The effect of a FTT on market volatility and revenues
Bachelor Thesis Economie en Bedrijfskunde
Marty Pellikaan
Studentnummer: 5800374
Begeleider: Damiaan Chen
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Statement of Originality
This document is written by Student Marty Pellikaan who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents
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Table of Contents
1. Introduction ... 4
2. Literature Analysis of the effect of a FTT on volatility ... 6
2.1 The current Debate ... 6
2.2 Evidence from theoretical models ... 7
2.3 Empirical evidence ... 11
3. FTT effect on Revenues ... 13
3.1 Revenues Sweden case ... 13
3.2 Revenues France case ... 14
3.3 Review FTT revenues from European Commission proposal ... 15
4. Conclusion ... 17
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1. Introduction
There has been a lot of discussion about implementing a financial transaction tax (FTT) for all EU member states. The implementation of a FTT was proposed by José Manual Barroso, the president of the European Commission, in order to reduce excess market volatility and raise direct revenue for the EU. Although many countries support his proposal, most notably France and Germany, it has met with tough opposition from the United Kingdom, Sweden and more recently, the Netherlands. Most used argument against implementation is the concern over the potential loss of competitiveness of their nations financial sectors. The UK supports this concern, but they are willing to adopt the tax only if it is implemented worldwide. The Dutch government announced that it will continue to block the proposal until certain conditions are met, of which the most important one is that pension funds are excluded from taxation. Sweden’s opposition comes from a more personal note, they had introduced a comparable FTT in the past, that ultimately resulted in an exodus of capital from their financial sector. The initial implementation date would have been 1 January 2014, but it was postponed, due to the heavy opposition, to 1 January 2016. Currently only 11 euro-area countries are willing to implement the tax .
The discussion about FTT implementation is not exclusively being held in Europe. In America, different FTT bills have been proposed in Congress since 2009, but till this day none of the bills have passed. Many non-governmental organizations (NGOs) have launched campaigns to introduce the so called ‘Robin Hood tax’, a tax on financial transactions to raise funds to protect public services and to tackle poverty and climate change. Currently no such tax is in effect.
A financial transaction tax has 4 types:
Securities transaction tax
Currency transaction tax
Bank transaction tax
Automated transaction tax
The proposed tax is mainly a securities transaction tax, impacting financial transactions between financial institution, by charging 0.1% on the trade of shares and bonds and 0.01% across derivatives contracts. The tax would have to be paid if just one of the financial institutions resides in a member state who adopted the tax.
The idea behind the tax is that excess volatility in financial markets is being caused by short term speculators. By implementing a small FTT, speculative behavior is discouraged and excess volatility
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would gradually diminish (Tobin, 1978). Excess volatility is that part of price variability that cannot be justified by changes in fundamental values. In this study we assume that excess volatility is all kinds of deviation from the fundamental equilibrium price. The tax can be imposed on the trade of bonds, stocks, derivatives and foreign exchange currency. It is generally small, between 0.01% and 0.1%.
The main aim of this study is to investigate whether the proposed financial tax is indeed successful in both reducing volatility and generating revenue.
In this paper, we will explore what the effects will be when a FTT is implemented. We will focus on the two objectives specified by the European Commission. First we will look at the effect on market volatility. We will review the results of several theoretical models, using a heterogeneous agent model, that examines the effect of a FTT on volatility, and compare the results gathered with the evidence gathered from the empirical literature. The empirical literature consists of three case studies of country’s who have or had implemented a FTT (Sweden, UK and France).
Then we will focus on the second objective of the tax, the revenue collection potential. We will again look at Sweden and France who implemented a FTT, and see how much revenue they raised. And we will look at the potential negative aspects, such as capital outflow due to tax evasion. To conclude our study, we will examine at how much revenue a FTT will raise if its implemented according to the European Commission’s proposal, and review if these findings are realistic.
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2. Literature Analysis of the effect of a FTT on volatility
In this section we will study the effect a FTT has on volatility. First we start with examining the opposing views of two groups on this effect, then we will turn to evidence resulting from theoretical models. We will conclude this section by comparing the results of the theoretical models to the empirical evidence.
