[4] Oxera (2007) Stamp duty: its impact and the benefits of its abolition, Report prepared for the ABI, City of London Corporation, IMA and London Stock Exchange, May.
[5] Best, M.C. and Kleven, H.J. (2013) Housing market responses to transaction taxes: evidence from notches and stimulus in the UK. Mimeo.
[6] Six Member States were chosen to reflect those intending to participate in the tax and those not intending to participate and to reflect a mix of sizes and geographies.
[7] 'The impact of a financial transaction tax on corporate and sovereign debt', City of London