18th April 2011
Ministry of Finance of the CzechRepublic
Contribution to the consultation on financial sector taxation
The Ministry of Finance of the CzechRepublic would like to thank the Commission for the opportunity to contribute to the discussion on financial sector taxation. At the same time we would like to emphasize that our comments should be viewed as initial and indicative only and are not meant as our final official policy position on the issue.
Generally, the CzechRepublic does not support the introduction of sector-specific taxes as suggested in the consultation document. We are of the view that before further steps are taken the suggested tax measures should be subject to in-depth analyses and impact assessments taking into account specific nature and business models of the financial sector. We would like to emphasize the importance of the sound financial sector for the economic development of the EU and its Member States and the global context of a potential unilateral decision to introduce financial-sector taxesthat could hamper the global competitiveness of the EU. Below we provide a brief recapitulation of our views on the issue.
1. Rationale for financial sector taxation
We consider that financial sector taxation to be justifiable only on the grounds of fiscal sovereignty of each state. Government of any state may decide to impose a sector-specific tax or any other tax measure and such a decision always lies fully inthe discretion of the country.Likewisein the EU, Member States retained high level of independence andthe principle of unanimity must be followed in tax harmonizationprocedures.To conclude, we believe that the ways to achieve the objective of fiscal consolidation is in the discretion of individual governments who are responsible to find out most suitable solutions for the individual specific economies.
Financial sector is without doubts an appropriate object of taxation. Financial institutionshave an enormous capacity to pay and are alleged to achieve outstanding returns. Financial sector is also very concentrated, which is a convenient situation in view of tax administration costs as there could be a relatively low number of taxpayers.
On the other hand, specific nature of the financial sectorhas to be taken into account, in particular following factors:
-Strict prudential regulation of the financial sector activities which will be further strengthened in the near future
-Special character of financial products (e.g. different risk profiles or mutual substitutability)
-Significant market sensitivity to the changes in relative prices of financial products
-Necessity and irreplaceabilityof financial services for real economy (e. g. credit market, money and capital markets, payment and settlement systems)
-Uncertainty regarding the final tax incidence
-International character and interconnectedness of the financial sector highlighting the issues of double taxation,tax competition concerns and easy transfer of market infrastructure and business abroad.
These aspects make a potential decision on the introduction of a specific financial sector tax to be very complex and risky.
Regarding overtaxation or undertaxation of the financial sector, we believe that this issue demands an in-depth empirical analysis. Generally, financial institutions are not treated in a significantly different way from other companies (with some exceptions related to national fiscal policies). VAT exemption of financial services in the EU could be viewed as a problem causing undertaxation. However, unlike other taxpayers, the amount of input VAT paid by financial institutions is not recoverable offsetting the imbalance, thus the overall results remain unclear.Moreover, considerations of appropriate level of taxation of a specific sector should take into account a number of factors; i.e. among others: implicit public subsidies (e.g. guarantees and lender of last resort facilities that allow to increase ROE by higher leverage), public goods provided by the sector (efficient financial intermediation and risk management services)and public bads (pro-cyclical nature of lending increases GDP swings). These are many (the above is by far not an exhaustive list), uncertain and complexly interrelated. Therefore any claim of alleged over/undertaxation of a specific segment is likely to be rather premature.
We have difficulties with the argument to impose taxes on the grounds of the retrospective responsibility of financial institutions for costs of the financial crisis. We consider the approach to be unsystematic and inconsistent with desirable objectives of tax policies. As a less important technical consideration, it should be noted that given the complexity of the financial sector it may be rather difficult to attribute the significance of undesirable behavior to individual institutions in order to assure for some minimal level of taxation fairness.
As a result of previous discussions, two objectives of financial sector taxation have been articulated:
-corrective objective (a Pigouvian tax approach) and
-fiscal objective.
We remain unconvinced as regards the correction of market failures and negative externalities in the financial sector through tax measures. Such correction could be efficient in case of systematic market failures, which could be sufficiently and transparently addressed through a simple change in relative prices of goods. Irrespective other reasons for rejection (Please see the paragraph on the FTT) the alleged excess of speculative transactions on financial markets may be the case. However, fine-tuning of risk profiles of financial institutions or complex rent-taxing approach demands very complicated tax measures with very high compliance and administrative costs. Compared with direct (and more precise and better targeted) regulation of the financial sector we do not expect any substantial positive outcome from adopting a FTT ora FAT in context of influencing the risk profile of financial institutions.On the contrary, we are afraid of unnecessary overlaps. At the same time we have worries about cumulative effects of the suggested tax measures and future regulatory framework. We would rather continue in the efforts on a number of measures that may help to prevent the financial sector from growing too big and thus the employment from becoming excessive by treating the risks of financial system more appropriately, in particular:
-dealing with procyclicity of regulation
-better supervision and micro/macroprudential regulation
We are of the view that, considerations of optimal size of any sector should be only of secondary importance rather than a part of implicit policy targeting. Relative sector size, employment, and qualified labor allocation should be primarily result of market processes and driven by demand and supply conditions.