2.1 The current Debate
Most media call the FTT also the Tobin tax, because of the similarity between the two. Tobin (1978) wanted to improve the autonomy of macroeconomic policy by reducing international currency speculation and its negative effect on national exchange rates. According to his theory, there is excessive liquidity in financial asset markets due to a large amount of short-term speculation. In his paper, Tobin argues that speculation causes prices to often move away from their fundamental equilibrium values, and thus causing a destabilizing effect in the medium to long run. By introducing a small uniform tax per transaction, the cost of speculative trading rises the shorter their time horizon is. Tobin concluded that a transaction tax would reduce speculative activity and lead to a stabilizing effect on asset prices. Although only playing a minor role in the original Tobin tax proposal, the tax could create considerable revenues to be used by governments as they see fit. Due to the recent financial crisis aftermath, the revenue creating component of the tax only increased in importance. Although Tobin is labelled as inventor of the theory behind the tax, he was not the first one to come up with this theory. Keynes (1936) argued in the General Theory that speculation can have adverse effect on the real economic outcomes. According to Keynes, public access to financial markets should be “inaccessible and expensive”, suggesting that the “introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the dominance of speculation over enterprise in the United States”(Keynes 1936).
The critics of a FTT implicitly reject the idea of any FTT because it conflicts with their most fundamental assumptions, such as market efficiency and rational expectations theory. Friedman (1953) argued that speculative behavior could not be destabilizing in general, because if it were, the persons involved would lose money. “People who argue that speculation is generally destabilizing
seldom realize that this is largely equivalent to saying that speculators lose money, since speculation can be destabilizing in general only if speculators on the average sell when currency is low in price and buy when it is high” (Friedman, 1953). According to Friedman’s reasoning, if there are
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destabilizing (irrational) people who sell financial commodities when cheap (driving prices lower) , or buy when financial commodities are expensive (driving prices higher), this behavior will cost them their money and drive them out of the market. Only (rational) speculators who buy low and sell high can survive in the market. Concluding Friedman’s reasoning, markets are (more) stable even when speculation is in play. Another point critics raise is that a FTT increases transaction costs. Not only speculators will face the burden of a tax but all traders. Therefore, trading volumes will decline leading to a drop in liquidity. Lower liquidity can have a negative effect on the market and increasing its volatility (Schwert & Seguin, 1993). Another argument against the introduction of such a tax is the difficulty of its implementation, in particular taxes on international transactions. Higher transaction costs will create an incentive for financial market participants to find ways to circumvent the tax, leading to capital outflow to regions not subjected to the tax (ECB, 2004).
2.2 Evidence from theoretical models
Clearly there are opposing views of the impact of a FFT ultimately has on volatility. In order to get a clear view we will examine different theoretical models, created by various different authors, in the hope to reach a conclusion on the effect of the tax on volatility. There are two theories that describe how assets are priced in financial markets, the efficient market hypothesis (EMH) and the inefficient market hypothesis. According to the EMH all financial assets are accurately priced and therefore there are no opportunities for investors to beat the market because the price already reflects all relevant information. Implementing a tax in a perfectly efficient market will therefore have no effect on volatility because prices do not deviate from their fundamental value. The inefficient market theory states that certain market forces work to deviate the price from their fundamental value. One of those market forces that causes prices to deviate from their fundamental value is noise trading (De Long et al, 1990). Assuming markets are inefficient, a FTT can have an impact on volatility as we will now discuss.
Most of the following theoretical models are based on the Heterogeneous Agent Model (HAM), so before we dive into the research, we first need to discuss what the HAM entails. HAMs used in economics and finance assume the existence of at least two different types of traders. The two most common are ‘fundamentalists’, who base their expectations of future asset prices and their trading strategies upon market fundamentals and economic factors. They use for example dividends, earnings, unemployment rates, macroeconomic growth, etc. to predict future prices. They also tend to invest in assets that are undervalued and sell when they are overvalued. The other type of traders are called ‘chartist traders’ or ‘noise traders’. ‘Noise trader’ as a financial term was first introduced by Kyle (1985) and Black (1986), referring to a stock traders who lacks access to inside information
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and makes irrational investment decisions. They do not take market fundamentals into account but instead use observed historical patterns in past prices to form expectations about future asset prices. Noise refers to the constant changes in market volumes and prices that causes investors to become confused about the market’s direction. Noise traders usually jump on the bandwagon and try to react quickly when they think noise is driving the market in a certain direction. Therefore they can make poor decisions by overreacting to good or bad news. Noise traders’ behavior usually have a short-term effect on the market, due to the constant buying and selling done by these investors, causing an increase of price volatility (De Long, 1990). In very specific cases noise trading can have long term effects. If enough noise traders jump on the same bandwagon due to a certain noise in the market, this can lead to the creation and burst of a bubble. The assumption is that the volatility of the market depends on the share of market traders that are noise traders relative to the share that are fundamentalist. The higher the share of noise (fundamentalist) traders in the market, the higher (lower) the volatility will be.
