Bad idea of the week – taxing seclending and repo

Do they still not get it? In a letter to the EU tax commissioner, France and Germany are pressing for a tax of 0.1% for shares and bonds and 0.01% for derivatives whether bilateral or listed. These derivatives transactions could also include securities lending, repo and forex. The idea is to have investors pay the bill and banks collect the tax and pass it on.

Short sellers would be hit twice: once on the transaction and again on the basis point charge for a securities loan. It isn’t impossible to conceive of this tax being accepted; after all, ten basis points on a trade’s value plus one basis point for a loan is not a tremendous sum as interest rates rise. However, it still adds friction to the market.

The bad news is that history has proven repeatedly that taxes on financial markets mostly serve to push trading elsewhere (Exhibit A: the UK stamp tax basically created the Contracts for Differences or CFD industry).

However, the argument by the tax-inclined nations also shows how far the differences are between EU member-states that favor liquid financial markets and those that don’t. The UK, with a major international financial center, would be badly wounded by a large-scale new tax on derivatives trades. Other nations with the new tax would see their own liquidity hurt as traders move to venues or products with lower or no taxes. The game of regulatory arbitrage is still going to work so long as investors have options. But none of this may matter to countries that fundamentally believe that financial services is a necessary evil rather than part of a healthy modern economy.

This is not the first time we have heard about taxes on derivative products, and not the first time we think it is just a bad idea. If regulators want to tax banks and reduce their profits, then that would call for one series of actions. However, if the goal is to damage liquidity on financial markets and increase the cost of investments to national economies, this is just the right way to do it.

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