Report of the Committee of Experts to the Taskforce on International Financial Transactions and Development

8/9/2019 Report of the Committee of Experts to the Taskforce on International Financial Transactions and Development

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Report2010

Globalizing Solidarity:

The Case for Financial Levies

Report of the Committee of Experts to the Taskforce

on International Financial Transactions and Development


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GlobalizinG solidarity:the Case for finanCial leviesreport of the Committee of experts to the taskforCe

on international finanCial transaCtions and development

a c 22 oc 2009 p

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2 Leading Group on Innovating Financing for DevelopmentGlobalizing Solidarity : The Case for Financial Levies

Members of the group participated in their personal capacity.The views expressed do not reect those of the institutions,

organizations or companies to which they belong. While noneof the group members disagrees with the general thrust and approach

of the report, none would, either, fully support or endorse eachand every specic reection or recommendation.

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The opinions expressed in this document are the sole responsibilityof the Committee of Experts

Reproduction and translation for non-commercial purposesare authorised, provided the source is acknowledgedand the publisher is given prior notice and sent a copy.

Manuscript completed in June 2010.Paris Leading Group on Innovative Financing for Development 2010.

Photos: F. de la Mure/MAEE


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ecu u .............................................................................. 4

t c ............................................................................... 7

C ............................................................................8iuc: t G s d .................................... 9

r ................................................................................................ 111 The Funding Gap: development, environment and global public goods ........................................... 11

2 Innovative nancing mechanisms: criteria for assessment and primary areas of focus ................... 12

3 Innovative nancing options evaluations ..........................................................................................14

4 A Global Solidarity Levy: detailed assessment .................................................................................27

5 Options .............................................................................................................................................30

a .............................................................................................32Appendix 1 References........................................................................................................................32Appendix 2 Terms of reference of the Taskforce on International Transactions for Development

in October 22nd in Paris. ..................................................................................................33

Appendix 3 Committee work schedule................................................................................................. 37

Appendix 4 Assessment of options matrix ........................................................................................... 37

Appendix 5 Glossary ............................................................................................................................ 38

e .............................................................................................39

Tableof conTenTs


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1. This report is a response to the request of theTaskforce on International Financial Transactionsfor Development to assess the feasibility ofinnovative nancing options to address globaldevelopmental and environmental challenges.

2. The aim of the report is to address a forgot-ten nancial crisis: the vast shortfall in nancerequired to meet international development andenvironmental commitments. Estimates for thisfunding gap are in the range of $324-336 bnper year between 2012 and 2017 ( $156 bn forclimate change, $168-180 bn for ODA OfcialDevelopment Assistance). Compounding the chal-lenge, the global nancial crisis and recession, andthe resulting scal consolidations, have seriouslyundermined governments ability to meet theirpre-existing commitments. The recent sovereigndebt crisis in Europe has only served to underline

the severe pressure which is continuing to beplaced on the scal positions of many countries.

3. This report links the funding crisis directly towhat is termed the global solidarity dilemma.Put simply, the growth of the global economy hasnot been matched with effective means to levyglobal economic activity to pay for global publicgoods. If the global community fails to fund therequired mitigative and adaptive measures, weface a shared risk of global economic, nancial,social and environmental instability, which wouldundermine the foundations of globalisation. In theview of the Committee, resolving this dilemma iscentral to addressing the funding gap in a sustai-nable way.

4. Given this context, there is a clear need to inves-tigate innovative ways of nancing developmentand environmental goals. Given the scale of thefunding gap, these will need to be of signicantlylarger scale than previously established innovativenancing mechanisms. Our focus, therefore, ison mechanisms that can enable the wealth of theglobal economy to be channelled at a scale thatcan make a meaningful contribution to the crisisfacing the funding of global public goods. This

should be in a form that addresses the globalsolidarity dilemma and causes the least distortionto the real economy. Innovative nance, which wedene as mechanisms based on global activitiesthat can help to generate substantial and stableows of funds, have a growing record of success.

Notable examples include the air ticket solidaritylevy and the International Finance Facility forImmunisation.

5. The Committee believes that the nancial sectoris the most appropriate point to levy such an inno-vative nancing mechanism. The architecture of thesector is intertwined with the globalised economy,is a primary beneciary of the growth of the globaleconomy, and with the liberalisation of the capitalmarkets has been pivotal to the development ofthe global economy. As such, the nancial sectoris uniquely placed as a channel to redistributesome of the wealth of globalisation towards theprovision of global public goods.

6. This report analyses nancing options againsta number of criteria: sufciency (where potentialrevenues are sufcient to make a meaningfulcontribution); market impact (where market distor-tions and avoidance are within acceptable limits);feasibility (where legal and technical challengescan be feasibly addressed); and sustainability andsuitability (where the ow of revenues would berelatively stable over time, and the source suitedto the role of nancing global public goods). Allthe options considered are technically credible andhave already been analysed, in different degreesof details, by respected economists and scholars.The purpose of the analysis is therefore to assessthe following options against the set criteria.

A nancial sector activities tax

A Value Added Tax (VAT) on nancial services.

A broad nancial transaction tax

A nationally collected single-currency tran-saction tax

A centrally collected multi-currency transac-

tion tax

execuTivesummary


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7. As with the recent IMF report, the option ofa Financial Activities Tax (FAT) levied on the sumof the prots and remuneration of nancial institu-tions, and paid to general revenue is considered.

While a FAT has many merits and is well suited tothe IMFs remit, the Committee concludes that, it isnot appropriate to the remit set by the Taskforce onInnovative Financing for Development. In particular,a FAT would leave the global solidarity dilemmaunresolved. Moreover its broad implementation,designed to avoid a misallocation of resourcesand dislocation, would require time consuming(and possibly politically unachievable) elaborationof a commonly agreed taxable basis, tax rate andtaxing assessment procedures. This is incompa-tible with the urgency facing the nancing of global

development and environmental challenges.8. Although nancial services have traditionallybeen exempted from VAT for technical reasons,advances in information technology have weakenedthe technical obstacles to such a tax. A nancialservices VAT based on the users of nancialservices might now be possible to implement.However divergent views on the notion and thescope of nancial services (e.g. on the capitalremuneration component) would require politicalchoices at the international level. With respectto the remit of this Committee, the option has

similar merits, but suffers from similar problemsas a broad-based nancial transactions tax (FTT).

9. In addition to traditional asset markets, a broadFTT would apply to nearly all nancial transactions,such as futures and options as well as bonds, equi-ties and commodities. The majority of the revenueswould therefore be drawn from transactions that arealready taxed in a number of countries. The FTThas the clear advantage of comprehensiveness,so that the revenues raised could be very high,but avoidance could be difcult to cope with. Whilethis could be addressed in time, the technical and

legal feasibility of such a wide-ranging mechanismremains uncertain. More importantly from theperspective of the Committee, the FTT is vulne-rable to the issue of, what the Committee terms,geographical asymmetry in revenue collection,as well as the domestic revenue problem.Therefore, whilst an FTT might be appropriatewithin particular jurisdictions for specic scal orregulatory purposes, it is less well suited to thetask of funding public goods at the global level.

10. A single-currency transaction tax (CTT),levied unilaterally, by a tax raising jurisdiction

and its Central Bank through its Real TimeGross Settlement (RTGS) or similar settlement

infrastructure (e.g. EUs TARGET), has the advan-tage of political feasibility. To be viable, it wouldnot have to be universally adopted and enforcedand so could be introduced unilaterally by any

country, group of countries, or currency zone thatwished to do so. It is also technically feasible.The national basis of collection, however, raisesissues of revenue stability, as the tax base maybe subject to erosion over time due to domesticnancing pressures.

11. A global currency transaction tax (CTT)would apply to foreign exchange transactionson all major currency-markets at point of globalsettlement. An attractive feature of this optionis that it appears to resolve the global solidaritydilemma. Although the nancial sector, which

benets disproportionately from the globalisa-tion of economic activity, would pay a signicantcontribution, the burden of payment would alsoripple out from settlement institutions acrossglobal nancial and economic activity. Revenuewould not be raised in an asymmetrical mannerby the nations with global nancial centres, butwould be spread across global activity to pay forglobal public goods. Global collection mecha-nisms also avoid the domestic revenue problem,enhancing stability. Despite these advantages,a global CTT has challenges. Principally, the tax

would have to be scaled and other incentivesweighed so that it did not lead to avoidance ofcentralised settlement. However, the Committeehas concluded that these would not be difcultto introduce and are consistent with the directionof regulatory reforms currently being discussedto encourage centralised settlement, as well aswith market trends in the same direction.