In general,the fiscal objective of taxation cannot be challenged. Moreover, the financial sector is a very promising object in this respect. However, the aforementioned specific factors of the financial sector and potential impacts of particular tax measures should be borne in mind and considered carefully. The reason is that overall social costsof taxation can easily offset oreven exceed actual tax revenues, e. g. the case of the FTT in Sweden in 1980s. Even if it could be argued that better tax policy design and implementation in case of Sweden might have mitigated some of the inefficiencies, the argument in favor of FTT is still far from certain. For example the cases of the UK and Switzerland need to be considered in the context of the specific nature of those financial markets thatbelong to major global financial centers.
2. Financial transaction tax
First of all we have to stress that we do not support the FTTintroduction in any of thesuggested forms. We consider the FTT to have very distortive effects on financial markets and believe that the FTT will not be an effective measure of taxation of the financial sectorbecause of the specific nature of financial instruments and markets. Generally, the FTT could incentivize tax and regulatory arbitrage resulting in yet another increase in shadow financial activities and products. As a result, the FTT may hamper feasibility and effectiveness of regulation, supervision and micro/macroprudential measures.
Below you may find some of our insights on principal elements of the FTT.
2.1. The level of introduction
Regarding the level of introduction, we are of the view that in case the FTT is intended to generate a relatively significant amount of income, it could work only if introduced globally in order to prevent tax evasionas much as possible. However, so far we haven’t seen any international agreement on the issue and we are very concerned about tax competition issues in case the FTT would be introduced in the EU only. In this respect the competiveness of the whole financial sector in the EU could be at stake.
In case the FTT is intended to generate relatively insignificant revenues, with a low tax rate or a narrow scope of taxation, we admit that the relocation incentives would be limited. In some countries such a tax is levied (the UK, Switzerland). In this respect we would like to point out that the discretion of states is desirable and any harmonization is neither legitimate nor practical as it needs to be pointed out again that the UK and Switzerland enjoy the power to tax financial markets that are among major global financial centers.
2.2. Atax base of the FTT
A broad based FTT is potentially the best solution as it provides an opportunity for maximization of income and minimization of a tax rate.
On the other hand there are shortcomings of this form of the FTT.
-An implicit need to differentiate tax rates or bases (currency, derivatives, securities) creates very distortive market conditions as financial instruments can be very easily substituted by other forms of financial instruments.
-If implemented at the EU/national level only, tax competition issues will become of the utmost importance.
Regarding a narrow based FTT we think that it distorts relative prices of financial instruments, which could incentivize tax arbitrage with highly negative effects, e.g. a tax on transactions with stocks only could result in the state where derivative markets take over price-making function at the expense of the stock exchange markets.Moreover, we think that a narrow based FTT with a moderate tax rate does not have a potential to generate a significant amount of tax revenue. It could be rather used as a complementary tax measure.
2.3. A connecting factor for the place of levying
We are of the view that there is no simple answer to this question.
a) The place of trading or settlement could be an easy platform to administrate the collection. On the other hand:
-Such a place would be significantly disadvantaged as the transactions could be easily relocated to another jurisdiction.
-Revenues would be distributed within jurisdictions asymmetrically, which is not desirable as traders could be from different parts of the world without any connection to the place of the transaction.
-The variability of trading platforms should be born in mind, because different financial instruments are traded in different ways (stock exchanges, OTC markets, foreign exchange market). This fact could have major negative implications for the simplicity of tax collection.
b) The place where the buyer or sellerare established.
This approach raises significant tax collection issues, because traders mayoften be subject to different jurisdictions. Such a system could demand an inconceivable information sharing system among particular jurisdictions, if the FTT would have been collected in the country of residence.
c) The place where the initial issuer is established.
Regardless the fact that such a feature of financial instrumentscould be missing in some cases, this approach could lead to the tax arbitrage taking an advantage of securities which will be issued in non-taxed jurisdictions but will be issued as a derivative on underlying taxed assets. Consequently, these securities could be traded in jurisdictions with the FTT introduced without the tax being imposed.
d) The place where the financial intermediary is established.
In this case, it needs to be noted that the financial intermediary is not always a necessary party in financial transactions. The arguments from the paragraph b) could be also applied.
2.4. Tax incidence
In case customers of financial intermediaries trade on their own accounts, it is clear that the FTT will become a part of their costs.