Westerhoff (2008) developed a model using heterogeneous interacting agents. In his framework, market participants were free to engage in speculative activity. Traders had 3 options: predict asset prices on the basis of technical (noise trader) or fundamental analysis or abstain from the market. Traders based their actions on profit considerations but were also influenced by their social
environment. He found that introducing a FTT had the potential to reduce volatility and distortions. The introduction of a small transaction tax, crowds out both chartists and fundamentalists. Since the profitability of trading declined, speculators began to leave the market, leading to a decline in volatility. Westerhoff noted that if the tax exceeded a certain critical value, the reduction of the number of fundamentalists causes asset prices to deviate from their fundamental value. Due to the emergence of bubbles, the chartist trading behavior becomes more profitable leading to a rise in volatility. Westerhoff and Dieci (2006) expanded the model by adding another market. Agents had now five options to choose from; abstain, or apply technical or fundamental analysis in either market 1 or 2. Their results show that the introduction of tax rate of 0.25% reduces distortions and volatility in the taxed market, the untaxed market however experiences stronger bubbles and higher volatility. Westerhoff and Dieci conclude that due to the tax in market 1 , some agents abstain from trading and some destabilizing speculators migrate from market 1 to market 2, leading to a higher volatility in the latter market. But if agents have to pay a uniform tax in markets 1 and 2, chartist behavior drops in favor of fundamentalism in both markets, leading to lower price fluctuation and deviations from fundamentals.
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Ehrenstein (2002) used the microscopic herding model of Cont and Bouchaud (2000) to investigate the impact of a FFT on volatility, market distortions and government revenue, by increasing the size of the tax from 0 to 1 percent. Overall they find that a transaction tax can stabilize financial markets, but care should be taken in choosing the level of the tax rate. As long as the tax is not too high to significantly reduce market liquidity, the tax will reduce volatility. In their model, a tax rate of 0.2 percent or higher starts to destabilize the market , meaning that both volatility and distortion increases.
Shi and Xu (2009) analyzed the effect of a FTT on exchange rate volatility. The idea follows the HAM, that volatility is caused by changes in the relative share of fundamentalist and noise traders. The authors note that to understand the effect of a FTT on exchange rate volatility , it is important to investigate their effects in a model where the activity of both types of traders are effected. A key assumption they use is that informed (fundamentalist) traders’ unconditional expectation of excess return depends on the ‘noise component’. The noise component is the ratio of noise entrants to informed entrants. But this ratio does not influence noise trader’s expectations. As a result, the relative noise component affects the gross benefit of entry differently for the informed traders than for the noise traders. Since this effect works through expectations of traders, the authors call this the ‘asymmetric expectation effect’. They find when the entry decisions of all traders are endogenous, three different outcomes can occur.
When the relative noise component equals 1, meaning there are the same number of noise and informed entrants, all traders form their expectations in the same way. A FTT then increases the entry costs, causing both types of traders to leave the market in pairs. The composition of traders does not change, so volatility is not affected, but the overall market volume decreases.
The second outcome occurs when entry costs , are sufficiently high to prevent the entry of noise traders. The presence of asymmetric expectation effect implies that the entry benefit of the
informed traders will be higher than that of the noise traders. This will lead to an equilibrium where all the noise traders leave the market. So introducing a tax will have no effect on volatility because the relative noise component remains unchanged.
The third outcome occurs when the noise component ≠ 1. When entry costs are increased due to the tax, the asymmetry in expectations causes a larger reduction in benefits of entry for the informed trader compared to the noise trader. The composition of traders changes, leading to an increasing of the noise component and thus volatility. The findings are surprising, their results show us that imposing a transaction tax may not effect volatility or may even increase it.
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Markus Haberer (2004) created a model explaining the potential effect of a FTT on volatility in a perfectly efficient market and in an inefficient market. The model assumes that in a perfectly
efficient market setting, market participants are fully rational, homogenous and completely informed about the structure of the model and the behavior of relevant fundamentals. In contrast to the efficient market hypothesis, prices do not immediately jump into a new equilibrium but follow an approximation path. According to Haberer, this is because the participants do not know about the expectations of others. So in this framework, liquidity is the only factor that causes the price to move back to equilibrium. In Figure 1 line X-X shows this. The higher the market liquidity the lower the excess volatility will be and the closer the price will be to its fundamental value.