12. Following the assessment of options againstcriteria, the report concludes that a global CTTis the most appropriate nancing mechanismfor global public goods. The report reviews the

complex legal and technical issues that surroundthe implementation of a Currency Transaction Taxat the point of settlement, and concludes that theimplementation of a global CTT is technically andlegally feasible.

13. There are two major policy tools to limit thescope for avoidance of a CTT. First, in a compa-rable to the UK technique of non-enforceabilityon relevant contracts untaxed by the Stamp Duty,the legal monopolies held by the Central banks ofthe currencies exclusively issued by those CentralBanks offer a unique opportunity to frustrate, if

not eliminate, geographical tax avoidance in anefcient way. Second, the Committee supports the


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policy trend towards increased central settlementof foreign exchange transactions and proposals forregulators to apply an additional capital adequacyrequirement for counterparties whose transactions

are not settled through an approved settlementarrangement and, as a consequence, representincreased risk to the nancial system. As theimpact of such additional capital requirement wouldexceed the cost of the CTT proposed, it woulddiscourage evasion of the CTT, even though itsmain aim would be prudential.

14. This option is recommended as it best meetsthe criteria as the most appropriate source ofrevenue to fund public goods and share the wealthgenerated by globalised economies. In the knowle-dge that nancial institutions will pass on part of the

cost of the levy, it would be distributed across global

nancial and economic activity. Proportional to theirinvolvement, the economic market participantsthat participate in and benet from globalisation,including the nancial sector, would therefore pay

a small fee to fund the global public goods thatunderpin and provide stability to the globalisationprocess. For this reason, we term our proposala Global Solidarity Levy (GSL).

15. The proceeds of the GSL would be paid intoa dedicated fund. The governance of both thelevy raising authority and the fund must upholdprinciples of accountability, representation andtransparency. This report evaluates the governanceand operational requirements for the distributionand administration of the funds, and proposes theestablishment of a new Global Solidarity Fund

nancing facility for global public goods.


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This report is the response of the Committeeof Experts on Innovative Financing for globaldevelopmental and environmental challenge to the

request of the Taskforce on International Financial

Transactions for Development to assess the feasi-

international development and environmental

crises, including climate change mitigation and

adaptation.

On 22 October 2009, twelve countries agreed

to set up a Taskforce to explore several

assessment of the feasibility of an approach

The creation of the Taskforce on International

Financial Transactions for Development built on

the 2004 Declaration on Action Against Hunger

and Poverty and recommendations of the Leading

Group on Innovative Financing for Development

and complements the work of the Taskforce on

To support the Taskforce report to the Leading

Group, the Taskforce convened a committee of nine

Experts (the Committee of Experts) with compe-

a r

options to fund international development and

climate change by June 2010. The Committee

was asked to examine:

how the levies would operate in practice;

their conditions for implementation;

risk of distortion); their coherence with existing development

financial instruments and the objective

sought (raising additional resources for

development);

The risks of distortion of competition and

circumvention;

For more details on the terms of reference of the

Committee of Experts, please see Appendix 2.

To produce this report, the Committee of Experts

reviewed a large body of existing literature on

in a programme of consultation with interested

stakeholders, across London, Brussels, Paris,

Washington and New York. The consultation

services and industry, civic society, and interna-

authorities.

For more details of the Committee consultation

schedule please see Appendix 3.

TERMS OFREFERENCE


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Experts

Michael Izza, Chief Executive of the Institute of Chartered Accountants in England and Wales, London.

Pr Lieven Denys, Free University of Brussels, Brussels.

Pr Stephany Grifth-Jones, Initiative for Policy Dialogue, Columbia University, New York.

Pr Thore Johnsen, Norwegian School of Economics and Business Administration, Bergen.

Dr Inge Kaul, Adjunct Professor Hertie School of Governance, Berlin.

Pr Mathilde Lemoine, Sciences Po Paris and Economic Analysis Council of France, Paris.

Dr Avinash Persaud, Chairman, Intelligence Capital, London.

Pr Marcio Pochmann, Institute of Applied Economic Research, Brasilia

Pr Takehiko Uemura, International College of Arts and Sciences, Yokohama City University, Yokohama.

Research team

Dr Stephen Spratt, International Institute for Environment and Development, London.

Dr Giorgio Romano Schutte, Federal University ABC/Institute of Applied Economic Research, Brasilia.

Secretariat

Maria Villanueva, Ministry of Foreign Affairs and Cooperation, Madrid.

Nick Maxwell, Institute of Chartered Accountants in England and Wales, London.

Dr Tarik Mouakil, Ministry of Foreign and European Affairs, Paris.

commiTTeemembers


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The world seems entangled in an ever denserweb of crises, spanning an ever wider gamutof policy concernsglobal warming, poverty andinequity, failed and failing states, internationalterrorism and excessive nancial volatility andcrisis, caused to an important extent by under-regulated nancial markets. In many countries,there is risk of agging, if not negative, economicgrowth due to the effects of the continued nancialcrisis. Real or perceived scal constraints limit theability of governments to maintain or increase theirspending on nancing development or mitigatingclimate change.

The world is passing through a transformation.Increasing openness of national borders andmarket integration have led to a growing volumeof cross-border economic activity, and deepening

policy interdependence among countries. Ashappened during earlier periods of major trans-formation, the reform of governance processestoday, particularly in areas such as regulation andtaxation, is lagging behind the change in privatesector and commercial activity. The reform backlogleads to an accumulation and exacerbation ofemerging inconsistencies and imbalances, so thatlingering problems can assume crisis-proportions.

This is the situation in which we nd ourselvestoday. It is a situation that urgently calls for policyinnovation. In many actual and potential crisis

areas new policy approaches have been identied.Just think of the many innovations in the eld ofmitigating, and adapting to, climate change, or theght against global communicable diseases. Sofar, however the mobilisation of nancial resources nding for each respective challenge the rightamount and right type of money, at the righttime has remained an important stumbling block.

Yet, globalisation has not only contributed to manyof the challenges we are facing today. It also offersnew opportunities for meeting these challenges.One such opportunity is to recognise that while

less crisis-prone, more balanced and sustainableglobalisation benets all, it is particularly true for

those most engaged in transborder economic acti-vity-international business corporations, investors,traders, shippers, as well as travellers. They havea major stake in such global public goods as openeconomies and enhanced global stability and secu-rity. For example, airlines and maritime transport

companies would benet from averting the riskof storms and turbulences that might accompanyglobal warming; and so would their clients, mainlyinternational traders, investors and other travellers.Similarly, an outbreak of a communicable diseaselike SARS or avian u could seriously jeopardizetransnational economic and nancial activity; andso would episodes of hunger and mass starvationin poorer countries due to droughts or oodingand other factors that could lead to a spiking ofcommodity prices. Furthermore, less and smallernancial crises would make the world economy

a far more stable and prosperous place for inves-tors, workers and consumers. Finally, there is alsoa broader argument that those beneting fromglobal economic activity have some responsibilityto contribute towards social and environmentalstability at the global level1.

Studies on the costs of various crises have shownthat inaction or delayed corrective action is oftensignicantly higher than the costs of correctiveaction and prevention.

Globalisation and the growing human footprint

on the natural environment have created a newoperational international cooperation agenda: theprovision of global public goods. This new strandof international cooperation calls for a new strandof nancing.

One option for mobilising additional resources forthis purpose would be to tap national budgets;and to the extent that joint, collective efforts at theinternational level have to be funded, to pool theseresources internationally. But, although nationalfunding for global challenges has increased inrecent decades, it still falls short of what has been

identied as being required for the most pres-sing problems, such as meeting the Millennium

inTroducTion:

The Global

solidariTydilemma


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Development Goals (MDGs), halting environmentaldegradation, or preventing the spread of commu-nicable diseases.