If financial intermediaries trade on their own accounts, thecosts connected with the FTT (an amount of paid tax, administrative costs) will be distributed among:
-users of financial services
-creditors
-shareholders
-tax authorities (through a decrease in other tax revenues)
The degree of redistribution of costs depends on the structure of particular national financial markets (e.g. the level of competition within the financial market, the structure of the consumption of financial services, the level of importance of financial services for real economy).
Though the primary objective is to restrict speculative trading activities, we think that hedging would eventually be impaired as well. The reason is that it is difficult to draw a clear line between speculative transactions and hedging. These increased costs will be borne by users of these services. E.g. treatment of derivatives can make it more difficult for some corporations to hedge risks associated with international trade and thus harm the global division of labor and consequently the economic output.
We further note that the FTT could raise costs of asset management services (e.g. pension funds or collective investment funds management fees or life insurance). These institutions will probably shift the costs to their customers.
2.5. Conclusions on positives and negatives
To conclude, we are of the view that potential benefits of the introduction of the FTT are low in comparison with related shortcomings.
Positives of the FTT
-Relatively easy to introduce and administrate (depending on a final form of the introduction)
-The FTT could raise significant revenues
Negatives of the FTT
-International tax competition issues with respect tonon-taxed markets jurisdictions
-Negative effects on the liquidity of financial markets and asset prices
-Potential effectson the volatility of assets remain unclear
-An unclear effect on the extent of speculative trading
-The FTT could create tax evasion incentives and distort relative prices of financial instruments
-Cumulative effects of the FTT and the financial sector regulation
-Increased costs of hedging transactions and asset management services
-Variability of trading platforms makes tax administration and collection to be more difficult
-Concentration of revenue in a few financial centers
-Financial institutions could shift a substantial part of their FTT-related costs to other subjects
3. Financial activities tax
Regarding the FAT introduction, we think that discussions have got stuck at an early stage without any noticeable progress. Only essential elements of the tax have been clearly presented so far. More detailed considerations on tax structure and impact assessment are thus needed in order to make an advance in the debate. We are of the view that attention should be paid to following matters:
-A complex empirical analysis and evidence on over/under taxation of the financial sector
-Context with the current VAT system in the EU as regards the exemption of financial services
-Potential effects of the FAT introduction on competitiveness of the EU financial sector as we consider that the efforts to introduce the FAT are mainly limited to the EU
We are of the view that the FAT should not be introduced without a proper analysis of above suggested issues. In our opinion the FAT needs to be properly aligned with the specific features of a particular national tax system including the VAT. Of course, Member States may introduce the FAT individually if they wish to do so.As the tax base of the addition method FAT is very similar to the tax base of income taxeswe do not think that it could represent significant barriers to the internal market. Thus, harmonization is not necessary in this context.
At the international level we do not see a scope for an agreement on the FAT introduction as a result of quite different tax systems and different tax policies.
For the moment, we consider the addition method FATto be the most suitable version of the FAT. The reasons are as follows:
-The version is relatively easy to introduce, administrate and collect
-It has no ambitions to regulate risk-taking
-The version could be compatible with the current or future VAT system
At the same time we have to emphasize that results of suggested analyses could provide arguments to reject this position.
We noted the suggestion that the state of the head office or group headquarters may tax on the basis of consolidate statements. In this context we have to emphasize, that applicable rules which could be easily adapted are already in place (e.g. the rules on permanent establishment or transfer pricing rules).In each case primary taxation rights must be inevitably left to the state where an income was created.
Regarding the industry scope, it would be a mistake to encompass strictly only the banking sector. The financial sector level playing field could be significantly hampered. Moreover, we see no legitimate reason to exclude other subjects from thefinancial sector, in particular whether it is argued for the FAT in the context of the VAT exemptions. The argument of the responsibility for the crisis was refused above.
As we noted above we are sceptical about intentions to regulate the risk-taking behavior of financial institutions through taxation. For that reason we consider the risk-taxing FAT to overlap relevantprudential rules and thus creating unnecessary administrative costs without corresponding benefit.
We consider that the rent-taxing FAT is not a suitable concept as long as the question of determination of the rents has not been resolved. The methods that have been suggested so far are rather subjective and lacking legal certainty. Moreover, it is not clear, why should be the rents in the banking/financial sector taxed exclusively. In case a suitable method of determination of the rents is developed, there is no reason to exclude other sectors.To conclude, we are of the view that the rent-taxing FAT is not a viable solution not only for the presence but also for the future, as a robust and objective method of determination of rents which could be easy to applyis probably unfeasible to be developed.
Thecosts associated with the FAT (an amount of tax paid, administrative costs) will be (as similar to the FTT) distributed among:
-users of financial services
-creditors
-shareholders