The Case Against the Financial Transaction Tax
by John Lee Von Leon
“This piece examines the arguments against the financial transaction tax and its implications on an emerging market country, Malaysia.”
It is said there are two things certain in life: death and taxes; but, at least death doesn’t repeat itself the way a financial transaction tax (FTT) would. In the wake of seething anger over the role financial market players played during the recent Global Financial Crisis, one economist, Jared Bernstein went so far as to say, “…. (The FTT) is a smart, fair way to raise urgently needed revenues while reducing unnecessary trading” and present several arguments touting the benefits of the tax while sneakily understating its negative effects. In this essay, I will be zooming in on one such argument and in light of space constraints, only equities trading. In what follows, I will briefly explain what FTT is, present Malaysia’s current FTT practices called the stamp duty, examine a claim that the FTT promotes market stability and analyse the potential effects of an abolishment of the said FTT on its main stakeholders.
The financial transaction tax is a levy imposed on the purchase/sale/transfer of financial instruments. Malaysia is in the list of 40+ countries (Beitler, 2010) who had already long implemented the FTT and her FTT regime is quite competitive when benchmarked against fellow adoptees. Malaysia’s The Bursa Malaysia, Malaysia’s exchange marketplace charges a stamp duty fee of 0.1% (among others) for equities trading payable by both buyer and seller (effective 0.2%). For comparison sake, Singapore charges a rate of 0.2%, Indonesia: 0.1%, South Korea:0.3%, Switzerland: 0.15% and UK: 0.5% (Leonard E. Burman, 2015).
Proponents of the FTT argue that the tax promotes market stability by curbing excessive speculation particularly those of the High Frequency Trading (HFT) variety, evidenced by the high trading volumes in recent times. Bernstein, for example, charges that “… it (HFT) does nothing to help ordinary investors and can destabilize financial markets. Yet, the reality is that the high transaction volumes in recent times reflect the liquidity necessary for the price discovery process (process by which a given asset value is established in a market through trading) and, hence, for “… facilitating and smoothing the movements of asset prices towards their fundamental equilibria” (Schulmeister, 2009). Ironically, it can be argued that the practice of high frequency trading often so demonised, actually promotes market stability by reducing price volatility i.e. any errors in pricing are short lived as markets adjust/align prices the values as per information available in the market, a fact agreed by Habermeier and Kirilenko (Habermeier, 2001). In fact, Bursa Malaysia had just recently welcomed HFT into its fold in 2011 with even its chief executive officer gushing over the potential liquidity benefits that it brings to the market. Since its (HFT) introduction, market capitalisation and trading velocity (measures for liquidity) has grown from RM1.46tril and 28% respectively in 2012 to RM1.65tril and 29.5% by year ending 2014- arguably in large part due to the introduction of HFT (Bursa Malaysia Berhad, 2014, p. 14). As with many things in life, it is at the extremities that matters become dangerously harmful and to expect to cure “excessive speculation” by painting all speculating activities like HFT as deleterious and then bandying around the FTT as a solution would prove disingenuous.
Next, we’ll examine the effect of an abolishment (technically exemption) of stamp duties on equity trading for both investors and the government, its two main stakeholders. Needless to say (for interest of space), the lowered transaction costs (i.e. cost of doing business) would greatly benefit investors particularly foreign investors from FTT-adoptee-nations in search of investing opportunities. One example of that is 1990s Sweden. Trading volume in Sweden increased for almost all equities in 1992 by the tune of about 56 percent when the tax was abolished in 1991 on the back of a disappointing revenue collection due to widespread tax-avoiding behaviour by the investing community (Habermeier, 2001). While the same magnitude might not be observed due difference in size, nature and complexity of the economies of the two countries, nevertheless a rise in trading volume and investor quality (generally developed nations which make up the majority of 40 countries with FTT) can be expected. More interestingly is what’s at stake for the government. Annually, the government collects RM7b from stamp duties that are culled from a variety of sources ranging from stamp duty on leases, sale and purchase all the way to even those collected by Bursa Malaysia’s stock exchange (Ministry of Finance Malaysia). On a market of Malaysia’s size that has transaction value of RM789 billion traded yearly and at the current rate of 0.2% combined for buyers and sellers, the government stands to lose more than RM1.6bil (a mere 0.7% of total revenue) if the tax was lifted on equity trading (Bursa Malaysia Berhad, 2014). Revenue loss would be a drop in the ocean compared to the benefits as seen by the Swedish experience i.e. increased trading volume and investor quality. To add further motivation, the government of Malaysia through the Economic Transformation Program had set a target of increasing Bursa Malaysia’s market capitalisation and trading velocity to RM3.9 trillion and to 60% respectively by 2020 (Economic Transformation Program). We are lagging far behind our desired targets with less than 5 years remaining and one effective way to boost that would be to exempt stocks from the unfair levy of the FTT.
In conclusion, in light of the arguments presented above, I hope I have made the case that it would be more sensible to no longer tax equities trading. Malaysia stands to gain more in terms of improving market liquidity, price discovery process, and trading volume while sacrificing little in terms of revenue if she were to exempt stamp duties on equities trading. However, as policymakers. Caution is to be still observed. Unintended consequences are a hazard of our jobs and hence further research will greatly help in deciding if abolishing the tax is a wise decision.
“ The author is a Supervisor at the Central Bank of Malaysia and is co-author of ‘Redefining Success: Learning to Lead for Change’. The opinions expressed in this article are the author’s own and do not reflect the view of the Central Bank of Malaysia and the Government of Malaysia.”