One reason for this shortfall is that the provisionof global public goods is still a relatively new andnot yet fully developed and institutionalised strandof operational international cooperation. A furtherfactor could be that voters no doubt prefer thattheir governments spend nationally collectedrevenue at home. National public goods sufferfrom such collective action problems. Individualactors and business corporations may not revealtheir true preferences for a public good, becausethey prefer others to step forward and contributeto the nancing of the good, which, once providedand in the public domain, they will then enjoy forfree, without having contributed their fair share.

Global public goods suffer from even greater collec-tive action problems, which tend to arise amongstates because of the nationally oriented focus oftheir policymakers and delegations to internationalnegotiations. Although understandable and rationalfrom a national perspective, this fact has often ledto an under-nancing of global challenges andallowed global problems to linger and assumecrisis proportions. This represents what we callthe Global Solidarity Dilemma.

The time is ripe for extending principles that arewell-established within the national context to theinternational level. These are the ability to payand the beneciary pays principles.

Based on these principles, it can be argued that themain beneciaries of more balanced globalisationshould contribute to meeting the funding needsof global challenges, which, if left unaddressed,

could seriously disrupt the efcient functioning oftransnational economic activity.

Newly erupted crises tend to loom large initiallyand to grab at least for some time, the spotlightfrom earlier, yet still unresolved problems. Thisis also happening now. Policymakers and theirconstituencies are rightly pre-occupied with thecurrent financial and economic crisis, whichremains unresolved. However, this takes politicalattention away from issues like climate change orthe fact that the MDGs will not be met in manycountries by the target date of 2015.

There is a risk that the other crises will deepen,because they have been moved backstage bythe current nancial turmoil and its effects onnational real economies. But, neglect of thesecrises demonstrates a lack of responsibility andmay have irreversible and costly implications. Itmay place additional nancial burdens on statesand non-state actors at a time when they alreadyface serious resource constraints.

If the world is not to enter into an ever-fasterdownward spiral of crises, we have, therefore,

today to seek to tackle several of the most pressingglobal challenges.

For this reason, the search for new, additionalnance sources is imperative.


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1 t fug G:,

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uc g The funding gap for international develop-ment and environmental challenges can be

seen in the broader context of the internationalcommunitys inability to fund global public goods.The Committee believes that this failure can beexplained, to some degree, by the global soli-darity dilemma described in the introduction tothis report. The ability of nations to meet fundingcommitments can be stymied by free-rider effectsand rst-mover disadvantage in the internationalsphere, and undermined, particularly at the current

time, by political and budget pressures at home.

Although in Monterrey in 2002 the developed worldagreed to contribute 0.7% of Gross National Income(GNI) towards development spending and meetingthe Millennium Development Goals (MDGs), thiswas a reconrmation of a 25-year old commitment,which remains unmet. In December 2009, theCopenhagen Accord agreed on actions to preventan increase in global temperature above 2 degreesCelsius relative to pre-industrial times. Estimatessuggest that this will require annual funding of $30bn from 2010 to 2012 and $100 bn a year by 2020to address the needs of developing countries alone.Despite the scale of the funding required, somestudies have demonstrated that the costs of inactionor delayed corrective action are signicantly higherthan the costs of acting now (Stern, 2006).

Combining the funds needed to meet the MDGs by2015, the Ofcial Development Assistance (ODA)target of 0.7 percent of GNI, and Environmental crisistargets, the resource gap is in the range of $324-336 bn per year between 2012 and 2017 ( $156 bnfor climate change2, $168-180 bn for ODA).

Compounding the challenge, developed countrygovernments are now struggling with vast scal

consolidations as a result of the nancial crisisand the global downturn it precipitated. The IMFestimated the net direct cost to advanced econo-mies of the recent support to the nancial sectorat $862 bn, or 2.7% of GDP, which is likely toincrease as result of new phase of sovereign

debt crisis in Europe. In November 2009, theOECD predicted unprecedented post-war levels ofgovernment budget decits and public debt for thecoming decade. Total OECD government budgetdecits and public debt are forecast to exceed 7.6and 103% of GDP respectively by 2011, comparedwith 1.3 and 73% in 2007.

Based on UN estimates and its own projection forthe ODA gap, the Trade Union Advisory Committeeto the OECD recently estimated the resource gapin nancing development and climate changeat $324 bn per year for the 2011-2015 period(OECD, 2010a).

Against this backdrop of a quantiable crisis ofpublic funding in general, and for global publicgoods in particular, innovative nancing hasbeen receiving even more widespread interest asa source of predictable, sustainable and additionalnance. This was clearly recognised by worldleaders at Doha:

We recognize the considerable progress made sincethe Monterrey Conference in voluntary innovativesources of nance and innovative programmes linkedto them...We encourage the scaling up and the imple-

mentation, where appropriate, of innovative sourcesof nance initiatives. We acknowledge that thesefunds should supplement and not be a substitute fortraditional sources of nance, and should be disbur-sed in accordance with the priorities of developingcountries and not unduly burden them. We call onthe international community to consider strengtheningcurrent initiatives and explore new proposals

(t d dc

fcg d, 2008)

Innovative nancing mechanisms have demonstra-ted their potential for securing additional resourcesfor distribution to low-income countries. The

success of the air ticket solidarity levy, as well as thegoverning body of revenue (UNITAID, International

reporT


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Drug Purchase Facility) has shown it is possibleto meet long-term needs through non-traditionalnancing mechanisms. Other innovations havedemonstrated the ability of nancial mechanisms

to bring forward and focus long-term funding to thepresent (e.g. the International Finance Facility forImmunisation [IFFIm]), while the Advance MarketCommitment pilot project (AMC) can be seen asan innovative way of using resources.

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Given the scale of the funding crisis, this Committeewas required to examine innovative nancingmodels of signicantly larger scale and differentcharacter than previously established. The criteriafor assessment are elaborated in the next section.

2 i cgc:

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2.1 C

Based on the term of its enquiry, theCommittee has identied four criteria forassessing innovative nancing options:

Sufciency

Market impact

Feasibility Sustainability and suitability


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First and foremost, options must be capable ofgenerating annual revenues on a scale sufcientto make a meaningful contribution that achievesvisible impacts. As well as addressing the funding

gap detailed above, this would also contribute tothe task of restoring condence in the effectivenessof global development cooperation.

Any mechanism that is likely to meet the revenueraising sufciency requirements, particularly inrelatively concentrated markets, can be expectedto create distortions and incentives for avoidance.Consequently, market impactshould be minimised,in terms of both undesirable changes in the waynancial markets operate and the possibility ofavoidance.

Third, the mechanisms must be both technicallyand legally feasible. Infrastructure should exist orbe feasible to establish, and it should be operatio-nally and legally possible to raise revenues at a lowadministrative cost. Key issues include whetherthe option is technical feasible; whether globalagreements for revenue raising cooperation arerequired, including avoiding multiple taxation andtax avoidance; and whether the option compati-bility with existing regulation and internationalobligations.

Fourth, annual revenues must be sustainable in

that they are predictable and stable over time, and

suitable in that the source and its mechanismsshould be appropriate to the nancing of globalpublic goods.

Those that operate within the global economicarchitecture receive signicant nancial benets.It is therefore appropriate that funding for publicgoods to support the economic and social stabilitythat underpins the global economy should comefrom those who benet most from participationwithin it.

Based on this analysis and its remit, the Committeebelieves that the international nancial system isthe most suitable source of revenue to fund globalpublic goods. International nance has grown enor-mously in recent decades, far outstripping growth

in world trade and production. The protability ofthe sector has also increased, so that in the UnitedStates, for example, nance represents 40% ofall corporate prots. Given its role at the centre ofthe globalisation process, innovative mechanismsapplied at the level of the global nancial system3would not just tax an activity that has relativelylow taxation and concentrates a great deal ofwealth, but would also ripple out through the worldeconomy, so that global economic activity wouldbe the ultimate source of funding for global publicgoods.

au fx c . G Gdp G e

Source: IMF and BIS

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

1992 1995 1998 2001 2004 2007

G g c G Gdp G fx c


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As is shown in the chart above, the growth inforeign exchange transactions alone has faroutstripped that of world trade or global GDP. In1992, the foreign exchange market was around

8 times larger than total world output. By 2007, ithad grown to more than 14 times the size of thereal economy.