Figure 1: Haberer 2004, pp15
The inefficient market, consists of heterogeneous participants. Fundamentalists who do not contribute to volatility and chartists or noise traders who do. In this market higher liquidity due to speculation increases volatility. Line YN-YN shows this relation. By combining both markets we end up
with line Z-Z and see a U shape relationship between market liquidity and excess volatility. Haberer concludes that introducing a transaction tax could have two different outcomes depending on the market liquidity. A transaction tax in a low liquidity market would increase volatility, but in a highly
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liquid market such a tax would lead to a reduction of volatility by reducing the incentives for speculative trading.
2.3 Empirical evidence
Although theoretical models are helpful in offering insights in how a tax might affect volatility, we cannot be sure that real financial markets will behave in a similar manner. Therefore it is time to examine the empirical evidence. We will review three countries who had (Sweden) or have (UK and France) implemented a FTT. The FTT Sweden introduced in the 1980s provides an ideal setting for a controlled laboratory style experiment to investigate how the tax effected stock market behavior. In 1984 a 1% round-trip tax (0.5% on the sale and 0.5% on the purchase) was imposed by Sweden on equity transactions. In 1986 the equity transaction tax was increased to 2%. By 1991 the tax was already abolished completely due to a massive loss of trading volume. It must be noted that the motivation of the tax were largely political. The tax was implemented foremost as a political
appeasement towards the labor sector, the potential benefit of volatility reduction was considered to be a secondary concern. Umlauf (1993) examined the variation in stock market behavior across the three (0, 1%, 2%) tax regimes and attempts to isolate the empirical effect of the tax. Umlauf’s data consists of continuously compounded daily and weekly Swedish all-share equity index returns for the 1980-1987 period. He then compares the weekly and daily returns under the three tax regimes. He finds that there was not a significant difference in weekly variance across the three tax regimes. However there was a statistically significant increase in the daily variance of returns. Moreover, the daily variance increased when moving on to a higher tax regime. In his paper, Umlauf also attempts to estimate the impact of the tax by calculating the ratio of the volatility of London and Swedish traded share classes. This was possible because some stocks of Swedish firms were also being traded in London. If the ratio starts to diminish after introduction of the tax, it would suggest that volatility increases in the taxed market. Umlauf used 11 companies that were being traded in both countries, he found that the average reduction of the ratio was 6% on a daily basis and 2% on a weekly basis. This shows, contrary to belief, that an implementation and an increase of a FTT leads to a rise of the volatility in the taxed market.
The united kingdom also implemented a tax on securities. This tax is more commonly known as the ‘stamp duty’ tax. It was first introduced in 1963. In the beginning the exchange of a financial
instrument could only be made effective by an official stamp applied to the instrument. Currently the official name is the Stamp Duty Reserve Tax (SDRT). The tax, in contrast to the Sweden case, is an internationally applied tax on domestically registered companies. The tax only applies on share transactions of UK incorporated companies. The stamp duty tax rate has varied over the years. The
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tax rate began at 1% and was increased to 2% in 1974. It was reduced back to 1% in 1984, and again reduced in 1986 to the rate currently being applied at 0.5%. Saporta and Kan (1997) analyzed the effects of the UK stamp duty on market volatility for the period 1969 and 1996. In order to isolate the effect on volatility, they compared two instruments which are identical except for the levied stamp duty. They choose to compare the variance of return of four companies listed on the London Stock Exchange (treatment group) to the return variance of their corresponding American Depositary Receipts (ADRs) listed on a US exchange (control group). As a research methodology they used an univariate GARCH model. The generalized autoregressive conditional heteroscedasticity (GARCH) is a tool often used to estimate volatility in financial markets. Although Saporta and Kan find that
volatility slightly increased during the 2% tax regime compared to its ADR counterpart, their findings however show that there is no statistically significant effect of the UK stamp duty on market volatility during the different tax regimes.
