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COMMENT: France’s decision to unilaterally tax financial transactions is a risk, but one worth taking

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French President Nicolas Sarkozy has followed through with his promise to go it alone with a financial transactions tax (FTT). The announcement has already hit shares in the banking sector, but France should weather the short-term pain to see long-term gain.

In a move that has drawn sharp criticism from French banks, which fear being placed at a competitive disadvantage when no other country has introduced a FTT, a 0.1% tax will be placed on financial transactions from August.

Banks are right to be worried that France has jumped the European Commission’s gun, and the decision to move on a FTT when many other countries, most notably the UK, are unlikely to follow suit, could well cause transactions to be moved abroad.

Sarkozy’s decision is a bold one, however, and though a risky political gamble, it is a necessary one.

There is a widespread perception that the financial sector is undertaxed and, whether or not this is the case, its role in the global economic turmoil of the last few years and the hefty bailouts it has received mean it certainly owes a debt to the public purse. But perhaps more importantly, governments simply need the money, a fact that led the Commission to change its mind in pressing for an EU FTT when it realised agreement could not be reached to implement the tax globally.

France has gone one step further, but its move could spur other countries to jump on board.

“What we want to do is provoke a shock, to set an example,” Sarkozy said.

Germany, which has been almost as vocal as France in its support for a FTT, is the most likely country to stick its head above the parapet next. Meanwhile the new Italian Prime Minister, Mario Monti, himself a student of James Tobin, the man who first thought up the then niche and radical concept of a FTT, is likely to be emboldened by Sarkozy’s decision.

In the short-term, the FTT may have a negative impact on the French economy as banks move transactions abroad, but if Sarkozy’s gamble pays off and the FTT is rolled out across Europe and to other countries, it has the potential to raise vast sums with a miniscule rate because the base is so large.

The flipside is that no matter how many countries introduce the FTT, it is likely to reduce the total volume of transactions. While this is unavoidable, however, it may actually be a blessing in disguise. Taxes do not just exist to raise revenue. In much the same way as taxes are imposed on alcohol and tobacco to encourage people to consume less, the FTT could be used to constrain risky behaviour and curtail the kind of high-frequency trading which serves no social purpose and undermines markets.

The FTT, once the preserve of socialists, radical academics and development activists, has arrived in the mainstream. If nothing else, Sarkozy’s move has proved it can no longer be ignored. It remains untested in practice, and as many of its effects, positive or negative, remain to be seen, the world will be watching the French experiment closely.

For an exclusive interview with Manfred Bergmann, follow www.internationaltaxreview.com this week.

Further reading:

Should France go it alone with a Tobin tax?

Ten things you need to know about the EU financial transactions tax

Why EU FTT hitting cross-border transactions might not be so bad

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