2.2 t :u cc

Financial sector taxation is not new or inno-vative in its own right. There is a long anddistinguished economic theoretical tradition arguingin favour of nancial taxes, starting with Keynesand Tobin, but also including Nobel Prize winnersJoseph Stiglitz and Paul Krugman, as well asLawrence Summers, John Williamson and BarryEichengreen, amongst others. While the nancialsector is already subject to traditional nationaltaxes, such as income and corporation tax, this isnot the case with VAT, suggesting that the sectormay be under taxed.

Following the nancial crisis, a number of countrieshave instituted or are evaluating nancial sectortaxation as a means to fund public support for

the nancial sector or as an insurance resolutionfund for future crises at a national level. Examplesinclude: the Financial Crisis Responsibility levyproposed by President Obama in the US; legisla-tion in France and the UK for temporary taxes onnancial sector bonuses; a stability fund paid forby the nancial sector liabilities levy in Sweden;a proposed nancial sector levy in Germany; andrecent proposals for a EU bank Resolution Fundnanced with ex ante levies on assets, liabilitiesor prots.

Responding to the G20 Pittsburgh Communiqu,

the IMF evaluated the issue of nancial sectortaxation in response to the nancial crisis. In linewith its remit of recouping the cost of support forthe nancial sector and reducing the probability offuture crises, the Funds Interim Report suggestedthe need for two mechanisms, alongside betterregulation and supervision:

a Financial Stability Contribution (FSC) initially applied at a at rate on liabilitiesand assets, to pay the cost of supportingthe nancial sector. The FSC would accrueto general revenue.

a Financial Activities Tax (FAT) levied onthe sum of the prots and remuneration of

nancial institutions, and paid to generalrevenue (IMF, 2010).

The proposals made by the IMF have signicantmerit for their specic purposes of containingsystemic risk and repaying the cost to nationalexchequers of the nancial bail-out. However,addressing the development and environmentalfunding crisis presents very different, but equallyimportant, challenges, and so is likely to requiredifferent solutions.

These challenges appear to exceed existingunilateral, bilateral and multilateral funding arran-gements, and have been hugely exacerbated bythe nancial crisis and the anticipated period ofglobal scal consolidation.

As these traditional channels seem ill-suited to thetask of funding global public goods, the Committeehas identied the global nancial sector, rather thanthe respective nancial sector in each country, asthe most suitable source of revenue in this regard,not least because of the ability of nancial sectortaxation to spread the burden of payment of globalpublic goods throughout the global economy. Incontrast to the IMF, and reecting our differingremits, options that can be expected to partiallyshare the burden beyond the nancial sector to theglobalised economy as a whole are not considered

inappropriate by the Committee. Furthermore,given the concentration of wealth and income inthe nancial sector, it is appropriate that a greatercontribution is made by those most able to bearthis. Financial sector taxes are therefore likely tobe more equitable than alternatives.

3 i cg u

The following parts of this report assess

innovative financing options against thecriteria described above. While each presentsdifferent technical or legal challenges, we haverestricted this assessment to proposals that havebeen reviewed by other respected bodies andhave been assessed as technically credible. Whatfollows are the summary conclusions drawn fromthe Committees in depth analyses.

The following levies are analysed on the basis ofthe criteria described above

A nancial sector activity tax

A VAT on nancial services A broad nancial transactions tax (FTT)


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A nationally collected single-currency tran-saction tax

A centrally collected global multi-currencytransaction tax

3.1 a c c c (c) u

It should be noted that proposals to recoup thecost of public support for the nancial sectorand from subsequent economic crises, and/or tocreate an insurance fund to protect against futurecrises, are designed for a purpose distinct from thatwhich is under investigation by this Committee.

Our focus here is on proposals for more generaltaxation on the prots and remuneration of thenancial sector to fund development and envi-ronmental goals.

Options to be considered within this category arethe Bank Payroll Tax legislation implemented inthe UK, the Bonus Tax in France, and the taxesproposed by the IMF, which were described above.

3.1.1 succ

The revenue potential of a prot/bonus taxdepends on the rate and the behaviouraleffects created by the higher tax burden in thenancial sector. However, it is undoubtedly thecase that there is signicant revenue potential,as illustrated by the speed with which institutionshave moved to pay-back government support andthe return to high protability across the bankingsector.

Despite initial expectation that the UK Bank PayrollTax would raise 550 million, tax receipts are nowexpected to be between 2 to 2.5 bn. The Fundestimates that a nancial activities tax of 2% onBritish banks (with all salaries included into the

base) would raise about 0.1-0.2% of UK GDP( 1.4 bn to 2.8 bn).

The French tax of 50% on bonuses above 27,500paid to bank employees in 2010 is expected toraise 360 million (ibid).

The European Commission estimates thata surcharge of 5% on the tax burden for the nan-cial sector could lead to additional tax revenue inan order of magnitude of 3-4 bn per year in theEU (European Commission, 2010).

Given that the proposals are designed for domestic

purposes, the scope for additional funds to bemade available for development and environmental

crises is relatively low, if not zero. The funds poten-tially available are considerable but have alreadybeen earmarked for nancial resolution funds orhave owed to general budget.

3.1.2 m c

Approximating to a tax on rents or excessin the nancial sector, proponents arguethat the taxation of prots would not interfere withcurrent regulatory reforms or with the pattern ofmarket transactions (IMF, 2010).

That said, depending on its design a tax onbonuses could affect this pattern, by disincentivi-sing excessive risk-taking. If this were the case,benecial effects in terms of market stability could

accrue (Grifth-Jones and DArista, 2010).From the perspective of avoidance, there isa risk of the nancial sector shifting prots andremuneration to low-tax jurisdictions or alternativecompensations to avoid the tax. Proponents argue,however, that if applied at a low rate, the tax wouldnot signicantly inuence current incentives for taxplanning, particularly if adopted at broadly similarrates in a range of countries (IMF, 2010).

3.1.3 f

Perhaps the greatest single of advantage

of proposals of this kind is that they rely onexisting tax bases and systems. There are alsohistorical precedents for taxing the sum of protsand remuneration in the nancial sector. Israelapplies such a tax; the province of Quebec inCanada has a related tax; Italy applies a tax withbroadly similar structure to all activities, includingnance and insurance. France levies an additionaltax on remuneration for rms, including nancial(IMF, op cit).

However, there are considerable legal feasibility

issues owing from the need to internationallyagree on a common tax basis and avoid multipletaxation. This can be related to the classic interna-tional legal problems of residence based taxation,such as the multiple international intra-grouptaxation and avoidance4.

If global implementation of this option is to avoida misallocation of resources and dislocation,it would require time consuming (and possiblyunachievable) elaboration of a commonly agreedtaxable basis, tax rate and taxing assessmentprocedures. This is incompatible with the urgency

facing the nancing of global development andenvironmental challenges.


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19/46


3.2.4 s u

As VAT is designed to be passed on to theend-users or nal consumers, the cost ofthe levy option is likely to be distributed acrossglobal nancial and economic activity. All users ofnancial services, including households but alsocapital providers, would be taxed. In other words,if VAT on nancial services was used to nanceglobal public goods, the wealth redistributed wouldcome from all end-users of nancial services.

Since the nancial VAT would be integrated into theregular VAT system, the legal feasibility should notbe problematic. Moreover the international spreadof the VAT model9 has encouraged internationallyharmonised taxation without the need of stringent

international legal agreements.Financial VAT, if not properly designed, may besubject to both the asymmetric revenue collectionand domestic revenue problems. Countries withdisproportionately large VAT end users of thenancial sectors would pay a correspondinglyhigh level of tax. As VAT on non-nancial productsis a major contributor to the national budgets ofcountries where such a system exist, it is unlikelythat a nancial VAT collected at the national levelwould be earmarked for the nancing of globalpublic goods.