France introduced a FTT in August of 2012. The tax was only imposed on stock purchases of French publicly traded companies, of which the company’s market value was over €1 billion. The tax rate was 0.2% and has not been changed since it has been introduced. In their paper, Blancard and Havrylchyk (2013) assessed the impact the FTT had on France’s market liquidity and volatility. Due to the tax only being imposed on large French firms, of which all of them were listed on Euronext, they used smaller French and foreign firms, who were also listed on Euronext, as control groups. Their sample data consisted out of 244 firms (about 1/3 of which are subjected to taxation) observed over a 12 months period, 6 months before introduction and 6 months after introduction of the tax. As a statistical technique they used a difference-in-difference (DiD) approach to isolate the impact of the tax from other economical occurrences during the researched period. Using their methodology, Blancard and Havrylchyk find no evidence that a FTT decreases market volatility by reducing
speculative behavior. Furthermore they conclude that, in the observed period, there is no significant effect on market volatility and even liquidity. The authors note that the reason market liquidity was not affected, is due to the way the tax could not be easily avoided, contrary to what we have seen in Sweden .
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3. FTT effect on Revenues
When a tax is imposed on a market, the cost of each transaction naturally increases. This might incite tax avoidance behavior on the part of the investor. If and how much tax avoidance occurs depends on several points. The size of the tax, potential substitution options, or the costs of migration. Thus in responds to the introduction of a FTT, investors face different behavior options
They continue trading and pay the tax
Trade substitute securities who currently are not being taxed
Change the location of the trade to an area not subjected to the tax (migration)
Or choose not to trade and leave the market
McCulloch and Pacillo (2011) studied the effect a transaction tax can have on the reduction of market volume, for data they used different models that specify how the tax base responds to tax rate increases. This led to the figure below. A rather clear patterns emerges, showing a positive relation between tax increase and reduction of volume.
Figure 2 Source: McCulloch and Pacillo, 2011 pp.47
3.1 Revenues Sweden case
If the taxable trading volumes fall, so will the revenues from capital gains taxes. When the drop is too high, it can entirely offset the revenues collected from the transaction tax. This was the case with Sweden in the 1980’s. As discussed in the previous section, Sweden introduced a transaction tax in
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1984 of 1% and increased it to 2% in 1986. The tax applied to all equity security trades in Sweden using local brokerage services as well as to stock options. In 1990 Sweden started to dismantle the FTT and by the end of 1991 the tax was completely abolished. There were various reasons why the tax was abandoned. Before the tax was imposed, it was expected that revenues would be about 1.5 billion Swedish Krona (SEK) per year. The results proved to be very disappointing, with an average revenue collected of around 50 million SEK per year (Umlauf, 1993). As already hinted, trade volumes also fell dramatically, especially when the tax was raised to 2%. Ironically the tax increase was
imposed to raise more revenue, but due to the reduction in capital gains taxes, the net effect was close to zero. According to Umlauf, the most important aspect in the downfall of the tax was the rapid decline in trading volume. When the tax rate stood at 2%, 60% of the trading volume of the 11 most actively traded Swedish share classes migrated to London to avoid taxes. In the end it can be concluded that the Swedish implementation of a FFT was a failure. Schulmeister (2009) points out that the FFT failed due to bad tax design. Avoiding the tax involved only using a foreign broker services , which explains the resulting migration of trading volume.
3.2 Revenues France case
France introduced a 0.2% tax rate on the transfer of shares of listed companies established in France with a market value of at least € 1 billion. According to estimates of the French government, the tax should have yielded around €0.53 billion in the remaining months (August-December) of 2012 and a €1.6 billion in 2013. The raised revenues proved to be less than expected, €0.2 billion in 2012 and only €0.53 billion in 2013. Based on the 2013 result, the French government adjusted the estimate downward by fifty percent. Due to the reduction of expectations, the tax revenue almost raised its targeted value, by collecting €0.70 billion in 2014. According to Blancard and Havrylchyk (2014) the difference in expected and actual raised revenue was caused by the reduction in stock market trading, of around 19%, because of the tax implementation. Due to way the tax was designed, the tax was not easily avoidable. Large capital outflow, as we have seen with the Sweden experience, were not witnessed. This concurs with the findings of Blancard and Havrylchyk that there was no evidence that market liquidity was affected. This means that the tax base remained stable and revenues collected by the FTT were not offset by a loss in capital gains tax revenues.
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3.3 Review FTT revenues from European Commission proposal
The second motivation of implementing the tax was to generate substantial revenue. This section will investigate how much revenue the tax might raise based on the assumptions the European
Commission used. Due to different assumptions, calculating the potential revenue will be very ambiguous. As discussed, to evaluate the potential revenues to be raised, one has to take into account the tax base, the tax rate and the effect on volume reduction caused by introducing the tax. In order to make tax evasion unprofitable the tax incorporates the ‘issuance principle’, whereby financial institutions outside the participating FTT countries would also be obligated to pay the tax if they traded financial assets originally issued within one of the participating countries. Another crucial component of the tax in reducing the risk of tax avoidance is the ‘residence principle’. This means that financial products issued outside the FTT adopting countries but subsequently traded by at least one financial institution that lies within the participating countries, the transaction tax would have to be paid.
