By Maximilian Clarke

As support for a tax on financial transactions grows, a leading libertarian think-tank have today (Friday) warned of its ‘eye watering’ effects that would effectively destroy the UK’s financial heart as well as increasing market volatility.

In theory, the tax would skim a small (often cited as 0.7%) tax from each financial transaction, and not from the institutions themselves. The result, advocates argue, would be a decrease in risky and excessive speculative trading that would generate billions for the treasury at a time of need. Popular versions include the ‘Robin Hood Tax’ and the Tobin Tax.

Financial Transactions Taxes (FTT) are a unifying theme across many of the Occupation protests spreading throughout the world's cities, and its proponents include numerous MPs from all sides of the political spectrum as well as celebrities and thinkers, including Bill Nighy, Sienna Miller, as well as Archbishops Rowan Williams and Desmond Tutu and even Bill Gates.

But the report, carried out by Adam Smith Institute (ASI), highlights the devastation it would wreak on the the UK's lucrative service sector and questions the validity of estimates of the revenue it would bring.

Writing on the institute's blog today, Adam Baldwin and Sam Bowman summarise the report's key findings:

1) The European Commission has proposed a Financial Transaction Tax (FTT) on all securities traded with at least one party within the European Union. A tax of 0.1% would be applied to shares and bonds trades and 0.01% to derivatives trades, including over-the-counter derivatives, of which London is a world centre.

2) The EC’s impact assessment projects a 1.76% hit to long-term (20-year) growth across the EU. This would amount to a £25.58 billion cost to the UK economy over this period, and a £185 billion cost to the total European Union economy (2010 prices). This is based on a direct application of the cost to Britain’s economy. The true figure is likely to be far greater, because of Britain’s disproportionately large financial sector (and especially its derivatives trading sector).

3) The EC impact assessment also projects up to a 90% decline in derivatives trading if its proposed Financial Transaction Tax is implemented. The City of London is the centre of global over-the-counter derivatives trading, accounting for nearly half (45.8%) of all global interest rates derivatives turnover. This would adversely and disproportionately hurt the London economy, and would destroy a socially-valuable financial activity that it integral to the modern British economy.

4) Contrary to some supporters of the FTT, the tax would increase market volatility. There is no empirical support for the idea that the FTT would reduce volatility. Indeed, by making transactions more costly, the tax would make markets less responsive to new information and more prone to violent lurches up and down. Academic models of the tax have been inconclusive at best.

5) The FTT would reduce market liquidity in all securities markets. 40% of the London Stock Exchange’s volume is based on high-volume, low-margin transactions, which would be wiped out by the FTT, making markets far more illiquid. Markets’ ability to incorporate new information into asset prices would be undermined.

6) Unemployment would rise if an FTT was introduced. At the margin, the FTT would mean less investment and less output. The tax, if implemented in 2014 as proposed by the EC, would slow down an economic recovery and reduce capital investment. The EC’s long-run projection for this is a 4.5% reduction in investment.

7) If the FTT was only introduced in the EU or G20, many traders currently operating in the UK would relocate to places like Hong Kong, Singapore or Zurich. There is little scope for a worldwide FTT — even types of trades that are affected in a minor way by the FTT would likely move en masse to other jurisdictions that would flourish as FTT-free zones.

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