3.3 a cc

3.3.1 succ

While there are a number of FTT proposalscurrently being debated this Committeefocuses its analysis on a broad FTT, as it has thepotential to raise most revenue and proponentshave asserted that it is possible. Proposals of thisform are best described in Schulmeister (2009)where the FTT would be applied to all non-retailmarkets, including foreign exchange, exchange-traded and OTC derivatives.

Given the breadth of the proposed application, itis unsurprising that revenue estimates are veryhigh. Schulmeister suggests that a rate of 0.01%would reduce trading volumes by 65%, but stillraise up to 2% of global GDP, or $1,060 bn.Worldwide, a tax at 0.1% would generate reve-nues equivalent to 1.688% of world GDP: thatis roughly $917 bn, $650 bn at a 0.05% rateand $286 bn at 0.01% (ibid).

In reviewing the Schulmeister proposal, boththe IMF and European Commission question

the estimates of total taxable volumes, and theresulting revenue estimates. For derivatives, whichaccount for between 80 and 90% of total revenueestimates, the IMF has questioned whether the

entire notional value of such transactions wouldconstitute the tax base. Without the contributionfrom derivatives traded on OTC markets andexchanges the remaining tax revenue from spottransactions on exchanges would be between $72bn, and $80 bn, or 0.15% and 0.17% of globalGDP (IMF, 2010; European Commission, 2010)10.

3.3.2 m c

Broad FTT proposals generally intend tomodify the market, by disincentivising whatis termed speculative trading, which proponents

argue would contribute to market and thereforemacroeconomic stability. However, both the recentIMF and European Commission reports highlightthe concern that an FTT could lead to increasedshort term volatility of asset prices by reducingliquidity. A review of the existing theoretical andempirical literature is beyond the scope of thisreport, but the ndings are quite mixed on thispoint and turn on the time-horizon being considered(short-term volatility vs. medium-term cycles, withthe latter being far less affected) and the mix oftrading strategies in a given market (i.e. propor-

tions of momentum vs. contrarian). Most studies,however, suggest that very low taxes would eitherreduce volatility or maintain it, especially whenviewed over the medium term. Furthermore,some studies (e.g. Stiglitz, 2010) suggest that,when combined with adequate regulation andsupervision, a small tax would contribute to nan-cial stability by discouraging excessive level oftransactions. In a review of the empirical literature,Schulmeister (2008) nds that 15 out of 21 relevantstudies suggest that transaction taxes would belikely to reduce volatility.

The IMF also highlights the likelihood of geographi-cal avoidance, through trading activity relocatingto untaxed countries11. The case is underlined bythe example of Swedens adoption of a nancialtransaction levy in the mid 1990s, which led toa high proportion of the securities trading activityin Sweden moved to London and other nancialcentres. While factually correct, this criticismseems overstated, as the Swedish tax was set ata relatively high rate and is widely seen as havingsignicant design problems12. Clearly, carefuldesign to prevent geographical avoidance and

asset and product substitution is essential to avoidmajor unintended consequences. This is shown


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by the far more successful experience of the UKwith the stamp duty on shares.

3.3.3 f

Correctly, the IMF concludes an FTT shouldnot be dismissed on grounds of administrativepracticality as most G-20 countries already taxsome nancial transactions.

As pointed out by proponents of a broad FTT,the growth of the electronic communication andsettlement of nancial transactions undoubtedlymake it more feasible to identify and tax tran-sactions than was formerly the case. Feasibilityis further strengthened by the increasing trendtowards central settlement of OTC derivatives,driven by reduced risk and cost. OTC practitionersestimate that only a third of OTC will ultimatelyremain bilaterally settled.

From a legal perspective, the proposals on thetable would need further renement. Since unila-teral introduction bears the risk of conicts oftaxing rights and multiple taxation, the appropriateframework for such regulations should be a multi-lateral treaty and/or regional instrument containingthe basic tax characteristics, denitions and mutualassistance which States could than implementand integrate in their domestic legislation.

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Overall, there remain important legal feasibility

concerns around this option, particularly crossborder intra and extra EU free movement of capitaland the EU and WTO General Agreement onTrade in Services (GATS) liberalisation of nancialservices. The specic requirements for compatibi-lity are considered later in this report, but it is clearthat the explicit aim to modify market practice bydiscouraging speculative transactions and theproportionality tests developed in ECJ case lawshould thus be carefully scrutinised.

3.3.4 s u

A universally applied FTT could, in principle,raise signicant sums. In practice, however,the Committee believes the same factors outli-ned previously in this report could undermine thestability of these revenues over time, as well ascalling into question the suitability of the proposalfor funding global public goods. First, not all nan-cial transactions and underlying assets/productare equally linked into the globalised economy.Second, although there would be global benets interms of improving the efciency of collection, theFTT could be seen as disproportionately affectingthose countries that play host to major internatio-nal nancial centres. This is largely an issue ofperception, however, as global nancial centreshost institutions from around the world with clientbases spread broadly. Consequently, the impactof the FTT would be more widely distributed thana tax focused on purely domestic issues. Third, therevenues would be collected at the national level,making the proposal vulnerable to the domesticrevenue problem. However, at a later stage whenimplementation issues are overcome, a broad FTTcould be a valuable source of nance, especiallyfor domestic purposes. Thus it could ultimately

complement options more appropriate to nanceglobal public goods.


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3.4 a cccuc c

This proposal is for a single-currency tran-saction tax, levied unilaterally by a tax raising

jurisdiction with authority over Real Time GrossSettlement (RTGS) settlement infrastructure. Whilesupporters assert that a currency transaction tax(CTT) could be levied unilaterally, most proposalsargue for a coordinated series of CTTs agreed bythe major trading currencies.

3.4.1 succ

Assuming daily turnover of a little over $3trillion, Schmidt (2008) suggests that a 0.005%CTT just on UK sterling would raise $4.98 bn, per

year, Japanese Yen $5.59 bn, Euro 12.29 bn, andUS dollar $28.38 bn The same research found thata co-ordinated transaction tax levied on all fourmajor currencies would yield $33.41 bn annually,while a CTT on all major currencies except thedollar would raise $16.52 bn.

Other relatively recent estimates have producedsimilar gures. For example, when estimatingrevenues from a combined CTT of all majorcurrencies, Nissanke (2004) suggests a rangeof $17-31 bn, while Spratt (2006) estimates totalrevenues at $24 bn.

3.4.2 m c

Proponents of the tax seek to clearly differen-tiate the proposal from the original Tobin Tax,which deliberately sought to modify the market bydisincentivising short-term, speculative transactions.Many recent incarnations have argued for a CTTpurely on revenue-raising grounds, with the proposedrates being set very low so as to minimise marketimpact. Commonly, the proposed rate is 0.005%, orhalf of one basis point. However, as pointed out bySchmidt (op cit), the 0.005% rate applies to eachleg of the currency trade (i.e. the currency boughtand the currency sold), so that the combined rateon a total transaction is one basis point.

Each of the three studies cited above attemptto take account of the impact of the CTT onvolumes. Schmidt estimates elasticity across themarket at 0.41, while the implied elasticitys forNissanke and Spratt are 0.12 to 0.23 and 0.11respectively.

While designed to minimise impact, supportersaccept that there would be a reduction in volumes,

though they argue that the effect will be concen-trated on high-frequency trading (more associated

with destabilising effects on the nancial sectorand the macroeconomy), rather than low-frequency(more associated with pension funds or trade-related activities).

Schmidt (op cit) estimates the volume reduction onthe basis of the ratio of the CTT to the spread, sothat for currency pairs where spreads are tighterthe reduction in volume would be greater.

t 1. ag -

Currency pair 2005-20066 2009-2010$/Euro 2.95 2.42

$/Yen 3.39 2.30

$/ 2.59 3.44

Euro/Yen 4 3.55

Euro/Sterling 5 2.67

Sterling/Yen 9 5.86

However, as shown in table 1, spreads have fallenin most markets since 2005/2006, with the resultsthat the volume impact of a 0.005% CTT will belarger than that estimated by Schmidt, and thecorresponding revenue estimates lower.