In the original proposal the European Commission (2011) estimated to raise around 57 billion euro annually, but this figure took into consideration that all 27 EU countries would take part in adopting the tax. As mentioned in the introduction, only 11 countries are currently willing to participate. The European Commission (2013) estimates that the EU-11 will raise between 30 and 35 billion euro per year.
Table: Revenue estimations in billions Euros
EU27 EU11 Securities 19.4 13.0 -Shares 6.8 4.6 -Bonds 12.6 8.4 Derivatives 37.7 21.0 -Equity linked 3.3 1.8
-Equity rate linked 29.6 16.5
-Currency linked 4.8 2.7
Total 57.1 34
Table 1 Source: European Commission Impact Assessment, 2013 pp. 24
In order to reach the above revenue estimates, they used the following formula for each financial product:
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where τ is the tax rate, V is the annual transaction volume, E is interpreted as relocation and fiscal evasion, c describes the transaction costs in percent of the transaction volume and ε is an elasticity which describes the effect of a tax increase on the transaction volume, i.e. the tax base.
Nerudová and Dvořáková (2014) reviewed how much revenue a FTT would generate using the above formula and compare it to the 2013 European Commission’s proposal. Their study was based on the following assumptions. The tax rate was set at the same rate in accordance with the proposal, 0,1% on financial transactions of shares and bonds, and 0.01% applied to transactions related to derivate contracts. Data on transaction volume were gathered from the Federation of European Stock Exchanges. Relocation and fiscal evasion estimations come from the impact assessment of European Union (2011). For elasticity data they used the research of McCulloch and Pacillo (2011) on the empirical estimates of elasticities of financial markets, ranging from -1.5 to 1.5. Table 2 shows the results.
The estimated FTT Revenue for EU-11 in billion Euros Financial product Estimated FTT revenues
Shares 3.4
Bonds 7.3
Derivates 22.4
Total 33.1
Table 2 Source: Nerudová and Dvořáková, 2014 pp. 458
Their findings, an estimated revenue of 33.1 billion, is in accordance with the predicted revenue interval specified by the European Commission.
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4. Conclusion
To investigate the impact a FTT has on volatility we first started by discussing theoretical evidence derived from models that have been developed by different authors. Some studies concur that implementing a tax could lead to a reduction of volatility. But the models, with each their somewhat different assumptions, also suggest that care should be taken in choosing the size of the tax. It can be seen that a small tax will generally lead to a reduction of volatility, but when the tax reaches a certain value, a gradual decline in market trading and thus a reduction of liquidity can occur that may lead to rise in volatility. Also changes in composition of traders could induce a reduction in volatility, but the tax can reduce fundamentalist traders by more than noise traders leading to a counterproductive higher volatility. This leads to the most important point gathered from the theoretical evidence. Due to the inability of a FTT to discriminate between encouraging stabilizing and discouraging
destabilizing trading activity, its effect on volatility will be ambiguous.
Looking at the empirical evidence provided by three studies conducted on three different countries we find that real financial markets do not behave in a way that theoretical models predict. Sweden’s experience with the tax can be called disastrous, with market volatility even increasing. However it should be noted that the level of the tax rate plays a large role in its effect on volatility. As predicted by the discussed models, choosing a too large tax rate, as was the case with Sweden, may explain why market volatility increased. The results from the UK and France case studies on volatility were less pronounced. Both authors conclude that there was no statistically significant effect of a FTT on volatility. In review of both the theoretical and empirical evidence, it is strange that the European Council would expect that the FTT will reduce market volatility. In the literature we discussed, we have not found strong conclusive evidence to support their claim.
When we look at the revenue raising component of the tax, we can be more optimistic. Although the FTT did not work out in the long run for Sweden, this was mostly due to the bad design of the tax. It was too easy to avoid the tax, leading to a large capital outflow towards other financial centers. France’s experience shows us that it is possible to generate revenues without reducing its market liquidity. The proposed European FTT is structured in such a way to curb tax evasion and thus preventing capital outflow. In review of the assumption made the European Commission in
predicting potential tax revenues, it can be concluded that the estimated €30 to €35 billion revenue raised, is not unfounded.
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