However, this needs to be set against the factthat total trading volumes have risen over thesame period. Consequently, while Schmidtsestimates may underestimate the proportional

reduction in volume from a 0.005% CTT, they alsounderestimate total transactions in the market.The net result of these changes in considered insubsequent sections.

It is likely that different trading strategies would alsobe differentially affected by a CTT, which could affectmarket behaviour. In particular, it is suggested thatalgorithmic trading23 would be severely impacted bya CTT, even at a very low rate, and that this wouldhave a signicant effect on total market liquidity.To the extent that algorithmic trading is higher-frequency than other approaches, the impact of

a CTT would be greater. The actual impact thiswould have on volumes is less clear-cut, however,and in the view of the Committee would be focusedon high-frequency, momentum-based strategies24.

On balance, it is probable that certain forms ofalgorithmic trading would be substantially affectedby a CTT, but others would not. Also, it is difcult tojustify the claim that market liquidity in general isdependent upon a form of trading activity that onlycame into existence a few years ago. Furthermore,many regulators and analysts are concerned aboutpotential negative effects of algorithmic trading

on nancial stability; thus, some reduction of thisactivity may be benecial for nancial stability


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3.4.3 f

Supporters of a unilateral CTT argue thata combination of the move to RTGS systems,through which a significant proportion of FXtransactions are settled, and the automation andcomputerisation of the foreign exchange marketsgreatly increases the technical feasibility of a CTT,making it relatively straightforward to implementwithin any jurisdiction, and practically impossibleto avoid for any individual currency regardless ofwhere the transaction takes place25.

In simple terms, currencies are held and ultimatelysettled within their own jurisdiction. Despite allthe complexities of trading in different parts ofthe world, dollar holdings are held in US banks,

Sterling in UK banks, Euros in Euro-area banks,and so on. Offshore currencies such as Eurodollarsor Eurosterling are also ultimately based upondomestically held dollars or Sterling respectively.

Connecting the different components of nationaland international payment settlement systems areelectronic message providers such as SWIFT26,Which supporters argue could be used to transferdetails of transactions to national revenue collectionagencies, with revenues collected from settlementaccounts held at the respective central bank27.

The alternative to settling foreign exchange tran-

sactions through national RTGS systems is to usethe Continuous-linked settlement (CLS) bank. CLSsettles around half of global foreign exchange tran-sactions, but is inextricably connected to nationalRTGS systems. Funds to settle transactions withinCLS pass through these national systems for eachof the seventeen currencies that are settled. Also,payment instructions from CLS member banksare submitted via the SWIFT messaging system.Supporters suggest that the collection of the CTTcould therefore occur through settlement accountsheld at the central bank, before or after the funds

are transferred from the RTGS to the CLS system,as described above28.

Critics of these proposals point out that there is noregulatory obligation to settle through particularRTGS systems and those different countries havevery different relations between central banksand settlement systems. In the rst instance, theimposition of a CTT through a particular systemcould thus provide an incentive for institutionsto set up a rival, or encourage migration to analternative system already in existence. In theEuro area, for example, the ECB RTGS system,

TARGET2, and its securities settlement system,have a competitor (EBA) which has a 40% market

share, compared with 60 percent for TARGET2.For the second point, central banks or regulatoryauthorities do not necessarily have direct controlover large-value RTGS systems. For example,

while in the UK CHAPS is owned and operated bythe Bank of England, in the US CHIPS is privatelyowned.

Proponents argue that all large-value settlementsystems require regulatory approval in one formor another, with the result that public inuenceover the operations of such a system is very highin practice. This applies to all possible settlementsystems operating within a national jurisdiction,so that migration from one to another would notaffect the feasibility of applying a CTT.

Second, while the information required to identifyand tax all gross currency transactions passingthrough national RTGS systems or CLS may notbe currently available to revenue raising bodies,this information exists and could be copied tocentral banks or other bodies were this to be madea requirement.

Third, it is suggested that the low tax rate proposedwould limit incentives to build costly alternativesettlement systems or to increase settling positionsinternally within banks in order to avoid the tax29,and that there is no economic incentive for banks

to move outside the existing frameworks, thuswriting off capital expenditure.

Critics also suggest that the implementation ofa CTT would increase incentives for banks tonet obligations so as to avoid paying tax on thegross sums. However, given that the proposalfor a nationally-based CTT relies upon existingmessaging systems (such as SWIFT) which recordall transactions, and on the (economic) incentivesand (regulatory) pressure to settle within RTGSsystems, this may not be a particularly strongcritique.

For currencies and central banks that reecta national jurisdiction, such as the GBP, JPY, USD,the levy would be raised by national revenue autho-rities relying on the central bank RTGS system.For the Euro, an EU/euro-zone agreement ondevolving tax coordination between national taxauthorities and the Eurosystem (Euro zone networkof Central Banks), governed by the ECB wouldhave to be reached.

A purely unilateral CTT does not run into the compre-hensive international tax coordination requirements

the FTT poses. In general there would be no needfor an international agreement on the design of


23/46


the tax to prevent geographical avoidance andasset substitution nor the allocation of taxing rightsand revenues. International double or multipletaxation is avoided if all States limit the tax to the

transactions of their currency. That the two legsof a single transaction may be taxed each by thecurrency State is technically not double taxation.The lack of extraterritorial executive jurisdiction(i.e. collection abroad through foreign settlementinstitutions) is resolved through the coordinationwith the Central Bank, which as to the Euro zonemay require appropriate EU agreement30.

However, the tax could be seen as discriminatingagainst foreign currencies and therefore tran-sactions involving trade between countries withdifferent currencies. Legal concerns have beenraised on the compatibility of such a tax with thenon discrimination principles and free movementof capital and payments between EU MemberStates and between EU Member States and thirdcountries as well as regarding compatibility withGATS. The requirements for such compatibilityare considered later in this report.

In conclusion, a unilateral single currency CTT, ifproperly designed and preferably embedded ininternational tax cooperation is legally feasible.The single currency approach has a strong andinnovative systemic avoidance-proof dimen-sion because of its integration in the monetarysovereignty of a State and its Central Bank. Ininternational perspective it requires a thoroughlegal justication that meets the non-discriminationtest implying a legitimate purpose that justiespossible restriction and that meets the standardsof proportionality.

3.4.4 s u

Once the initial reduction in volume fromthe implementation of a CTT had occurred,revenue streams from a CTT, or group of CTTs,would be expected to be relatively stable. As wehave seen, there is no scope for geographicalavoidance and a similar argument can be madewith respect to the possibility of using alternativeinstruments in general terms, there is no alter-native asset to a particular currency.

Positively from the perspective of this Committeesremit, foreign exchange transactions, by denition,relate to the activities of the global economy, andso are potentially well suited to the task of fundingglobal public goods.

The issue of asymmetry of global collection isalso less pronounced with this option than for

those previously considered. Dependent uponthe number of countries that wished to participatein a CTT of this form, revenues would be broadlyaligned to relative engagement in international

economic activity. In turn, this broadly correspondsto each countrys weight in the global economy.Contributions to the funding of global public goodswould therefore reect the extent to which diffe-rent countries are engaged in, and benet from,globalisation.

That said, a unilateral CTT by only one country,or a small group of countries, would not havethese advantages, which is a signicant weakness.More fundamentally, the proposal fails to addressthe domestic revenue problem. Unilateral CTTswould be taxed and collected within national juris-dictions by domestic revenue raising agencies.The proceeds, therefore, would ow into generalgovernment funds in the rst instance. While propo-nents generally envisage these then being passedonto an international body of some form, thereis a clear risk that domestic spending pressurescould undermine this process, which brings intoquestion the long-term predictability and stability ofnationally-collected CTTs as a source of revenuefor funding global public goods.

3.5 a c cc u-cuc c

While there are many similarities betweena centrally collected, multi-currency CTTand the previous option there are sufcient diffe-rences for the Committee to conclude it warrantsa separate assessment.

Unlike a unilateral CTT, this option is intrinsicallymultilateral in that it would be applied to all tran-sactions, whatever currencies are involved, settledwithin the jurisdiction through central systems. At

present, this is the CLS Bank31, though the optionis not specic to this particular institution. Rather,it refers to any and all centralised, multi-currencymechanisms for settling foreign exchange transac-tions. That said, centralised settlement of globalforeign exchange transactions would appear to bea natural monopoly, suggesting that a plurality ofsuch institutions is unlikely to evolve.

3.5.1 succ

Estimates for this option are equivalent tothose for the nationally collected CTT appliedacross all major currency groups. As we saw inthe previous section, however, existing estimates


24/46


do not take account of changes in market volumeor in bid-offer spreads in recent years.

To address this, we have estimated new guresfor the potential tax base32 and combined thesewith more recent data on spreads for the major

currency pairs to arrive at a more accurate estimateof current annual revenues.

Table 2 gives volume estimates for the four majorcurrencies at end 2009: Dollar, euro, yen andsterling.

t 2. au fg ecg tu e, 2009 (Us $ )

Dollar Euro Yen Sterling

USD/EURO Volume EURO/JPY Volume JPY/GBP Volume GBP/OTHER VolumeSpot 87427.85 Spot 8020.80 Spot 603.55 Spot 4868.73

Forwards 28265.20 Forwards 2593.11 Forwards 195.13 Forwards 1574.05

FX Swaps 134996.11 FX Swaps 931.94 FX Swaps 7517.74

USD/JPY FX Swaps 12384.81 JPY/OTHER

Spot 42290.16 EURO/GBP Spot 4799.69

Forwards 13672.30 Spot 6589.91 Forwards 1551.73

FX Swaps 65299.64 Forwards 2130.50 FX Swaps 7411.14

USD/GBP FX Swaps 10175.39

Spot 28917.32 EURO/OTHER

Forwards 9348.90 Spot 20618.01

FX Swaps 44650.84 Forwards 6665.75

USD/OTHER FX Swaps 31835.98 Total annual $909,392 bn

Spot 113014.48 Total daily $3,637

Forwards 36537.30

FX Swaps 174504.08

Sources: BIS (2007); London Foreign Exchange Joint Standing Committee (FXJSC); New York Foreign Exchange Committee; Tokyo Foreign

Exchange Market Committee; and authors calculations.

As can be seen, average daily turnover is estimatedat $3,637 bn, which represents growth of around20% from the last BIS Triennial Survey publishedin 2007, despite the fact that the intervening periodhas witnessed the most serious nancial crisis inliving memory.

Table 3 combines these volume estimates withthe spreads presented in table 2 to give revenueestimates in three scenarios. In each case weassume that 87.5% of foreign exchange tran-sactions are centrally settled (compared with theapproximately 75% settled through CLS today). Asa base case, price elasticity is taken to be 0.43,following Schmidt (2008).

t 3 Ctt ru & u uc 2009

Scenario 1 Scenario 2 Scenario 3Annual revenues (US $ bn)

USD 28.63 29.42 21.34

EURO 12.75 13.13 9.22

JPY 5.76 5.94 4.12

GBP 4.47 4.57 3.57

Global 33.47 34.38 25.00

Volume reduction (% fall)

Spot 14.60 14.60 14.60

Forward 14.60 11.68 14.60

FX Swap 14.60 9.73 50.93

Sources: as above, plus Olsen Financial Technologies for spread data.


25/46


In scenario 1, we assume that spreads are the samein all three market sectors (spot, forward, and FXswap), though they obviously differ for each currencypair. We also set elasticities at the same level across

these three sectors. As we can see, the resultingglobal revenues would be $33.47 bn, which is veryclose to the gure produced by Schmidt (op cit). Assuggested previously, the 20% increase in volumehas been offset by the narrowing of spreads, leavingthe revenue estimates broadly unchanged, usingthese assumptions.

In scenario 2, we increase the size of the spreadin the forward and FX swap markets by 50 and25% relative to spot, reecting the fact that liquiditywill be lowest in the forward market (due to therebeing a xed settlement date), but also lower in

the FX swap than the spot market. Here totalrevenues rise slightly to $34.38 bn, reecting thefact that the CTT rate is a smaller proportion ofthe larger spreads and so has less of an impacton volumes traded.

For scenario 3, we again assume a uniform spreadacross the three types of market, but signicantlyincrease the elasticity of FX swaps from 0.43to 1.5. While this is essentially a sensitivitytest, it is designed to show the effect of a majormigration away from FX swaps. Here revenuesfall substantially, but remain signicant at $25 bn.

An important point to note is that these estimatesare for transactions where only one leg of thetrade is taxed. So, if pounds are sold and Eurosbrought, a 0.005% levy applies to the whole tran-saction rather than both sides of it. However, ifboth the UK and the Eurozone are participants ina CTT mechanism, there is no reason why bothsides of the transaction should not be taxed. Forexample, the UK authorities may levy the selling ofpounds and the Eurozone the buying of Euros. Inthis case, the revenue estimates would obviouslyrise substantially. While this would not be a straight

doubling of revenues, as the effective rate on thetransaction would have doubled reducing volumesconsiderably, a situation of a global CTT with bothlegs subject to a CTT for all major currencies wouldsee total global revenues considerably in excessof the estimates presented here.

3.5.2 m c

Table 3 also gives estimate for the potentialmarket impact of a CTT in the three scenarios.The core estimate of a 14.6% fall is similar to thatfound in Schmidt (op cit), with the slightly greater

fall here reecting the narrowing of spreads in theintervening period. In scenario 2, we assume that

both forwards and FX swaps have wider spreadsthan pertain in the spot market, reecting their lowerrelative liquidity. Here, the impact on volumes isless for both of these markets. In the nal scenario

we assume very high price elasticity for FX swapsof 1.5, which is reected in a substantial (50%)fall in volumes.

In these estimates, we have assumed that 87.5% offoreign exchange transactions are settled centrally.In the rest of this sub-section, this assumption isexplored.

Settlement in the global foreign exchange marketis becoming increasingly centralised. Two factorshave encouraged this trend. First, nancial insti-tutions are seeking to mitigate the settlement

risk involved in foreign exchange transactions indifferent time-zones/jurisdictions. When one legof a trade is transferred before the correspondingleg is received, the risk of a default preventingthe completion of the trade raises serious riskfor the institution involved. Second, as well ascreating major risks for the individual institutions,the interconnectedness of global nancial insti-tutions is such that a failure in one could createserious systemic risk at the global level. As a result,financial regulators and central banks haveencouraged centralised settlement on a payment-

versus-payment (PvP) basis, where both legs ofa foreign exchange transaction are transferredsimultaneously, thus eliminating Herstatt risk33The primary means of addressing settlement riskin the foreign exchange markets has been throughthe creation of CLS bank, which settles currencytransactions on a PvP basis across all time zonesin one window.

The recent global financial crisis has addedsignicant impetus to regulatory efforts to reducesystemic risk. These forces are highly likely tolead to a greater proportion of foreign exchange

transactions being centrally settled over time. Anopen question, however, is the impact that a CTTapplied through global settlement institutions wouldhave on these trends. The size of this incentive forany given institution will be a function of the costof the CTT (i.e. the rate times volumes traded)versus the costs of migrating to a different formof settlement. These can be broken down intofour categories.

First, there are the direct xed costs of abando-ning the institutional infrastructure establishedto trade through CLS34. Second, there are the

additional variable costs of trading through a non-centralised system, which is a) less efcient, b)


26/46


more expensive per trade, and c) would requiresignicantly higher liquidity to be made availableon a daily basis35. Spratt (2006) estimates thatthese variable costs savings amount to an annual

benet of $17.94 bn to CLS participants. Giventhat volumes traded have increased signicantlysince these estimates were made, it is likely thatthese savings have also increased. Third, thepossibility of counterparty default in a non PvPsystem creates huge settlement risk. Though oflow probability, the consequences of such an eventwould be devastating for any individual institution.

Fourth, these economic factors are accompaniedby potential regulatory costs. The systemic riskcreated by the consequences of a major coun-terparty default in the foreign exchange market is

signicant, a fact brought home by the repercus-sions of the failure of Lehman Brothers in 200836.Although the proposed reforms to nancial regu-lation and supervision remain a work in progress,indications are that regulators will acquire greaterpowers to discourage activities perceived to behigh risk, particularly where systemic impactswould be signicant.

Non-centrally settled foreign exchange transactionswould seem to fall squarely into this category, andthe Committee understands that discussions are

ongoing within the Basel Committee on BankingSupervision on the issue of applying higher capitalrequirements to foreign exchange transactionsthat are not centrally settled, reecting the higherrisks involved.

Many of the issues raised by derivatives ina centrally collected CTT are similar to thosediscussed above in the context of a nationallycollected CTT. However, there are also some diffe-rences. Increasing amounts of foreign exchangederivatives are already centrally settled, largelybecause of the economic benets to participants of

doing so. Consequently, the application of a CTTthrough the settlement system of choice, combinedwith the regulatory pressure described, reducesthe distinction between traditional and OTCforeign exchange transactions for the purposesof applying a CTT. Broadly speaking, therefore,applying a CTT to derivative transactions throughcentral settlement systems raises the same issuesas apply to the traditional FX market.

A consensus has developed among proponentsthat all traditional foreign exchange tran-sactions should be taxed spot transactions,

outright forwards and foreign exchange swaps37.Concerning non traditional FX transactions that

are not centrally settled, things are less clear. Onbalance, the view of the committee is that it is notdesirable nor feasible to tax the notional values ofthese contracts as: a) most derivative contracts do

not entail delivery of actual currencies; b) If optionswere taxed at the same rate as traditional FX tran-sactions there would be an over-taxation issue38;and c) derivatives are not perfect substitutes fortraditional FX transactions, and so would not offera real opportunity of avoidance if traditional FXtransactions were the only ones to be taxed.

However, while we think it is correct to leave FXoptions contracts untaxed, not least as they will betaxed in the spot market if the option is executed,the Committee believes that premiums would needto be subject to a multilateral CTT to create a level

playing eld. We have not included revenues fromOTC derivatives in the estimates given above.

Finally, the risk that complex derivative instrumentswould be constructed to avoid a CTT is, in the viewof the Committee, overstated. Financial innovationis essentially a cost-benet decision. A CTT leviedat a very low rate would be less than the cost suchmoves would entail39.

Moreover, were non-centrally settled transactionsto be unenforceable in legal terms which is akinto the UKs stamp duty on shares a robust legal

environment to discourage avoidance would becreated.

3.5.3 f

High technical feasibility is an attractivecharacteristic of a centrally collected CTT.CLS, for example, already charges a small tax of22 cents per $1,000,000 traded, which is equi-valent to a CTT of 0.000022%. A CTT of 0.005%applied through CLS could therefore piggy-backon this infrastructure, increasing the existing rateto 0.005022%.

Participating States that would call upon centralsettlement institutions such as the CLS bankcould impose a third party collection system40through the mutual mandate to those States thathave the territorial jurisdiction over the settlementinstitutions.

A centrally collected CTT, would obviously requiresignicantly more international legal arrangementsthan would the nationally collected version. Itrequires solutions for fundamental tax principlessuch as the principle of no taxation withoutrepresentation41, tax sovereignty, the practical

legal principle of territoriality in executive taxjurisdiction and the international principles of non


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discrimination and capital & trade liberalisation.However, in the view of this Committee, all thosechallenges can refer to experiences in internationaltaxation that, if applied in combination, can provide

the required solutions42.

Establishing a global levy, with revenue collectedcentrally through currently wholly private globalsettlement infrastructure, requires a high degree oftax coordination and cooperation and a design thatmeets the standards of international economic law,particularly with regards to compatibility with existinglegal liberalisation of capital and trade. The mutuallegal mandate and instruction given to the centralsettlement and payment institutions, such as CLSBank to collect the taxes for an international publicentity according to the commonly agreed design

could thereby address the risk of multiple taxation43.

As in the unilateral CTT the centralised collection ofthe multi-CTT through the (registered) payment andsettlement institutions would moreover facilitatethe compliance by the market players and assuch be an incentive since any alternative wouldbe more costly44.

On the issue of the international principles ofnon-discrimination and free trade, the multilateralCTT does not run into the legal issue of assetdiscrimination since the tax would not distinguish

according to the currency involved.The legal monopolies held by the Central banks ofthe currencies exclusively issued by those CentralBanks offer a unique international legal opportunityto combine the tax technique with the specicinternational legal dimension of the currency trade(the national currencies being the exclusive legaltender within each of the participating jurisdictions).Such strong and systemic device would frustrate,if not eliminate, geographical tax avoidance in anefcient way, comparable to the stamp duty on UK issued share transactions. It could be legally

re-enforced by the UK technique of non-enforcea-bility on non-taxed contracts, as suggested above.

3.5.4 s u

The stability of revenues from a centrallycollected CTT will be largely dependent uponthe evolution of the forex market, the robustness ofthe tax design and the degree of migration awayfrom central settlement. Migration in turn will bedetermined by the strength of the economic andregulatory forces, including central bank monito-ring, pushing in the other direction.

Assuming this balance is in favour of centralsettlement, however, this option has a number of

other positive features. First, by avoiding natio-nal collection and disbursal, a centrally collectedCTT overcomes the domestic revenue problem,which is likely to undermine the predictability of

revenues of time. Second, by being raised at thepoint of global settlement, a centrally collectedCTT appears to offer a resolution to the GlobalSolidarity Dilemma described above. Applyinga low tax to foreign exchange transactions settledcentrally overcomes the asymmetry of revenuecollection issue by linking the incidence of the taxwith weight in the global economy. Also, assumingthat nancial institutions would largely pass on theburden of the CTT to their nancial and corporatecustomers, the impact would be disbursed evenlyand market based across the global economy, but

again in proportion to economic market partici-pants engagement with it. As a result, the globaleconomy would be lightly taxed in order to pay forthe provision of global public goods, which is anappropriate means of raising this nance.

See Appendix 4 for a summary of these assess-ments in matrix form.

3.6 C c

The most appropriate source of funding forglobal public goods is the economic activityof the global economy itself, with the impact beingproportional to engagement in the internationalsystem. This can be thought of as a fee, or a levyapplied to the global economic system for thenancial benets obtained from the use of theglobal commons, with the proceeds being usedto fund the global public goods. This equates toa global responsibility for the global public goodsthat underpin the stability of the system: equi-table human development and a stable naturalenvironment. We do not recommend levying thisfee directly on all economic actors in the global

economy, but of nding a means of nancing thatwould see the costs widely disbursed throughoutthe international system, whilst making sure thatan important part of the burden is born by thosesectors that most benet and are most able tomake a contribution.

While all the options considered have value aspotential mechanisms to raise public funds, theyare not equally well suited to this particular task,which we have linked directly to the remit given tothis Committee: to identify the best potential sourceof stable innovative nance to fund international

development and environmental crisis mitigationand adaptation.


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This is crucial. The global economy cannot serveits purpose without a solid foundation of socialand environmental stability. Failure to providestable long-term nance to support this will see

development goals continue to be unmet andenvironmental change escalate alarmingly. Thisis not a recipe for long-term global stability, butfor ever-rising levels of social unrest, driven bypoverty, inequality and a rapidly deterioratingenvironment.

In the rst instance, this reasoning led us to identifythe global nancial sector as the most appropriatesource of revenues. International nance is inex-tricably linked with globalisation; it is the life-bloodof the global economy. Global economic activityand global nance have co-evolved and are highly

interdependent. Without nance globalisationwould not be what it is, but the same holds inreverse. The growth of the international nancialsystem is dependent upon globalisation.

Also, some aspects of the nancial system areintrinsically international. On balance, this isa major reason why this Committee does notrecommend general nancial transaction taxes(FTTs), taxes on nancial prots and remune-ration (FATs), or an extension of sales taxes tothe nancial sector (VAT). While each of theseproposals has merits, especially for domesticfunding, we do not nd them well suited to thetask of resolving the global solidarity dilemmaand nancing global public goods. While all haveinternational components, none are purely globaland all would draw upon nancial activity atthe national level signicantly. As a result, theyare both subject to the asymmetric revenuecollection problem, and the domestic revenueproblem.

In the view of this Committee, the foreign exchangemarket,

Documents

Report of the Committee of Experts to the Taskforce on International Financial Transactions and Development